C.P.M.

STUDY GUIDE
Seventh Edition 2000
ISM Certified Purchasing Manager Program

Edited by:
Alan R. Raedels, Ph.D., C.P.M. Associate Editors:
Lee Buddress, Ph.D., C.P.M. Carolyn Gordon, C.P.M., A.P.P. Gene Keel, C.P.M. Carla Lallatin, C.P.M. Eugene W. Muller, Ed.D. Scott R. Sturzl, C.P.M., A.P.P.

Published by: Institute for Supply Management , Inc.

Published by: Institute for Supply Management , Inc. Paul Novak, C.P.M., A.P.P., Chief Executive Officer

2001 Institute for Supply Management , Inc. 2055 East Centennial Circle P.0. Box 22160 Tempe AZ 85285-2160 USA All rights reserved. No part of this publication may be reproduced without written permission from the Institute for Supply Management , Inc.

Purpose of the Study Guide

The C.P.M. Study Guide is a general overview of the material covered in the C.P.M. examination. It is meant to provide the candidate with an introduction to the major topics covered in the test, and to provide direction for further study. The Guide is constructed according to the C.P.M. test specifications. Therefore, the Guide largely mirrors the material covered in the C.P.M. exam. While the Guide provides a good overview of the types of material covered on the C.P.M. exam, the candidate should be aware that the Study Guide is NOT meant to serve as a substitute for any of the major textbooks in the field of purchasing. Candidates are strongly urged to read at least one of the major purchasing texts in addition to the Study Guide when preparing for the C.P.M. exam. Reading the Study Guide alone, without any other resources, is not considered to be sufficient preparation for the C.P.M. exam. Also, please be aware that the actual exam may contain material that is not necessarily covered in the Study Guide.

Editor
Alan R. Raedels, Ph.D., C.P.M., Professor of Supply and Logistics Management at Portland State University, holds a B.S.M.E. from Colorado State University, an M.B.A. from Portland State University, and a doctorate from Purdue University. He has taught courses in a variety of areas including purchasing, materials management, production/operations management, and quality control. Dr. Raedels has taught seminars on a variety of supply and operations management topics including Certified Purchasing Management Review Courses; consulted in the areas of purchasing, distribution, and inventory control systems; published in a variety of journals including The Journal of Purchasing and Materials Management and NAPM Insights; and is author of the book Value-Focused Supply Management. Dr. Raedels has been active in ISM as former District XI Director, Vice-Chair of the Business Survey Advisory Committee, and Chair of the Educational Resources Committee; in the NAPMOregon affiliate in a variety of roles including Affiliate President, and Chairman of the NAPMOregon Business Survey Committee since 1984; administers the National Association of Educational Buyers Market Index survey; and is the 1999 recipient of ISM's highest award, the J. Shipman Gold Medal.

Associate Editors
Lee Buddress, Ph.D., C.P.M., is Co-Director of the Supply and Logistics Management Program at Portland State University. He holds a B.S. in Operations Management and Economics from the University of California at Berkeley and a Ph.D. from Michigan State University in Purchasing and Supply Management with minors in logistics and international business. He teaches courses in purchasing and supply management, operations and quality management, production planning and control, transportation and logistics, and negotiations. His 20 years of industrial experience in operations and supply and logistics management provide the foundation for his research interests in these fields and in forecasting. He is active in ISM at the local and national levels as well as several other professional associations. He has received numerous awards for his contributions to the operations and purchasing professions. He consults and speaks internationally. Carolyn Gordon, C.P.M., A.P.P., was a Senior Commodity Specialist with Sabre, Inc. Carolyn previously was a contract administrator for ATU Telecommunications in Anchorage, Alaska, and professional-development chair for NAPM District XI. Carolyn was also Chair of the NAPM Professional Development Committee. Gene Keel, C.P.M., is a retired U.S. Defense Department agency executive with 30 years purchasing and contract administration experience in international, national, federal, and local government areas. He is currently the contracts administrator for Charleston County government in Charleston, SC, and is adjunct professor of management at the Charleston campus of Southern Wesleyan University teaching courses in management and international business. He is a lifetime Certified Purchasing Manager having received his original certification in 1984. He has a B.B.A. in Marketing from the University of Georgia and an M.B.A., magna cum laude, from Dallas Baptist University in Dallas, Texas.

Carla S. Lallatin, C.P.M., CPPO, directs a consulting firm, Lallatin & Associates, whose mission is to promote the understanding and improvement of purchasers and supplier. Previously vice president of Dun & Bradstreets BidNet, Lallatin has over 25 years experience in all phases of purchasing and materials management. Her background in executive purchasing management includes D&B, United Computing Systems, Inc., the City of New York, and the state of Wyoming, giving her unique insights into both commercial and public sector procurement. She was one of the five original members of New York Citys Procurement Policy Board and is an advisor to the current Board. She serves as adjunct faculty at New York University and is a frequent lecturer at the University of Texas. In addition, she spends several days each month conducting lectures and seminars. Lallatin has chaired ISMs Educational Advisory Committee and is a member of its C.P.M. Item Writing Committee. She served as program chair for NAPMs 1997 International Conference and is past president of NAPMNY. She is author of NIGPs textbook Public Purchasing and Materials Management, and developed a self-study workbook for the Czech Republic to use in implementing its new procurement law and making the transition from government-owned suppliers to privately held companies. She is an honorary member of NIGP and NASPO, and has served on the boards of both organizations as well as on McGraw-Hills Editorial Advisory Board, the Government Advisory Council on Printing, Federal Surplus Property Advisory Committee, U.S. Minority Business Development Advisory Committee, and the Federal, State, Local Panel on Procurement and Supply. Lallatin has lectured and conducted seminars throughout North America, and her writings and training materials have been published and used extensively in both industry and government. She actively contributed to the development of the ABA Model Procurement Code for State and Local Governments and participated in the revision of OMB Circular A-102. In 1995, Lallatin received NAPM District VIIIs highest honor, the Erlicher Award. She has been named Woman of the Year by the American Business Womens Association, and received awards of merit and excellence from the International Association of Business Communicators. Eugene W. Muller, Ed.D., is an industrial psychologist for ISM. Dr. Muller is the developer of the C.P.M. and A.P.P. examinations, and the computer-based C.P.M. and A.P.P. examinations. He is also the developer of SkillQuest for ISM and is a consultant to ISM on other testrelated matters. Dr. Muller is the editor of the C.P.M. Diagnostic Kit (2nd edition) and author of a number of articles appearing in Purchasing Today magazine and the Journal of Purchasing and Materials Management. He received two Masters degrees and his Ed.D. from Columbia University. Scott R. Sturzl, C.P.M., A.P.P., is the Vice President of Certification for ISM. He received his B.S. from Arizona State University and his M.A. from the University of Phoenix. Mr. Sturzl directs and manages the national and international C.P.M. and A.P.P. program efforts for ISM. He served many years as manager of purchasing for US West

Contributing Authors
R. Jerry Baker, C.P.M., is currently a member of the Shoreline Community College faculty in Seattle, WA, where he teaches purchasing management, materials management, contract administration, and other business administration courses. Previously, he taught marketing, purchasing, and production at Elizabethtown College, Penn State University, Shoreline College, Edmonds College, and Arizona State University. He is the author of three reference books and numerous articles about purchasing, e-commerce, and inventory control. Mr. Baker was the Executive Vice President for NAPM for 18 years, retiring in 1998. He was the 1997 recipient of the J. Shipman Gold Medal awarded by NAPM for unselfish, sincere, and persistent effort toward the cause and advancement of purchasing and materials management. He also received the Arizona State University College of Business 1997 Distinguished Achievement Award. He earned a B.A. from Western Washington University and an M.B.A. from the University of Michigan at Ann Arbor. Alan M. Cabelly, Ph.D., SPHR, Professor of Business Administration at Portland State University, holds a Ph.D. from the University of Washington, an M.B.A. from The Pennsylvania State University, and a B.A. from the State University of New York at Stony Brook. He has taught courses in most of the distinct Human Resource Management areas at the undergraduate, graduate, and executive levels, and has taught professional development seminars to many diverse groups in high tech, service, manufacturing, public, and private sectors, both nationally and internationally. Dr. Cabelly has served on both the Society for Human Resource Management (SHRM) Area V and the Northwest Human Resource Management Association (NHRMA) Boards as their College Relations Directors. He also serves on the SHRM College Relations Committee, was part of the founding group that brought the Human Resource Collegiate Competition to fruition at SHRM 2000, earned the Human Resources Award of Excellence from the Portland Chapter of SHRM, and was named Distinguished Member of NHRMA in 1997. Joseph R. Carter, D.B.A. C.P.M., is University Professor of Supply Management, the Institute for Supply Management Professor in the College of Business Administration and Chair of the Supply Chain Management Department at Arizona State University. Dr. Carter holds a D.B.A. in Operations Management from the Boston University Graduate School of Management. His major research interests are supplier quality management, buyer and supplier communication systems, and international supply chain management systems. Dr. Carter has received many academic and professional awards, and has been involved in several research projects sponsored by ISM, the U.S. government, and CAPS Research, an affiliation between Arizona State University and ISM. Dr. Carter has published numerous articles as well as several case studies that are used as teaching instruments by some of the top business schools in the United States and abroad, such as Electronic Data Interchange: Implementation in a Purchasing Environment, Supplier Bar Coding: Closing The EDI Loop, Purchasing and Materials Managements Role in Total Quality Management and Customer Satisfaction, Purchasing and Supply Management: Future Directions and Trends and Purchasing: Continued Improvement Through Integration, The Future of Purchasing & Supply: A Five- and Ten-year Forecast, and Environmental Supply Chain Management. Dr. Carter is the founder and co-director of the Global Supply Chain Management Seminar, a hallmark of executive education for Arizona State University.

Lawrence Clark. C.P.M., is purchasing manager of Burleigh Instruments, Inc. Fishers, NY, a manufacturer of high technology scientific instrumentation and equipment. Mr. Clark was part of a value analysis (VA) team that was cited in Purchasing magazines VA contest, and which was written about in the December 1993 issue of NAPM Insights. He is active in NAPM Rochester having served as educational chair, vice-president, and president. In 1993, Mr. Clark was named Pro-D Person of the Year for his work in developing and teaching seminars for the purchasing profession. Mr. Clark has conducted several seminars and training sessions, including C.P.M. review classes. He has also presented two papers on value analysis, as well as writing several articles and editing a chapter for the latest edition of The Purchasing Handbook, published by McGraw-Hill. Mr. Clark holds an M.S. from the State University of NY at Oswego. Lisa Ellram, Ph.D., C.P.M., A.P.P., C.P.A., C.M.A., is an Associate Professor of Purchasing and Logistics Management at Arizona State University, where she teaches supply chain management and operations management courses. She has a B.S.B. in Accounting and an M.B.A. from the University of Minnesota, and a Ph.D. in business logistics with a minor in industrial engineering from The Ohio State University. Dr. Ellrams research has been published or is forthcoming in a number of journals, including The International Journal of Purchasing and Materials Management, The International Journal of Physical Distribution and Logistics Management, The International Journal of Logistics Management, Management Decision, Purchasing Today , and The Journal of Business Logistics. She won the Anderson Consulting Award with co-author Martha C. Cooper for the best paper published in The International Journal of Logistics Management in 1990. She is co-author of Purchasing for Bottom Line Impact (Irwin Professional Publishers 1995) and Fundamentals of Logistics Management (Irwin 1998), as well several CAPS focus studies. Dr. Ellram has taught seminars around the world and her research, teaching, and consulting interests include supply chain management; purchaser-supplier relationships, including alliances; and strategic cost management, including cost/price analysis, total cost of ownership, and target costing. Christina Foster, SPHR, is the Vice-President of Diversity for ISM. This is a newly created position that will primarily focus on increasing minority and women participation in the purchasing field. She received her M.B.A. from the University of Phoenix and her undergraduate degree from Indiana University. She also has her certification as a Senior Professional in Human Resources. Larry C. Giunipero, Ph.D., C.P.M., A.P.P., is ISM Professor of Purchasing/Supply Management within the Marketing Department of Florida State University. His primary teaching assignments are in the purchasing and supply chain management areas, as well as distribution/channel management, and business marketing and sales management. Dr. Giunipero has a Ph.D. from Michigan State University in Business, an M.A. in Accounting from Ball State University, and a B.S. from Purdue University in Industrial Management /Industrial Engineering. Previously employed by Westinghouse Electric Corporation in the Purchasing Department, he has served as a consultant to several major corporations and conducts various seminars nationally in the purchasing and supply chain management area. He is also the director for a week long executive management program entitled Developing Excellence in Purchasing Management. Dr. Giuniperos research has been published in several journals, including the International Journal of Purchasing and Materials Management, Sloan Management Review, Industrial Marketing Management, International Journal of Logistics, International Journal

of Physical Distribution & Logistics, and Electronic Buyers News. He is also the co-author of two textbooks: Purchasing Principles and Applications and Purchasing Internationally: Concepts and Principles. Mary Lu Harding, C.P.M., CPIM, CIRM, is a principal of Harding & Associates, specializing in consulting and education in materials management. She has over 10 years experience in purchasing management with Digital Equipment Corporation and Picker Corporation, as well as 12 years of experience as an educator in purchasing, materials, and cost management. She co-authored the textbook Purchasing (Barrons Press) as well as a video on systems contracting. She has served on ISMs C.P.M. Item Writing Committee and Educational Advisory Committee, and as President and DNA of NAPMVermont. Mary Lu holds a B.A. in Chemistry from the University of St. Thomas and an M.A. in Biochemistry from the University of Texas. Ralph G. Kauffman, Ph.D., C.P.M., is Assistant Professor of Management and Coordinator of the Purchasing and Supply Management Program at the University of Houston-Downtown. Prior to entering academia he had over 27 years of purchasing and supply management experience with Oryx Energy Company and Sun Company, including Manager, Procurement and Materials Management for Oryx. Currently Dr. Kauffman is Chair of ISMs Non-Manufacturing Business Survey Committee. From May 1994 to December 1996, he was Chair of the Manufacturing ISM Business Survey Committee. He is also a member of the ISM Educational Resources Committee. Dr. Kauffman has published articles in management journals including the Academy of Management Journal, the International Journal of Purchasing and Materials Management, and The Journal of Business and Industrial Marketing. He has presented papers at national and international academic and professional conferences including the Annual International Purchasing Conference. He is also a frequent guest speaker at professional conferences and seminars. Dr. Kauffman received a bachelors degree in electrical engineering from Lehigh University and an M.B.A. from the Kellogg School of Northwestern University. He received his Ph.D. in management science from the University of Texas at Dallas. He is a member of NAPMHouston, The American Marketing Association, The Institute for Operations Research and the Management Sciences, and the Southeast Texas Association of Public Purchasing. Erv Lewis, C.P.M., is the Director of Purchasing for Wellman, Inc., a multi-national polyester fiber and resin manufacturer, with functional responsibility for purchasing at Wellman sites. Mr. Lewis consults with business and industry on purchasing, supply, and inventory management; has conducted hundreds of seminars on these subjects across the country; and is a highly regarded practitioner. He frequently serves as adjunct faculty in the schools of business at area colleges and universities, and is a regular contributor to purchasing trade and professional publications, including Southern Purchaser, InfoEdge, and Purchasing Today magazines. Mr. Lewis served in all offices of the PMA of the Carolinas and Virginia and is a recipient of The Thomas Award, that associations highest award for contribution to the profession. He is a former chairman of ISMs Certification Board and of the 5th District Professional Development Committee. He holds an M.A. in Business Administration from the University of South Carolina. Michael A. McGinnis, D.B.A., C.P.M., A.P.P., is Professor of Marketing and Logistics at the University of South Alabama in Mobile, Alabama. He holds a B.S. and an M.S. from Michigan State University and a D.B.A. from the University of Maryland, College Park. He has published over 40 articles in the academic literature and trade press. He is co-author of the recently published CAPS focus study Purchasing and Supplier Involvement: New Product Development and Production/Operations Process Development and Improvement.

Mr. McGinnis is the Education Vice Chair of NAPM District VII and is a member of the Mobile Association of Purchasing Managements Professional Development Committee. He has served as Professional Development Chair of the Mobile Association of Purchasing Management and as a member of ISMs Educational Resources Committee. He teaches a Certified Purchasing Manager Review Course and has completed ISMs C.P.M. Instructor Information Program. He received the 1994-95 NAPM District VII Professional Development Person of the Year award. Helen M. Pohlig, Esq., is licensed to practice law in Arizona, Minnesota, and Washington, D.C. She currently lectures and writes on commercial law subjects and maintains a small practice representing business clients, especially non-profit organizations. Ms. Pohlig has extensive experience in government relations and regulation, previously specializing in telecommunications law. She started her legal career as in-house counsel at Republic Telcom Corporation in Bloomington, Minnesota, where she handled both regulatory affairs and general business matters including taxes, contracts, and vendor disputes. Subsequently she served as General Counsel for the Competitive Telecommunications Association and as Managing Director for the National Association of Information Services in Washington, D.C. She later became a Corporate Vice President at NAPM, where she was responsible for NAPMs government relations program, international relations, and in-house legal work. She now teaches extensively for ISM and previously served as an adjunct faculty member in the graduate school of George Washington University. Ms. Pohlig graduated with honors from Pacific Lutheran University, Tacoma, Washington, in 1975 and earned her J.D. with honors from William Mitchell College of Law, St. Paul, Minnesota, in 1982. Terry Smelcer is the Manager of Supplier Diversity for Sprint Corporation, in Kansas City, Missouri. His career covers over 34 years experience in public education, small business management, purchasing, and supplier diversity management. Terry started the Sprint Supplier Diversity Department in 1987. Under his leadership the Sprint Supplier Diversity Department has been recognized locally, regionally, and nationally for its efforts in working with small, minority, women, and disabled veteran-owned businesses. Mr. Smelcer is a member of ISM and is currently the Past Chairman of ISMs Minority Business Development Group. He also serves on the Try Us Resources, Inc. Board of Directors, and is active in the National Minority Supplier Development Council at both the local and national level. In addition, Mr. Smelcer is the Chairman of the Professional Development Committee with the Telecommunication Industry Group of NMSDC. He is a member of the Minority Working Group and the Small Business Development Center Advisory Board for Rockhurst College in Kansas City, Missouri. Mr. Smelcer has been with Sprint for 20 years, holding positions of Supervisor Network Purchasing, Manager of Staff Support Purchasing, Manager of Administrative Purchasing, and Manager of Purchasing. He has worked in the supplier diversity area for the past 11 years and is a recognized leader on supplier diversity issues. He received his B.S. and M.A. from Northeast Missouri State University, now known as Truman State University. W. J. Jack Wagner, C.P.M., is Senior Consultant Supply Chain Management for BellSouth Telecommunications Inc. in Atlanta, Georgia. He received his B.A. in Business Administration from St. Lawrence University, and earned his C.P.M. in 1976. His 30 years of experience in purchasing and supply chain management started with General Electric with assignments in their plastics and switchgear business units. Before joining BellSouth in 1983 he worked for Air Products & Chemicals Inc. He has been active in ISM for many years

and has served as Chair of the Ethics and International Committees, President of NAPM Georgia, and Program Chair for the 1994 International Conference in Atlanta. He has contributed articles on several topics to Purchasing Today as well as other publications. He is currently ISMs Senior Delegate to the International Federation of Purchasing & Materials Management. Alvin J. Williams, Ph.D., is Chair and Professor, Department of Management and Marketing, University of Southern Mississippi, Hattiesburg, where he has worked since 1980. He has been active in NAPM, where he has served on the Organization and Planning Committee, Educational Resources Committee, and other advisory task forces. In addition, he was on the Board of Trustees of the Center for Advanced Purchasing Studies (CAPS) and former Associate Editor of the International Journal of Purchasing and Materials Management. Dr. Williams has conducted over 200 workshops and seminars for supply management professionals in the United States and abroad. He has published in various academic and professional journals in marketing and supply management. Dr. Williams was a contributor to the last edition of the Purchasing Handbook. He has a Ph.D. from the University of Arkansas. Rene Yates, C.P.M., is the Materials Manager for B.A. Ballou & Co. Inc. in East Providence, RI. He received a bachelors degree in Management from the University of Rhode Island and an M.B.A. with honors from Bryant College. A former president of NAPM, he has over 25 years experience in the purchasing and supply management field. He has been active in serving NAPM at the local, district, and national levels, is an instructor in Bryant Colleges Center for Management Development, has taught numerous C.P.M. review courses, and is the 1996 recipient of the J. Shipman Gold Medal awarded by NAPM for unselfish, sincere, and persistent effort toward the cause and advancement of purchasing and materials management.

Table of Contents
Acknowledgements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . i Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ii Purpose of the Examination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ii Content of the C.P.M. Examination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . iii Guide to the Specifications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . iii Definition of a Purchasing and Supply Manager . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . iv Important Characteristics of the C.P.M. Examination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . vi How the C.P.M. Exam Was Constructed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . vi Scoring, Equating, and Scaling . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . vii Types of Questions in the C.P.M. Exam . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . vii Exam Process Levels . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ix Technical Properties of the C.P.M. Exam . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xii Writing/Reviewing Exam Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xii Distribution of Questions Within the C.P.M. Exam Modules . . . . . . . . . . . . . . . . . . . . . . . . xiv Study Materials Available Through ISM . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xvii Study Guide . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xvii Diagnostic Kit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xvii Bibliographic Reference Key . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xvii Other Study Material and Resources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xviii ISM International Conference Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xviii Video Programs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xviii Seminars and Overheads for Instructors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xviii Ordering Educational Material and Textbooks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xviii C.P.M. Examination Specification . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xix Overview of Module 1: Purchasing Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xx Overview of Module 2: Supply Environment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xxi Overview of Module 3: Value Enhancement Strategies . . . . . . . . . . . . . . . . . . . . . . . . . . . . xxii Overview of Module 4: Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xxiii C.P.M. Study Guide . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Module 1: Purchasing Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Module 2: Supply Environment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 163 Module 3: Value Enhancement Strategies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 267 Module 4: Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 387 Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 489

Acknowledgements
This study guide represents the combined efforts of literally dozens of highly dedicated individuals in the field of purchasing, who have graciously offered their time and expertise to this project. The Institute for Supply Management (ISM) is very grateful for their professionalism and sincere desire to see this project successfully completed. Particular thanks go to the participating authors of this Guide, who spent a great deal of time and care in the preparation of the manuscript. Special thanks also go to Paul Novak, C.P.M.. A.P.P., Chief Executive Officer of ISM, for his support. Kathy Little must also be thanked for her editorial assistance, and most of all to Scott Sturzl, C.P.M. for his input, guidance, and patience throughout this project. I would also like to thank the members of the ISM Certification Committee, which includes Chair, Barbara M. Donnelly, C.P.M., A.P.P., Johnson & Johnson Corp.; David D. Addler, C.P.M., A.P.P., SBC Operations, Inc.; Gerry P. Bundle, C.P.M., A.P.P., CSC Global PeopleSoft Practice; Steven J. Arnold, C.P.M., A.P.P., American Software USA Inc.; Lisa S. Deal, A.P.P., University of Southern Florida; Ronald C. Jones, C.P.M., A.P.P., University of Maryland; Charles H. King, C.P.M., A.P.P., SD Warren Co.; Thomas C. Meng. C.P.M., A.P.P., Los Angeles County Metro Transportation Authority; Susan I. Scott, C.P.M., Harris Consulting; Rene A. Yates, C.P.M., A.P.P., BA Ballou & Co Inc.; and Board Advocate, Jeffrey E. Yingling, C.P.M., Acquisition East. In some areas of this text, portions have been borrowed from the previous edition of the C.P.M. Study Guide, published in 1997. For this reason, we would like to acknowledge the work of the individuals who served as contributing authors and editors to that Guide. These individuals are: Prabir Bagchi, Ph.D.; Judith Baranowski, C.P.M.; Joseph Carter, D.B.A., C.P.M.; Joseph Cavinato, Ph.D., C.P.M.; Don Dobler, Ph.D., C.P.M.; Michael Dunleavy, C.P.M.; Donald Fesko, C.P.M.; Henry Garcia, C.P.M.; Dr. LeRoy Graw, CPCM, C.P.M.; Earl Hawkes, C.P.M.; Charles McDonald, Jr., C.P.M.; Paul Moffat, C.P.M.; Norbert Ore, C.P.M.; Harry Page, Ph.D., C.P.M.; Merle Roberts, C.P.M.; Eberhard Scheuing, Ph.D., C.P.M.; and Richard Young, Ph.D., C.P.M. Alan R. Raedels, Ph.D., C.P.M. June 2000

Introduction
Organizations are currently experiencing increased competition, rapid changes in technologies, and increased emphasis on quality, total cost, long-term contracts, supplier-base rationalization, inventory reduction, outsourcing, and reductions in purchasing staffs. Purchasing has seen a phase out of the traditional adversarial relationships between purchasers and suppliers and the phase in of partnerships based upon mutual trust and respect, increased use of value analysis, increased use of single sourcing, and doing more work with fewer people. Creating competitive advantage is what organizational strategy is all about. To compete in todays environment, organizations need to be competitive in terms of cost, quality, delivery performance, leadtime, time to market, and flexibility. Purchasing and supply management can contribute to an organizations success in several ways. Purchasing managers must think strategically, broaden their perspective of supply management, eliminate and automate the clerical transactions, and look at themselves as service providers. The goal of this study guide is to bring a broad perspective to the material and only be sector specific when the terminology or application demands it. The purchasing professional may be in a small, one-person purchasing organization or part of a large, multinational organization with hundreds of buyers worldwide. This guide tries to reflect that range of application. A review of the biographies of the editors and authors of this study guide shows the breadth of backgrounds and experience they bring to the project. The CAPS Research study, The Future of Purchasing and Supply: A Five- and Ten-Year Forecast, presents 18 propositions about the future of purchasing and supply management. We have tried to take these trends into account as each task is discussed. This version of the C.P.M. exam reflects a major effort to organize the material in and between modules into more rationale groups, and have the modules reflect a progression of professional growth in the individual. Module 1 presents the basic purchasing process, and Module 2 adds to the purchasers skill set and expands the purchasers outlook to the environment in which the purchaser operates. Where appropriate World Wide Web (WWW) addresses have been added to provide links for the reader to find more information. All the Web addresses have been checked at the time of publication. Given the dynamic nature of the WWW, some of these may no longer be valid by the time you obtain this study guide. Module 3 provides the tools and strategies that enable purchasing to increase its value to the organization. The module looks at outsourcing and leasing decisions, supply and inventory management issues, improvement strategies such as standardization and value analysis, and forecasting. Module 4 covers general managerial issues of concern to the purchasing manager such as strategic planning, performance measurement, and budgeting and human resource management issues including performance appraisal, hiring, firing, promotion, training, and performance problems.

Purpose of the Examination

The C.P.M. examination is a criterion-referenced occupational certification test, designed to determine whether a candidate is qualified to attain the title of Certified Purchasing Manager (C.P.M.). Candidates for the C.P.M. must pass Modules 1 through 4 of the examination.

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Content of the C.P.M. Examination

The contents of the C.P.M. examination is based on the findings of a job analysis of the purchasing and supply manager position. The test specifications were drawn to reflect the results of this job analysis as thoroughly and as accurately as possible. The modules of the examination are: MODULE 1: PURCHASING PROCESS A. B. C. D. A. B. C. D. E. A. B. C. D. Identifying Requirements Preparation of Solicitations Supplier Analysis Contract Execution, Implementation, and Administration Negotiations Information Technology Quality Issues Internal Relationships External Relationships Sourcing Analysis Supply and Inventory Management Value Enhancing Methods Forecasting and Strategies

MODULE 2: SUPPLY ENVIRONMENT

MODULE 3: VALUE ENHANCEMENT STRATEGIES

MODULE 4: MANAGEMENT A. Management and Organization B. Human Resources Management

Guide to the Specifications

The examination specifications are presented in two ways: A General Overview, which lists the major parts and tasks of each module. Detailed Test Specifications, which lists the major parts of the exam, followed by the tasks and the knowledge, skill, and ability areas related to each task.

Each question on the examination is designed to test for a specific task. The number of questions appearing within the tasks of each module are summarized in pages 14-15. Each module includes a specified number of experimental or try-out questions that are NOT used in the determination of a candidates exam score, but are only used by ISM to gather information on the efficacy of the questions. Note that the specifications are only an outline of the material that appears in the examination. Please refer to the C.P.M. Study Guide for more comprehensive discussions and explanations of the various exam topic areas

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Definition of a Purchasing and Supply Manager

What exactly is a purchasing and supply manager? What sort of job responsibilities and duties distinguish a person in this position? While the actual duties of personnel will vary from organization to organization, ISM has developed the following general definition of the purchasing and supply managers position, which directly reflects the content of the C.P.M. examination: A purchasing and supply manager is an individual working for any private, public, or nonprofit organization, who performs and/or has primary responsibility for the procurement of materials, equipment, or services for that organization. The size of the purchasing and supply managers department may range from one person to several thousand. The commodities may be purchased either for the use of the organization, for the manufacture or development of other materials, or for resale to other organizations or the general public. In order to perform this function, the purchasing and supply manager will engage in, or else will have direct responsibility for, some or all of the following functions: establishing procurement plans and making procurement decisions reviewing and approving purchase requisitions determining appropriate methods of procurement performing cost/benefit analyses developing and reviewing product specifications, statements of work, performance terms, and/or acceptance criteria locating, selecting, and maintaining lists of potential sources of supply preparing and soliciting competitive bids evaluating competitive offerings conducting supplier visits and evaluations measuring supplier performance using rating systems and/or predetermined standards reviewing supplier samples and/or product demonstrations preparing, issuing, and administering contracts and purchase orders conducting expediting and follow-up procedures when necessary resolving contractual disagreements and payment problems with suppliers reviewing and revising procurement practices to ensure their compliance with established laws, policies, and ethical principles obtaining legal advice on these practices when appropriate

In addition to this, the purchasing and supply managers position will place particular emphasis on one or more of the following areas: developing strategies/tactics for and conducting negotiations developing and/or utilizing technology within purchasing and supply systems and inventory management systems dealing with quality issues such as the development of quality measurements, target setting, and the resolution of quality problems developing and managing effective relationships with other internal departments participating in cross-functional and/or multifunctional teams

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disseminating information on and recommending changes to the organizations purchasing and supply management policies and procedures developing and managing effective relationships with suppliers using such tactics as supplier partnerships, strategic alliances, supply chain management, and supplier training programs reviewing product availability and/or pricing information and interviewing sales personnel dealing with supplier inquiries, protests, and appeals implementing a small business/disadvantaged supplier development program representing the buying organization in meetings with corporations, government agencies, professional associations, media, and other organizations

From time to time, and depending on the particular needs of the organization, the purchasing and supply manager can be expected to deal with specialized areas designed to enhance the value of the organizations procurement function. These include make or buy, privatization, and/or outsourcing decisions decisions to lease equipment the development of financing and leveraging strategies for purchases the organization, control, and storage of materials the establishment of restock levels and just-in-time strategies the reconciliation of inventory discrepancies the handling of obsolete or surplus equipment and materials the development and/or implementation of programs of standardization, process improvement, cost reduction, cost avoidance, and cost containment the coordination of new and modified products and services the planning and implementation of purchasing and supply strategies based on forecasted data and/or forecasts of future demand the development of market awareness through merchandise shows, trade periodicals and other resources the presentation of information on current and future market conditions to management, sales management, and/or user departments.

The purchasing and supply manager has or shares responsibility for the managerial and administrative aspects of the purchasing department, which generally includes: the development of strategic plans, objectives, and goals the development of operating policies, guidelines, and procedures the preparation of periodic reports of department activities for senior management and other areas of the organization the analysis and resolution of issues raised in purchasing and supply audit reports the development and utilization of criteria for the evaluation of department performance the design of operational forms the administration of a department budget

A major component of the purchasing and supply managers position involves the management of human resources, which includes: hiring, supervising, evaluating, promoting, and/or dismissing department personnel conducting job training resolving employee performance problems dealing with such issues as discrimination and harassment on the job

The four modules of the C.P.M. examination have been designed to cover the job responsibilities, duties, and skills of the individual depicted above.

Important Characteristics of the C.P.M. Examination

The C.P.M. exam is a criterion-referenced test. This means that it is designed to determine whether a candidate is qualified or not qualified in the area in which the candidate is being tested. The way that this determination is made is by comparing the examinees scores on each module to predetermined passing (or cut) scores. If the persons score is at or above the passing score, the person passes the test. If the persons score is below the passing score, the person fails the test. The C.P.M. exams will not tell how good a purchasing and supply professional one is or will be. It does not tell whether one candidate is a better purchaser than another candidate. It is not designed to rank candidates against each other. It only indicates whether the individual candidate has met the standards set by ISM for receiving the C.P.M. designation. The likelihood of a person passing the exam is in no way affected by the performance of other examinees. An individuals standing on the exam remains the same regardless of how well the other candidates score on the test. There are no quotas or curves used on this exam. An important feature of the C.P.M. exam relates to the issue of time. The exams are designed to give candidates the fullest opportunity to demonstrate their competency. There are time limits of 105 minutes for Modules 1 through 3 (each of which are 95 questions long), and 130 minutes for Module 4 (which is 120 questions long). This is an adequate amount of time for the majority of examinees to select all of the best answers within each of the modules, thereby eliminating speed as a factor in this exam. Most examinees should have no trouble finishing each module in the time allotted.

How the C.P.M. Exam Was Constructed

As a prime example of an occupational certification test, it is important to note that the C.P.M. modules are not final exams in the field of purchasing and supply. The exams are not designed to cover the content of any particular course or curriculum in the area of procurement. Rather, they are designed to reflect the knowledge areas needed to perform the important occupational duties of professionals employed in the field of purchasing and supply. Accordingly, the content of the C.P.M. exam is based on the findings of a job analysis, completed in 1999, to determine the important tasks or duties of the typical purchasing and supply manager and buyer, along with the knowledge, skills, and abilities needed to perform those tasks. The study involved the use of questionnaires, job descriptions, interviews, and a survey of 2,416 purchasing and supply professionals selected nationwide from the following sectors: manufacturing, U.S. government, state/local government, institutions, service, retail, and food. The study found a substantial amount of overlap between these sectors in terms of job duties. A similar investigation conducted in 1990 reached essentially the same conclusions.

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The data from this investigation were also used to distinguish those task areas relevant to the purchasing and supply managers position. In light of the job analysis results, a committee of prominent purchasing academics and distinguished purchasing and supply experts, sampled from the above listed sectors, constructed the exam specifications. The primary focus of this group was on the common ground of procurement knowledge for the above-mentioned sectors that is, the topics that are of importance to all or most of the sectors. Not all the content appearing in the specifications is applicable to all aspects of the profession. In spite of the large degree of overlap among the sectors, certain concepts and topics remain specific to certain purchasing and supply sectors. However, the primary focus of the examination is on the areas that the major private, public, and nonprofit sectors of the purchasing and supply profession have in common. As a result, the candidate who successfully completes this examination will have demonstrated ample knowledge of the common, fundamental concepts required to adequately perform the work of a purchasing and supply manager. The candidate will also be able to meet the special purchasing needs of an employer in any of the major public, private, or nonprofit sectors.

Scoring, Equating, and Scaling

While the content of the C.P.M. exam remains constant from form to form, the questions used in the exam are constantly being updated. This means, for example, that a test form taken on one occasion will contain different questions from a test form taken on another occasion. Because of this, the level of difficulty will vary slightly from form to form. To compensate for these variations, a statistical procedure known as test equating is used to correct for differences in test form difficulty. As an example, lets suppose that there are two forms of Module 1: Form A and Form B. Suppose it is established that in order to pass Form A, a person must get 52 out of 90 questions correct. Furthermore, suppose that Form B is somewhat easier than Form A. To compensate for this difference, the passing score for Form B is adjusted to prevent any bonus being given to candidates taking Form B. Thus, it may be established that a candidate must get a score of 56 out of 90 on Form B in order to pass. This is what is done in test equating it holds candidates to the same standard in terms of difficulty regardless of the form taken. To maintain consistency in test scoring, a second statistical procedure called scaling is used. Scaling on the C.P.M. exam converts all scores to a scale ranging from 25 to 75, with the passing score set at 55. Scores received from ISM are reported as scaled scores. If your scaled score on any particular module is in the range of 25 to 54, you failed that module. If your scaled score is in the range of 55 to 75, you passed that module.

Types of Questions in the C.P.M. Exam

All of the questions used in the C.P.M. exam are of the multiple-choice type, with 4 options per question (labeled A, B, C, and D), only one of which is correct. There are, however, several variations on this type of question appearing in the exam. The most commonly used formats are: 1) Closed-Stem Item: In this type of question, the examinee is asked a question and given four possible answers from which to choose. Example: Which of the following parties is ultimately responsible for ensuring that the correct freight classification rates are used in shipment?
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(A) The buyer (B) The carrier (C) The freight auditor (D) The seller 2) Answer: A Sentence Completion Item: This question is characterized by an incomplete sentence, followed by options that represent conclusions to that sentence. Example: In formal bidding procedures, a bid submitted by a supplier is considered to be (A) an offer to sell (B) a counteroffer to sell (C) an acceptance of an offer to buy (D) an acknowledgment of an offer to buy 3) Answer: A EXCEPT Format: In this type of question, an examinee is required to recognize that there are three correct responses within the question. The respondent does this by identifying the incorrect option. A variation on this type of question is to use the word NOT instead of EXCEPT in the stem, in the form of Which one of the following is NOT Example: All of the following are considerations in establishing freight rates EXCEPT (A) distance (B) density (C) stowability (D) reliability 4) Answer: D MOST/LEAST/BEST Format: This type of question requires the examinee to identify which option is better or worse than the others. Example #1: Which of the following forms of payment for international purchases is generally MOST favorable to the buying organization? (A) Cash in advance (B) Draft (C) Letter of credit (D) Open account Example #2: A major commodity is budgeted at $100 per unit for the next year. This price assumes no change from the previous year. The market is cyclical, and later that year the price drops by $10 per unit. The difference between the budgeted price and the actual price is BEST classified as:
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Answer: D

(A) cost reduction (B) purchase savings (C) cost avoidance (D) purchase price variance 5) Answer: D Master List Format: This type of question is actually several questions in one. Here the options are presented first, followed by several questions, all of which apply to those options. It is important to note that each option can be used once, more than once, or not at all by the questions. This question type only appears in the paper and pencil version. Example: Questions 1-3 refer to the following cost-type contracts: (A) Cost plus percentage of cost (B) Cost plus incentive fee (C) Cost plus fixed fee (D) Cost without fee Choose from the contracts above the one referred to by each of the following. A choice may be used once, more than once, or not at all. 1. 2. 3. Under this type of contract, a seller may lose all or part of its fee, but all of its costs must be paid by the buyer. This type of contract is usually used by universities doing research work for government and industry. Federal agencies are prohibited from using this type of contract, although it is still used in the construction industry. Answers: B, D, A

Exam Process Levels

In addition to the variety of question formats described above, the C.P.M. exam presents test questions at varying levels of difficulty or learning. These levels range from questions that require the mere recall of material, to questions that require the candidate to apply his or her knowledge to a novel situation. A description of each of these levels, along with sample questions, appears below. 1) Recall: This is the lowest or easiest level of learning. Questions written at this level are those that demand the recall of ideas, material, or phenomena related to the topic of interest. The process used to correctly answer such questions is the examinees memory of the material. Questions in this category ask individuals to define, identify, and select information. Example #1: The type of document used to enter into an interim agreement pending a definitive contract, so as to permit the start of delivery, is called a

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(A) letter of intent (B) purchase order (C) customized contract (D) standard contract Answer: A To correctly respond to the question above, the examinee has to recall the definition of a letter of intent. Example #2: The charge assessed by a railroad against a shipper that holds a rail car beyond the free time allowed is called (A) absorption (B) demurrage (C) drayage (D) dockage Answer: B To correctly respond to the question presented in Example #2, the examinee has to recall the definition of demurrage. For both examples, the form of the question is not too different from the way in which the actual definition of the term is stated in textbooks and other learning materials. 2) Comprehension: The second level deals with questions that test for comprehension. Questions in this category require the examinee to grasp the meaning of the material presented in some novel way. The question testing for comprehension describes some principle or fact in words different from those used in textbooks, and often uses some novel situation as a way to present an idea. In order to get it right, the examinee must recognize the principle demonstrated in the questionmemory alone will not be sufficient for getting the correct answer. Example #1: A buyer decides to issue a separate purchase order for each of several items, instead of combining the items on a single purchase order. The probable result of this policy will be a decrease in the (A) overall number of purchases made by the organization (B) average cost of processing a purchase order (C) number of purchasing errors (D) amount of staff needed by purchasing Answer: B To correctly answer the question in the example above, the examinee must recognize the consequences of using separate purchase orders. The examinee is asked to make an estimate or prediction based upon the circumstances described in the question.

Example #2: A buyer orders paint from a supplier and specifies that the paint must dry tack-free in four hours, and dry hard in twelve hours. These specifications are examples of (A) engineering specifications (B) performance specifications (C) restrictive specifications (D) technical specifications Answer: B To answer this question correctly, the examinee not only must know the definition of performance specifications, but also must be able to recognize circumstances which illustrate this definition. 3) Application: Application questions measure the understanding of ideas or content to a point where the examinee can apply it to an entirely new situation. The objective of these questions is to test whether the examinee can use the knowledge in an appropriate manner in a real-life situation. Example: Smith is a buyer for an automobile manufacturer. She is currently purchasing certain components for the engine of a brand new, eagerly-awaited line of cars that the company is counting on to lift it out of its current business slump. Two weeks before production is set to begin, XYZ, Inc., a major supplier of one of the engine components, calls Smith and states that a fire at its only manufacturing facility has caused a cessation in production, and that all orders will be delayed at least 30 but not more than 45 days. Smith checks her records and finds that the part is available from other suppliers, but at a substantially higher price. Given this situation, which of the following would be the BEST course of action for Smith to take? (A) Cancel the shipment with XYZ and pay the higher price to another supplier (B) Cancel all orders with XYZ, reorder the part from a different source, and undertake legal action against XYZ for the difference in costs (C) Order adequate supplies from a different source, absorb the excess costs, and accept delayed shipment of the balance from XYZ (D) Notify manufacturing to delay production of the line until the shipment is received from XYZ Answer: C The distinguishing characteristic of application questions is that they present specific situations that the examinee has not encountered previously, and cannot solve on the basis of general knowledge alone. The problem presented in the question above is a novel situation, and rather than rely on memory or comprehension alone to answer it, the examinee is required to draw on knowledge and experience to identify the solution to the problem. While all four modules of the C.P.M. exam can contain questions testing for Application, every version of Module 4 (Management) of the C.P.M. examination will contain a minimum of 25 questions designed to test candidates at the Application level. The purpose

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of this is to ensure that those who receive the C.P.M. designation will have demonstrated an ability to apply their purchasing and supply knowledge and skills to real-life work situations.

Technical Properties of the C.P.M. Exam

The C.P.M. exams are constructed, administered, and scored in accordance with the Standards for Educational and Psychological Testing (1985), published jointly by the American Educational Research Association, the American Psychological Association, and the National Council on Measurement in Education. The following principles are heeded in the development of these examinations: 1) Validity: The most important characteristic of a test is its validity, which is defined as the degree to which the test actually measures what it purports to measure. As is typically the case with occupational certification examinations, the C.P.M. exam was developed to be a content-valid test, meaning that the exam content reflects the knowledge, skills, and abilities (KSAs) associated with the purchasing and supply manager and buyer positions. These KSAs were determined through a job analysis that outlined the major tasks performed by the purchasing and supply manager and buyer in a variety of settings. The KSAs needed to perform each task were identified by a committee of experts, and the tasks and KSAs were used to construct the C.P.M. exam specifications. Concern for exam validity and job-relevancy dictated the methodology that was used to develop the ISM certification program. These steps include the conducting of a job analysis of the purchasing and supply manager position to determine the nature of the profession, the development of a set of exam specifications based on the results of this job analysis, and the writing and review of exam questions based on those exam specifications by a panel of experienced purchasing and supply professionals. 2) Reliability: Another major characteristic of a test is its reliability, which is defined as the consistency of the exam scores. The reliability of the C.P.M. exam is computed and expressed in several ways, including the KR-20 reliability, the standard error of measurement, and the reliability of the pass/fail decision. Passing Scores: The passing scores for each module were determined using a judgmental procedure for criterion-referenced test standard setting. The standard-setting committees are composed of purchasing experts from industry, government, academia, and other sectors.

3)

Writing/Reviewing Exam Questions

Exam questions are written by C.P.M.s with a variety of purchasing and supply backgrounds. All questions are reviewed for their efficacy and fairness by committees of purchasing and supply experts. Consideration is given to the composition of these committees with regard to purchasing practice, gender, and race, as well as the input of educators within the field of purchasing and supply. The committee makes every effort to see that exam questions do not represent subjective opinions relevant only to specific procurement situations. The review committee ensures that the correct answer to each question represents the consensus of the panel of purchasing and supply experts as to the appropriate course of action, or the best possible answer to the specific problem posed in the question. In no way do the answers to the C.P.M. exam questions represent merely the personal bias or opinion of the individual question writer.

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ISM also employs the use of quantitative item analyses to determine the effectiveness of the exam questions. Item analyses are statistics collected after the administration of a test to tell: (1) the difficulty of a question; (2) the correctness of the intended answer; and (3) the effectiveness of the incorrect options, or distracters. In this way, ISM ensures that the exam questions not only are acceptable to the review committee of purchasing experts, but also are valid for the actual test candidates. One other way in which questions are reviewed is through written comments (or, in the case of the computer-based exam, electronically entered) obtained from examinees. Candidates are encouraged to make comments on exam questions while taking the test, which are later reviewed by ISM. This approach has been particularly useful and often has yielded sound suggestions for improving questions.

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Distributions of Questions Within the C.P.M. Exam Modules

Module 1: Purchasing Process Part Questions
A. Identifying Requirements Task 101 Task 102 Task 103 Task 104 Task 105 B. Preparation of Solicitations Task 106 Task 107 Task 108 Task 109 C. Supplier Analysis Task 110 Task 111 Task 112 6 3 6 5 3 7 6 6 3 8 6 5

Module 2: Supply Environment Part Questions

A. Negotiations Task 201 Task 202 B. Information Technology Task 203 Task 204 Task 205 C. Quality Issues Task 206 Task 207 D. Internal Relationships Task 208 Task 209 Task 210 Task 211 E. External Relationships Task 212 Task 213 Task 214 Task 215 Task 216 Task 217 7 6 6 5 5 6 6 6 6 5 5 7 6 3 3 5 3

D. Contract Execution, Implementation, and Administration Task 113 4 Task 114 5 Task 115 3 Task 116 2 Task 117 4 Task 118 2 Task 119 4 Task 120 2 Total Questions 90 (Plus 5 unscored try-out questions)

Total Questions 90 (Plus 5 unscored try-out questions)

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Module 3: Value Enhancement Strategies Part Questions

A. Sourcing Analysis Task 301 Task 302 Task 303 7 5 5

Module 4: Management Part Questions

A. Management and Organization Task 401 11 Task 402 11 Task 403 9 Task 404 7 Task 405 5 Task 406 8 Task 407 7 Task 408 3 B. Human Resources Management Task 409 11 Task 410 8 Task 411 8 Task 412 9 Task 413 7 Task 414 6 Total Questions 110 (Plus 10 unscored try-out questions) * Twenty-five of these questions will test the candidate at the Application level

B. Supply and Inventory Management Task 304 6 Task 305 6 Task 306 3 Task 307 4 C. Value Enhancing Methods Task 308 Task 309 Task 310 Task 311 D. Forecasting and Strategies Task 312 Task 313 Task 314 Task 315 Task 316 6 7 7 6 6 6 5 5 6

Total Questions 90 (Plus 5 unscored try-out questions)

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Study Materials Available Through ISM

Study Guide
The C.P.M. Study Guide is in its seventh edition. Its table of contents provides an outline of the C.P.M. exam specification. The Study Guide takes a step-by-step approach to the basic material covered in the C.P.M. exam specification and lists the major parts of the exam, followed by the task and the knowledge, skill, and ability areas related to each task. The Study Guide is a general overview of the material covered in the exam. It is meant to provide the candidate with an introduction to the major topics covered in the test, and to provide direction for further study. While it provides a good overview of the types of material covered on the C.P.M. exam, the candidate should be aware the Study Guide is NOT meant to serve as a substitute for any of the major textbooks and other resources in the field of purchasing and supply. Candidates are strongly urged to read at least one other major source of information, in addition to reading the Study Guide, when preparing for the C.P.M. exam. Reading the Study Guide alone, without other resources, is not considered a sufficient preparation for the C.P.M. exam. Also please be aware that the exam may contain material that is not necessarily covered in the Study Guide.

Diagnostic Kit
A C.P.M. Diagnostic Kit tests the candidates current state of knowledge. It is an excellent assessment tool to use as a guide while preparing to pass the C.P.M. exam. Kits are made up of the following material: Introduction explains the purpose of the Kit and nature of the exam (including overview, characteristics, high-level content outline, discussion of scoring, equating and scaling, and examples of the format types of items that appear on the exam) Modules 1, 2, 3, and/or 4 Explanation for answers Answer keys, scoring tables, and conversion tables Despite the authenticity of the exam used, a candidate cannot extrapolate performance on the Diagnostic Kit exam to performance on the actual C.P.M. exam. A passing score on the diagnostic exam does not guarantee a passing score on the C.P.M. exam. There are many factors that enter into the test situation that can have a bearing on the individuals performance. While the diagnostic test, if taken in the proper manner, will give an approximate idea of how the individual is performing, it is not meant to be a predictor of actual C.P.M. exam performance.

Bibliographic Reference Key

The Bibliographic Reference Key is designed for those who desire to locate additional detailed material on specific topics. Organized in the same order as the questions in the C.P.M. Diagnostic Kit, the Key references each topic to appropriate discussions in a number of other sources in the field.

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Exam candidates will find this a good source of additional reading for the topics covered in the exam specifications. Instructors may find the Key an important source to use to supplement course material, or to determine reading assignments for students.

Other Study Material and Resources

The Purchasing Handbook, Glossary of Key Purchasing Terms, C.P.M. Articles for Exam Preparation, and ISMs four-volume series provide additional resources for candidates preparing to test, and for instructors developing programs to assist test candidates. The ISM Web site (www.ism.ws) includes a searchable database that includes articles from its monthly magazine, quarterly journal, conference proceedings, and other publications. This database is available free of charge to ISM members.

ISM International Conference Proceedings

Current, relevant presentations of purchasing, materials, supply management, and general management subjects from the professions leading authorities provide excellent material for all modules.

Video Programs
ISM has a number of videotapes available for purchase or rental covering purchasing and supply management topics.

Seminar and Overheads for Instructors

Instructors may contact the ISM Certification Department to obtain a set of overheads of the C.P.M. Examination Specification for classroom use. Instructors are encouraged to attend the C.P.M. and A.P.P. Instructors Information Program offered as a pre-conference seminar to the annual ISM international conference.

Ordering Educational Materials and Textbooks

To order C.P.M. or A.P.P. study materials, register for the C.P.M. or A.P.P. Exam, or learn about other educational products offered by ISM, please call ISMs Customer Service at 800/888-6276, extension 401, or connect to the ISM Web site at www.ism.ws.

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C.P.M. EXAMINATION SPECIFICATION

The C.P.M. Examination Specification Outline
The C.P.M. examination specification has been used to organize this material throughout the Study Guide. On the next page you will find an overview of Modules 1, 2, 3 and 4 of the C.P.M. exam, organized into parts with the corresponding tasks included in each.

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Overview of Module 1: Purchasing Process

A. Identifying Requirements Task 101 Establish procurement plans and make decisions necessary to purchase products or services in congruence with organizational objectives and sourcing strategies. Review purchase requisitions in accordance with organizational requirements and/or budgetary constraints. Determine appropriate methods of procurement. Perform cost/benefit analyses on planned acquisitions. Review supplier samples and/or demonstrations with the buying organization management and/or user departments. Develop/review specifications, statements of work, performance terms, and/or acceptance criteria. Locate and select potential sources of materials or services. Prepare and solicit competitive bids, quotations, and proposals with pertinent specifications, terms, and conditions. Manage and develop lists of recommended sources. Evaluate competitive offerings to determine the overall best offer for a product/service. Conduct supplier visits/evaluations to determine suitability. Measure supplier performance using rating systems and/or predetermined standards. Prepare and/or issue contracts/purchase orders. Obtain legal review and approval of a contract when required. Administer contracts/purchase orders from award to completion. Expedite deliveries and conduct follow-up procedures when necessary. Resolve contract/purchase order differences with suppliers. Resolve payment problems with suppliers and user departments. Review and revise purchasing practices to ensure their conformance with established laws, policies, and ethical principles. Manage files of agreements, equipment records, and/or specifications.

Task 102 Task 103 Task 104 Task 105

B. Preparation of Solicitation Task 106 Task 107 Task 108 Task 109 Task 110 Task 111 Task 112

C. Supplier Analysis

D. Contract Execution, Implementation, and Administration Task 113 Task 114 Task 115 Task 116 Task 117 Task 118 Task 119 Task 120

xx

Overview of Module 2: Supply Environment

A. Negotiation Task 201 Task 202 Prepare for and develop strategies and tactics for negotiations. Conduct negotiations with potential and/or current suppliers to obtain maximum value. Develop/utilize a computerized purchasing system (e.g., on-line buying, EDI, Web-based electronic commerce). Develop/implement/maintain a database of specifications, suppliers, products, and/or services. Develop/utilize a computerized inventory and/or capital equipment tracking system. Resolve quality problems with suppliers and user departments. Develop measurements for quality improvement and target setting (e.g., best in class benchmarks). Develop/manage/evaluate relationships with other internal departments. Participate in cross functional and/or multi-functional teams (e.g. project management, process improvement). Recommend/implement changes in the organizations purchasing, supply management, and material usage policies as needed. Disseminate information and provide training related to purchasing and supply management policies and procedures. Develop/manage effective relationships with suppliers, utilizing such techniques as supplier partnerships, strategic alliances, supply chain management, and supplier training programs. Review product availability and/or pricing information with suppliers. Conduct interviews with current and prospective supplier sales personnel. Coordinate/review/respond to supplier inquiries, protests, and appeals. Develop/implement a small-business/disadvantaged supplier development program. Represent the buying organization in meetings with corporations, government agencies, professional associations, media, and other organizations.

B. Information Technology Task 203 Task 204 Task 205

C. Quality Issues Task 206 Task 207

D. Internal Relationships Task 208 Task 209 Task 210 Task 211

E. External Relationships Task 212

Task 213 Task 214 Task 215 Task 216 Task 217

xxi

Overview of Module 3: Value Enhancement Strategies

A. Sourcing Analysis Task 301 Task 302 Task 303 Task 304 Task 305 Task 306 Task 307 Task 308 Task 309 Task 310 Conduct decisions to make or buy, privatize, or outsource products or services. Conduct decisions to lease or buy equipment. Develop financing and leveraging strategies for purchases. Organize, control, and minimize the storage of materials. Meet with appropriate departments to discuss current material inventories and establish restock levels or just-in-time strategies. Determine sources of and reconcile inventory discrepancies. Handle obsolete equipment/materials, surplus equipment/materials, and scrap. Develop/implement a standardization program. Develop/implement a process improvement program. Develop a cost reduction, cost avoidance, cost containment program (e.g., Value Analysis, consolidation of orders/suppliers, lead time reduction, Activity Based Costing). Coordinate the introduction of new and modified products and services with appropriate departments. Plan purchasing, sourcing, and supply strategies based on forecasted data. Develop supply plans and strategies based on forecasts of future demand. Provide forecasted data of future organization buying requirements to suppliers. Develop and maintain market awareness through merchandise shows, trade periodicals, and other resources to secure new product and pricing information. Provide data on current and future market conditions to management, sales management, and/or user departments.

B. Supply and Inventory Management

C. Value Enhancing Processes

Task 311

D. Forecasting and Strategies Task 312 Task 313 Task 314 Task 315 Task 316

xxii

Overview of Module 4: Management

A. Management and Organization Task 401 Task 402 Task 403 Task 404 Task 405 Task 406 Task 407 Task 408 Task 409 Task 410 Task 411 Task 412 Task 413 Task 414 Develop strategic plans and objectives (short and long-term). Develop goals and objectives of a purchasing and supply department aligned to organizational goals. Plans/develop/provide operating policies, guidelines, and procedures. Prepare periodic reports of department activities for senior management and other areas of the organization. Analyze and resolve issues raised in purchasing and supply audit reports. Develop/utilize criteria for evaluating purchasing and supply department performance. Prepare and/or administer a purchasing department/supply management budget. Design, modify, and/or manage operational forms (paper and/or electronic). Supervise and lead purchasing/supply staff. Hire, promote, and/or dismiss purchasing/supply personnel. Evaluate purchasing/supply staff performance. Conduct/authorize job training for the development of the professional competence of the staff. Resolve employee performance problems. Implement programs to prevent and respond to discrimination or harassment.

B. Human Resource Management

xxiii

MODULE 1: PURCHASING PROCESS

TASK 101: Establish procurement plans and make decisions necessary to purchase products or services in congruence with organizational objectives and sourcing strategies.
This section applies to both a requisition initiated purchase action (paper or electronic) as well as one in which purchasing is involved at the beginning of what will become a negotiated contract or other type of supply relationship. 1) INTERNAL ORGANIZATION CONDITIONS LEADING TO DECISIONS TO BUY A) Operational strategies Many purchasing requirements are transmitted as requisitions that originate from internal customer departments or in a manufacturing unit for production requirements. For ongoing needs, these orders are subsequently translated into a procurement schedule. Purchasing timing is crucial. If insufficient time is given to purchasing to obtain a needed product or service, not enough competition can be developed or not enough time can be devoted to negotiations. The outcome will likely be higher prices, special production runs, and premium transportation costs. Therefore, coordination and timing between purchasing and operations become crucial. Purchasing shares in productions desire to keep operations running smoothly. These factors are also present in heavy industries where the acquisition of capital construction and maintenance goods and services are crucial. Financial strategies Poor financial planning and management are major causes of business failure. Many economic factors periodically bring about good buying opportunities. Thus, there are times when an organization may wish to buy now to avoid paying higher prices later for the same requirement or, conversely, to delay placement of an order if a drop in price appears likely. Marketing strategies Sales forecasts are the basis for production and operations schedules, which, in turn, are the basis for purchasing decisions. Sales forecasts also influence an organizations capital equipment budget, and other sales activities such as product promotions and new product introductions. All of these will involve requests to the purchasing department for procurement assistance. Supply strategies Every class of product or service an organization purchases should have a defined supply strategy. A strategy is a long-term action plan that defines what needs to be done to attain a stated goal. A strategy should enable an organization to establish or maintain a competitive advantage. This strategy must support the business unit, corporate goals, and organizational strategies as well. The presence of a strategy gives the purchaser guidance in finding and selecting suppliers that will help support and improve the organizations competitive position. Some of the components that make up a supply strategy are the buying policy, sourcing policy (including number of sources and type of source), supplier relationship, and role and location of inventory.

B)

C)

D)

Task 101 2) MARKET CONDITIONS LEADING TO DECISIONS TO BUY

Module 1

The nature of the market, whether it is a suppliers market (demand is greater than supply), Purchasers market (supply exceeds demand), or a balanced market, affects how the purchaser will plan for and approach the acquisition. Anticipation of shortages in supply caused by demand, threat of strike, or political instability may cause an organization to purchase in advance of its near term needs. Other conditions that spur buying beyond current needs are the announcement of a price increase or the reporting of a suppliers financial condition. The purchaser must weigh the increased product cost against the costs incurred in carrying the inventory until it is needed. In a buyers market, the purchaser may use a subsistence buying policy (see Tasks 312 and 313), buying only what is needed at the time since supply is plentiful. The purchaser may also take advantage of the oversupply by taking an aggressive position with the supplier to lock in current low prices for an extended period of time. Use of forward buying, taking advantage of current low prices, also requires consideration of the costs incurred in carrying the inventory until it is needed. 3) SUPPLIER/CONTRACTOR MARKETING STRATEGIES AND HOW THEY RELATE TO BUY DECISIONS In addition to the market conditions, suppliers apply differing strategies and tactics in their quest to maximize profits in the short and long run. This form of marketplace intelligence is important information to the purchaser when planning an acquisition. One strategy used by organizations in the electronics industry is last runs. As a technology is replaced, organizations announce a last run for a particular product. Purchasers then have an opportunity to order as much as they need for the foreseeable future 4) USE OF A SHORT- AND LONG-RANGE MATERIALS / SERVICE PLAN Purchasing is increasingly anticipating and reacting to changes in the world marketplace. Purchasing departments continue to strengthen their techniques improving their organizations competitive positions. Purchasers have focused not only on short-term profit, but also long-term growth. Strategic planning is a central activity in most viable organizations today. Many purchasing departments have responded to these changes by developing projected annual and longer term buying plans, and by providing direct input for the organizations strategic planning process. Buying plans should support the organizations strategic plan by increasing the decision makers understanding of how purchasing and supply management help the organization to compete in the market and also satisfy external customer demands. 5) ORGANIZATIONAL OPPORTUNITIES FOR STANDARDIZATION, CONSOLIDATION, OUTSOURCING, PARTNERING, COOPERATIVE PURCHASING, AND OTHERS The purchaser is responsible for finding opportunities to lower the organizations total cost of materials and services. The purchaser can attain this goal by incorporating the following: 4

Part A: Identifying Requirements

Task 101

looking for opportunities to standardize materials and services (see Task 308): consolidating the supply base (see Task 310): analyzing outsourcing opportunities (see Task 301): developing supplier alliances (see Task 212): and making use of consortiums and cooperatives (see Task 107). BIBLIOGRAPHY Duffy, R.F. Trail Blazing, Purchasing Today , April 1999, pp. 45-52.

TASK 102: Review purchase requisitions in accordance with organizational requirements and/or budgetary constraints.
1) TYPES OF PURCHASE REQUISITIONS A) Standard requisition The basic form of requisition is the standard requisition, which is an organizations document (paper or electronic) that internal customers use to communicate to purchasing what, when, and how many products or services they need. Purchasing relies on this information in its acquisition process. Typically, a copy of the requisition or the purchase order is sent back to the original requester to show that the products or services have been ordered. Electronic requisitions Purchasing automation has eliminated many paper-based requisitions. Requisitioners and purchasers alike or linked by computer, and requests for products or services and acknowledgments of action are transmitted by wire and screen. This eliminates the need for paper-based systems, and it often enhances decision processes and recordkeeping. Intranets are often used as the mechanism to link the internal customer and purchasing in todays information environment. Bill of materials A bill of materials (BOM) is becoming an important element in the requisition process. The bill of materials is a listing of all the materials and components required to produce a product or service. Like a recipe, the bill of materials shows each part with a description. In some organizations, purchasers, acting as buyer-planners, use the BOM to generate purchase orders or trigger a release schedule against an existing order. A second application of the bill of materials concept is for projects. In this case, the purchaser is given a list of the materials and services needed for a project and is instructed to purchase from the list as needed for the project. D) Systems generated requisitions Many computer systems used today are in the production planning, consumption, supply management, and purchasing realm. Many of these will automatically or semi-automatically generate requisitions or direct orders with suppliers based upon previous arrangements. Traveling requisition In settings where high volumes of similar products or services are being requested, a traveling requisition is often used. In a manual purchasing system, this is usually a card that has standard part or item information along with listings of past requisitions and the organizations from which they have been ordered. Purchasers place the order, then insert the organization, quantity, and expected delivery date on the form and return it to be filed. With the increased computerization of the requisition process, traveling requisitions are seldom used.

B)

C)

E)

Task 102 2) COMMON ORGANIZATIONAL REQUIREMENTS FOR REQUISITIONS

Module 1

Most organizations use a purchase requisition form (paper or electronic) that is designed for its own specific needs, including the information needed and the distribution of that information. The required information for a requisition varies from organization to organization, but usually includes: The name of the internal customer. The signature (or approval code) of the person authorized to sign/approve the requisition. A description and use of the desired products/services. The quantity. The date needed. The date of the requisition. The estimated cost/budget allocation. Possible sources. The account to be charged. The ship to location.

An authorized signature or approval is necessary to ensure the appropriateness of the requisition. Formal responsibility for appropriateness rests with the internal customer, not purchasing. The purchase requisition is an internal communication document and should be available to all departments requiring the information. A) Specifications and statements of work (SOW): format and content Specifications or SOW are the major means internal customers have of communicating requirements to both purchasing and the potential supplier. Specifications can take the form of description by brand, specification of physical or chemical characteristics, specification of material, specification of performance, specification of method of manufacture, engineering drawings, or market grade. When purchasing services, specifications are usually stated in the form of a statement of work (SOW). Each SOW is unique as it describes the specific requirements applicable to a particular item or service. The SOW provides potential suppliers with a clear description of the work to be performed, including inspections, testing and acceptance, quality, support services, documentation, maintenance, results to be achieved, and any other requirements. Task 106 discusses the processes and problems in establishing specifications and statements of work. B) Justification to limit competition In the public sector, the supply process is typically open to all responsive and responsible bidders. Several situations exist where the purchaser can limit competition. Examples include low value purchases where the bidding process may be more expensive than the cost of the product or a technical requirement for compatibility with existing products. Emergency requirements are also a reason to 8

Part A: Identifying Requirements

Task 102

limit competition. The Department of Defense has raised their minimum contract size requiring formal competitive bidding in order to reduce acquisition costs as well as product costs from the supplier. Under designated amounts, either informal competition via quotes or justifications for proprietary or sole source purchases are used. C) Format and content of in-house estimates The purpose of an in-house estimate is to provide purchasing with a benchmark against which to compare supplier quotations. The estimate should be completed prior to receiving supplier prices. In order to ensure the decision maker is comparing apples-to-apples, the estimate should match the specifications or SOW given to the suppliers in terms of the level of detail. Costs that continue at the same level, no matter which option is chosen, may be excluded from the estimate. One approach for organizing cost estimates is to group the relevant costs by category, such as personnel, material and supply, equipment, and overhead costs. All included costs need to be documented for follow-up and auditing. Control of unauthorized buying (ratification) In most organizations, the only legally authorized buying agent is the purchasing department. When a non-agent in an organization makes a direct commitment with a supplier without contacting an authorized agent, this is known as unauthorized buying. Problems that can arise from unauthorized buying include: Unauthorized purchasing is likely to circumvent proper budgeting systems, thereby resulting in lack of expenditure control. Unauthorized purchasers are more likely to commit purchasing dollars to less-than-qualified suppliers. Unauthorized purchasers are likely to circumvent the approval procedures for purchases. Unauthorized purchases may result in a loss of volume from authorized contracts issued by purchasing. Unauthorized purchasers are more likely to make commitments with sham or boiler-room suppliers, creating unnecessary expenditures of funds.

D)

While there are problems with unauthorized buying, purchasing should not be the sole organizational contact with suppliers. There are many professional purchasing systems, wherein internal customers make direct releases to suppliers on contracts or agreements established by the purchasing department. These direct-release systems (see Task 103) include the use of systems contracts, blanket orders, and credit card buying. In situations where supplier partnership arrangements exist, it is common for internal customers to contact suppliers directly for technical and product advice. Furthermore, internal customers often perform the tasks involved in contract administration. When coordinated through purchasing, such arrangements provide internal customers with a quick response to their needs. Other problems may arise depending on the nature of the organization.

Task 102 E)

Module 1 Procedures to ensure that necessary approvals have been obtained Usually the director of purchasing, delegated individuals, and organization teams are responsible for the commitment of funds to acquire materials, equipment, and services. The establishment of organization-wide contracts typically requires approval from the chief purchasing officer for the organization. It is good practice for organizations to require the formal evaluation of suppliers receiving above a certain monetary amount per year. These policies ensure that proper source evaluations have been considered for orders over a certain amount. If there is an emergency or other situation where it may prove advantageous to the organization to do so, competitive bidding may be waived through management documentation of such actions. (Note: This may be more restrictive in the public sector, which has less flexible policies for the procurement process, and requires more extensive use of formal advertising and competitive bidding.) In most cases, purchasers are required to justify purchases from single or sole sources. For standard materials in common and repetitive use, most purchasers have some latitude to exercise judgment in purchasing for stock in advance of specific requirements.

F)

Signing limits/approval levels and thresholds Internal purchase requisitions must be approved by signature or electronically ratified by individuals having the proper dollar-authority levels. Reasons for obtaining proper requisitioner approvals include maintaining control over spending and spotting potential internal fraud. In some organizations, the finance or accounting department is in charge of maintaining lists of authorized internal requisitioners and their respective dollar approval limits. While requisitioners are responsible for obtaining correct approvals on purchase requisitions, purchasers must verify this prior to placing orders. Requisitions not following guidelines are returned to the submitting department. Often, blanket approval is given by management for direct material items used in production and requested by inventory or production control. Requisitions and other requests from internal customers affect specific purchasing personnel in terms of their authority to acquire the items. When individual purchasers, purchasing agents, and managers are given specific dollar limits, this is termed limits of authority. Thus, a purchaser may have authority for an individual purchase order up to $50,000, while a senior purchaser may have authority up to $250,000. An order over this amount requires the signature of the purchasing manager and, in certain cases, a higher-level purchasing executive. Contracts for continuing needs, such as blanket orders or open-end orders where the dollar expenditure level exceeds the individuals authority, should contain the managers signature. This is true even though individual order releases will be less than the purchasers authority limit.

G)

Leadtimes Leadtime has two components in the purchasing process. The first is the time it takes purchasing to process the request from the internal customer, and is

10

Part A: Identifying Requirements

Task 102

measured as the time between when the internal customer submits the request and when purchasing issues the purchase order. The second component is the time from when the purchase order is placed until the goods or services are received. Purchasing has the responsibility to inform the internal customer what those leadtimes are to avoid problems caused by inadequate notice such as premium freight, higher prices, poor product quality, and late deliveries. 3) SOCIOECONOMIC GOALS AND OBJECTIVES AS THEY RELATE TO REQUISITIONS The continued development of a socially and economically disadvantaged procurement program is a common practice in many organizations. The competitive benefits that organizations realize from such sources are not unlike those experienced when developing new suppliers. Requisitions should be reviewed for consideration of placement with this type of supplier. Executive Order 95-507, dating back to the early 1980s, extended the requirement that government contractors, and not just the government per se, had to increasingly use minorityowned business enterprises (MBEs). Some time later, women-owned business enterprises and other organizations, such as handicapped workshops, were added to this directive. Purchasers should be aware of the legal challenges that are currently proceeding through the judicial and legislative systems (see Task 216). 4) BUDGETARY REVIEW PROCEDURES A) Procedures for budgeted vs. nonbudgeted acquisitions In most operations, a purchase order should not be executed unless the expenditure is first authorized in the requisitioners or organizations budget. Large variances should be brought to the attention of the requisitioner prior to placement. Non-budget acquisitions normally require greater scrutiny and authorization prior to execution. The purchaser should have a clear understanding of the budgeted appropriation and proceed with the procurement of the goods or services in a cost-effective manner. Availability of funds Funds for purchases in organizations are typically made available through one of four types of budgets: Materials budget This type of budget covers an organizations need for production materials and components. Capital budget This type of budget covers the acquisition of equipment and construction that is capitalized as a depreciable asset on an organizations balance sheet. Maintenance, repair, and operating supplies (MRO) budget This type of budget covers items needed for the operation of a facility, but are not part of the finished product. Administrative budget This type of budget generally includes items for internal use such as office equipment and computers. 11

B)

Task 102

Module 1 Most public sector entities require that funding for the requisition be pre-encumbered or set aside at the time of requesting. This pre-encumbered dollar amount is adjusted, if necessary, by the encumbrance at the time the purchase order or contract is issued.

C)

Funding cost reimbursables Some contracts allow the supplier to be reimbursed for its costs. These contracts would specifically identify which costs are allowable and the requirements for documentation. The purchaser must exercise careful judgment in reimbursing expenditures in an effort to control costs. In government contracting, unallowable costs are identified in the Federal Acquisition Regulations (FAR).

5)

EXPENSE ALLOCATION An accounting system is the entire structure of records and procedures that discover, record, classify, and report information on the financial position and operations of an organization. For most organizations, the budget represents the authority for making expenditures. Up-todate and adequate information is therefore crucial. To ensure adequate control for budgetary and accounting purposes, organizations typically have rules and procedures in place such as: Requisitioning authority and processes are clearly defined. Budget data are clearly communicated and updated as necessary. Purchase orders, contracts, or procurement cards are required for purchase transactions. Purchase transactions are executed by those with the proper authority to do so. There is periodic review of purchasing practices and procedures. Invoices are sent directly to accounting for verification purposes. Accounting, purchasing, and receiving responsibilities are separated. Appropriate receiving processes and feedback controls are in place. There are prompt payment processes.

6)

TYPES AND SOURCES OF FUNDS AND THEIR RELATIONSHIP TO REQUIRED GOODS AND SERVICES (E.G., GRANTS, CAPITAL) The source of funds for the acquisition may affect how funds are spent. Funds may be available as regular budget items or may be from restricted sources such as grants, contracts, or municipal bonds. There are often limitations on how restricted funds may be used. Purchasing must be aware of these restrictions in order to prevent problems later.

7)

PRIORITY SEQUENCES FOR HANDLING PURCHASE REQUESTS In many organizations, a prioritization process exists for processing requisitions. The activity may be formal or informal. In formal systems, a supervisor may receive and review all requisitions as they are submitted. Assignments may be based on urgency and workload of individual purchasers. In informal prioritization, internal customers may bring urgent requisitions 12

Part A: Identifying Requirements

Task 102

directly to the appropriate commodity purchaser. Routine requisitions are deposited in a central location to be collected and prioritized by individual purchasers. A) B) First-come, first-served This approach ignores how important or critical a request is in favor of the concept of fairness to all requistioners. Arrangement by need date Processing by need date improves the delivery performance as measured against the requestors need date but ignores the issue of supplier leadtime. Thus orders with longer leadtimes may get processed after orders that are needed sooner but are ahead of the leadtime. For example, item A has a leadtime of 20 weeks and item B has a leadtime of 3 weeks. The need date for item A is 18 weeks in the future and the need date for item B is 5 weeks in the future. If the requests for both items arrived at purchasing at the same time, item B would be ordered first since it has the earliest need date even though the leadtime is only 3 weeks while item A would be ordered second even though it inside the normal leadtime. Rush orders/emergencies Rush or emergency requisitions are the top priority of any purchasing organization. They may occur for a variety of reasons, each of which requires immediate attention by purchasers. This urgency requires purchasers to put aside other tasks, address the rush requirement, and return to the previous activity. In addition, suppliers are often selected for proximity rather than the least total cost. Almost always, premium freight charges are incurred. Because of the additional costs related to rush orders, many organizations require supervisory concurrence to create a rush requirement. This initial prioritization balances individual urgency against organizational needs. Order of importance or impact With this approach, requests are prioritized using a variety of criteria. Relevant measures could include the difference between the need date and estimated leadtime, magnitude of dollar expenditure, criticality of product or service, and the complexity of the purchase. Seasonal This approach prioritizes purchases requests based upon purchasing seasonal items first since they may not be available at a later point in time. Longest leadtime Another important determination of requisition priority is the leadtime required for delivery of the item. Often, items with the longest leadtimes are ordered ahead of short leadtime items, other things being equal.

C)

D)

E) F)

BIBLIOGRAPHY Brusman, C. The Statement of Work Primer, NAPM Insights, April 1994, pp. 49-51. Hearn, S.R. Inside vs. Outside How Much? NAPM Insights, June 1995, p. 14.

13

TASK 103: Determine appropriate methods of procurement.

Before starting the procurement cycle, the purchaser should evaluate the overall situation to determine which methods of procurement are the most appropriate. 1) FACTORS IN THE DECISION TO USE COMPETITIVE BIDDING AND/OR NEGOTIATIONS Bidding can be formal or informal. In formal bidding, specifications are written, requests for proposal are advertised, and responses from all responsible suppliers are evaluated. A contract is awarded to the lowest qualified bidder. In informal bidding, the purchasing organization may pre-select or limit the suppliers from whom it solicits proposals. The requirement may not be advertised or widely distributed. Bids are solicited informally from suppliers, typically by telephone, fax, and e-mail (see Task 108). A) Degree of competition/market situation When the market consists of a large number of suppliers, competitive bidding is often the preferred course of action. If there are very few suppliers of the needed product, competitive bidding can be less effective. Industry norms and standards Products that are manufactured to the same general specifications by all producers are commonly referred to as industry standard products. Because of the competitive nature of the markets for these products, competitive bidding rather than negotiation is ordinarily used for acquisition. Custom-made products, by contrast, may not have sharply defined specifications or many capable suppliers. In these situations, negotiation may be the preferred tactic. Urgency The time available to obtain the product or service must be sufficient in order to allow for competitive bidding. This includes time for purchasers to obtain and evaluate bid invitations, and time for suppliers to respond to them. If adequate time is not available, the purchaser usually will resort to negotiation. Dollar value If the dollar value of the item is relatively low, the time and expense of competitive bidding is probably unjustified for both purchaser and supplier. Nature of product/service specifications If the specifications are clear to both purchaser and supplier, competitive bidding may be used. However, when the purchaser anticipates that there will be changes in the specifications, or when the specifications are not clearly defined, negotiation becomes more useful for the procurement process. Type of contract desired Fixed-price contracts are based on a price that will not differ from that agreed upon at the time of ordering. This type of contract is a good candidate for competitive bidding. Cost reimbursable and indefinite delivery quantity contracts are better candidates for negotiation as there is greater uncertainty surrounding the costs and often there is a need to change the terms after the contract is created (see Task 113).

B)

C)

D) E)

F)

15

Task 103 G)

Module 1 Procedure for selection of successful offer The criteria for bid selection will affect the choice of contracting method. Finite, clearly defined, and measurable sets of criteria allow the use of competitive bidding. The more subjective the criteria set, the more desirable will be the use of negotiation. The exception is the public sector where law or administrative rule may set evaluation criteria, and often is the lowest responsible and responsive bidder unless criteria are clearly defined in the solicitation. Organizational policy Many organizations have minimum dollar levels that are necessary before formal bidding or negotiation is required. These levels are balanced against available human resources, and the effort required to prepare and conduct bidding and negotiation, and whether or not a payback of potential savings is possible to obtain. Frequency of purchases A product or service that is purchased frequently is usually a poor candidate for competitive bidding because of the time requirements of the competitive bidding process. This type of purchase may be candidate for the use of a blanket order, systems contract, or procurement card (see Task 108 for competitive bidding and Task 201 for negotiation).

H)

I)

2)

METHODS OF PROCUREMENT

Purchases can be made in a number of ways. Some of the more frequently used methods include: A) Purchase order Purchase orders are written contractual documents prepared by the purchaser to describe all terms and conditions of a purchase. For routine purchases, a standard purchase order form is most commonly used, detailing the requirements for either single or multiple items. Typically a multi-part snapout form is used, providing a copy of the order to all involved internal customers (see Task 113). Contracts Contracts are legally enforceable written or oral agreements that define a job or service to be performed. Contracts are used when the issues involved are more complex and/or when the timeframe of the agreement exceeds one year ( see Task 113). Letters of intent A letter of intent may be used between purchaser and supplier to confirm certain agreements in connection with a future procurement action. A letter of intent may serve as an interim purchase order or contract and provides immediate documentation of the more salient features of an agreement. A letter of intent is a precontractual document used to enter into preliminary agreements requiring further negotiation to develop a definitive contract. The purpose of a letter of intent is to gain time in a commitment to a supplier prior to the issuance of a more complete purchase order or contract (see Task 113).

B)

C)

16

Part A: Identifying Requirements D)

Task 103

Consignment methods At times, suppliers may be willing to place their inventories in the customers warehouse. Typically the inventory consigned by the supplier to the buying organization is paid for at the time of use. These consignment inventory systems are a means of sharing inventory and carrying costs between the purchasing and supplying organizations. The supplier provides the money invested in the goods, while the purchasing organization provides the storage space and incurs certain other costs associated with carrying inventories. Blanket order A blanket order is a term commitment (usually one year or more) to a supplier for certain goods or services over a predetermined time at predetermined prices, or at prices to be determined on market or other conditions. This practice is aimed at reducing the number of small orders, using short-term releases to satisfy demand requirements. When this method is used, the purchasing organization places a purchase order with a supplier that identifies the product or service to be purchased, the cost of the product or service in the appropriate unit of measure, and other applicable terms and conditions of the purchase. The purchasing organization then issues material releases or requisitions that identify the quantity to be delivered within a specific period of time against the base (or blanket) purchase order. Material releases are generally repetitive in nature and define requirements on a regular interval (for example weekly or monthly.). Systems contracting This type of ordering is most frequently associated with the procurement of office goods or maintenance, repair, and operating (MRO) supplies. The distinguishing feature of system contracting is the high degree of integration between purchaser-supplier operations, resulting in a net reduction of inventory for both. The contract itself often authorizes designated employees (generally from using departments) of the purchasing organization to place orders with the supplier for specified materials as needed during the time the contract is in force. This is accomplished by means of an order release form, which is frequently designed so that it can be used by the supplier for stock picking and order assembly, and instructions for routing and delivery. Such contracts can be written only after careful analysis and study, by both purchaser and supplier. The supplier must have materials available in the specified qualities and quantities when an order release is received from the purchaser. Consequently, the supplier must have accurate and sufficiently detailed usage estimates from the purchaser in advance of demand so the supplier can adjust production and its own procurement schedules to meet demand. This system is frequently referred to in the trade press as stockless purchasing. In principle it has the capacity to be stockless, in practice, however, inventories (along with paper work) are reduced but rarely eliminated.

E)

F)

G)

Telephone order/FAX order For small value orders, it may be appropriate to place orders by telephone, fax, or e-mail. This significantly reduces administrative costs by eliminating the issuance of a formal written purchase order. For systems that use numbered requisitions, the requisition number may be used for the purchase order number. 17

Task 103

Module 1 Other systems issue purchase order numbers to purchasers in blocks to be used for telephone or e-mail orders. Purchasers need to recognize that the Uniform Commercial Code allows enforceable verbal contracts for goods whose value is less than $500. Above that amount, the Code requires that there be written evidence of the contract for it to be enforceable. This is the purpose of a confirming purchase order.

H)

Electronic order systems In this system, the purchaser places a purchase order electronically with a supplier. This can be accomplished with computer-to-computer linkages that today include secured Internet links (see Tasks 203-205). Stockless buying/inventory systems This technique, sometimes referred to as just-in-time purchasing transfers responsibility for on-time delivery to the supplier. Advantages to the purchaser may include reduced inventory investment, reduced warehouse space, better inventory turnover, purchase savings from lower prices, and simplified paperwork. (see Task 304). Purchase order draft/check with order In this method, the purchase order document combines the purchase order with a blank check for payment purposes. The supplier completes the blank check, which is limited to relatively low dollar amounts, and sends it to the bank for processing. This method is being replaced by the increasing use of procurement cards. Petty cash/local small purchases Use of small amounts of cash for small or emergency purchases is another procurement method. This method is being replaced by the increasing use of procurement cards. Standing orders This type of order generally specifies all terms except quantity. Shipments are made against release orders per contract, with the supplier delivering goods at fixed, agreed-upon prices over a defined period. This method of ordering is also known as open-ended ordering, and is often made with rail and motor carriers to deliver a certain number of cars or trailers per day unless told otherwise. Credit cards/procurement cards The use of credit cards in purchasing involves issuing credit cards to authorized internal customers so they can charge purchases made directly from suppliers. 1.0 Function Purchasing cards add value to the organization in several ways including: Reducing the number of low value transactions in purchasing and accounts receivable. Reducing acquisition cycle time. Increasing internal customer satisfaction. Reducing total cost of acquisition.

I)

J)

K)

L)

M)

18

Part A: Identifying Requirements 2.0

Task 103

Applicability This practice is applicable mainly to purchases of MRO supplies within the internal customers departments budgets, and under contracts and/or guidelines established by purchasing. Dollar thresholds will vary by individual organization policy. Benefits Procurement cards benefit the procurement function by reducing the number of purchases in which purchasing can add little or no value, reduces administrative costs, and reduce purchase cycle times. Internal customers are then pleased because they perceive greater control over their purchases. Disadvantages If procurement card programs are not carefully designed to take into consideration the needs of the organization and the internal customer, the following problems can occur: Blocking out a lot of suppliers could reduce the benefits that might otherwise be derived from the use of the procurement card concept. Setting extremely low single-transaction limits could result in not relieving purchasing of many of the low-dollar value purchases. Failing to provide adequate training when introducing a program might result in failure of internal customers taking advantage of the program.

3.0

4.0

N)

Kanban/Pull signals Kanbans (Japanese for card) are communication devices for transmitting information within a process or to a supplier about what products and how much to supply. They are an order release mechanism. Direct release For items whose demand is calculated by an material requirements planning (MRP) system, the planned order release information can be used as a release mechanism. An agreement with the supplier specifies when a release for a specified quantity is to be issued. For example, the supplier is authorized to ship the planned order releases for the next four weeks and the purchaser guarantees at least 90 percent of the second four weeks. The planned order release information is sent to the supplier every time the information is regenerated and the supplier is then responsible for delivering the goods per the outlined schedule. Supplier replenishment/supplier managed inventory Supplier managed inventories mean the supplier is responsible for ensuring the stock levels are maintained at the appropriate levels in the purchasers facility, and replenishing items when the stocks are low. Ownership of supplier-managed inventories is dependent upon the arrangement between the purchaser and supplier. Basic ordering agreement See blanket order in section 2E of this task. Negotiation Negotiation is an exploratory and a bargaining process involving a purchaser and a supplier. Each party has their own viewpoints and objectives and they are 19

O)

P)

Q) R)

Task 103

Module 1 seeking to reach an agreement on all phases of a procurement transaction. Negotiation can be used both as a method of procurement and as a technique in conjunction with the other methods of procurement.

BIBLIOGRAPHY Bills, A.L. and K. Snow. The Basics Of Purchasing Cards, NAPM InfoEdge, (1:12), July 1995. Cohen, M. Its in the Cards, Purchasing Today , February 1997, pp. 50-52. Duross, N. Procurement Card Dos & Donts, Purchasing Today , May 1996, pp. 42-44. Griffiths, D. and L. Ellram. Managing Small Dollar Purchases, NAPM InfoEdge, (1:7), January 1996. Snow, K. Procurement Cards 101, Purchasing Today , September 1996, p. 10.

20

TASK 104: Perform cost/benefit analyses on planned acquisitions.

1) DEFINITION OF TOTAL COST Total cost is sometimes called all-in costs and is also known as Total Cost of Ownership (TCO) analysis. In purchasing, total cost generally includes the price the purchase and transportation cost, plus indirect handling; inspection; quality; rework; maintenance cost of use (For example: rework, handling, installing, operating.); and all other follow-on costs associated with the purchase, including costs of disposal. Total cost is a comprehensive systems approach to analyzing purchases, processes, and supply chain-related decisions. 2) STANDARD COSTS Standard costs can be defined in terms of either manufactured items or units of service. For manufacturing, standard costs are the predetermined costs of manufacturing a single unit or a number of product units during a specific period in the immediate future. These are the planned costs of a product under current and/or future expected operating conditions. For services, standard costs are the predetermined costs of providing a single unit of service or a number of service units during a specific period in the immediate future. These are the planned costs of providing a service under current and/or future expected operating conditions. It should be noted that, regardless of the area, standard costs are carefully predetermined. Accounting departments will frequently ask purchasing to assist in estimating the standard costs for materials to be used during the upcoming budget period. These are costs that should be attained under efficient operations. As such, they are the costs used as a norm for the product or service, and as the goal or benchmark against which actual costs will be compared in developing cost variance reports. Proper use of standard costs can be of great benefit to management. For the purchasing manager, standard costs provide a basis for developing budgets, controlling costs, and measuring efficiencies. Standard costs are also used in the reduction of costs and in evaluating bids and negotiating contracts. The standard cost of materials is the planned price for materials based on the projected environment in a given time period, generally one year. A) Purchase Price Variance Purchase Price Variance (PPV) is the difference between the standard cost and the actual price paid. Purchase price variance is not generally a good measure of purchasing performance because it does not consider changes in the market or whether the original standard price set is realistic.

3)

DIRECT COSTS Direct costs are those that can be identified with specific products or services. These costs accrue from the unit being produced and, as a rule, are classified as being either direct labor 21

Task 104

Module 1

cost, direct material cost, or purchased cost. Direct costs are usually 100 percent variable. With the exception of those industries in which there are large investments in fixed capital, direct costs generally represent the greatest percentage of total costs. This fact is of special importance for several reasons: Direct costs generally serve as the basis from which suppliers make their allocation of overhead costs. A reduction in the direct costs of a supplier is generally worth more to the purchaser than a major reduction in the suppliers profit percentage, an important factor to be used in the negotiation process. A reduction of direct costs of a supplier represents a win-win opportunity, where as supplier profit reduction is a win-lose approach.

4)

INDIRECT COSTS Indirect costs are those costs that can be identified with the operations of the organization (as in the production process), but not with specific products or services. As a general rule, indirect costs are all costs not classified as direct costs. The three basic categories of indirect costs are: fixed, variable, and semi-variable costs. A) Fixed costs Fixed costs represent costs that tend to remain constant regardless of the volume of operating activity (for example mortgage or rent). A fixed cost is one that meets the following criteria: B) The cost remains constant within a defined range of operational activity. The cost decreases as a cost-per-unit, or average cost decreases, when output levels are increased. The cost is assigned to departments either by managerial decision or an appropriate cost allocation method. Incurrence of the cost is a function of top-level management, not lower-level supervisors.

Variable costs Variable costs are those that are expected to fluctuate in direct proportion to changes in the level of operational activity, (for example sales, production levels, or some other measure of activity). Variable costs are constant on a unit basis, but tend to vary in direct proportion to changes in volume when measured over a specified period of time. A variable cost meets the following criteria: The cost exhibits a variability of total amount that is in direct proportion to changes in the levels of operational activity. The cost-per-unit is relatively constant even with changes in the levels of operational activity. The cost can be assigned to operating departments in an easy and reasonably accurate manner. Incurrence and consumption of the cost is controlled by the department head or manager who is responsible for it. 22

Part A: Identifying Requirements C)

Task 104

Semi-variable costs Semi-variable costs are those costs that display both fixed and variable characteristics. Examples of semi-variable costs include salaries of supervisors and purchasers, pension plans, utilities, and fuel. Such costs must be analyzed to determine both the fixed portion and the variable portion. This is generally accomplished by direct application of one of three historical approaches (the method of high and low points, the method of least squares, and the method of visual analysis of a scattergram) or by use of an appropriate analytical approach. As a general rule, a semi-variable cost is one that: Tends to change in proportion to changes in the level of operational activity, but not in direct proportion. Can be separated into a fixed and a variable element, for example a purchasers salary that consists of a fixed monthly rate plus a bonus, which is the variable portion.

5)

RELEVANT VS. IRRELEVANT COSTS These costs should be considered when a decision has to be made. Some costs change when a process is changed. Others remain the same. For decisionmaking or analysis purposes, only those costs that will change for the organization, if the decision is made, are considered relevant costs. For example, the organization has improved processes and will free up 10,000 square feet of space in its production facility. There are no other uses for that space. The saved space is an irrelevant cost, because the organization must still pay for the space and has no alternative use for the space. One problem that occurs when analyzing relevant versus irrelevant cost is the unit of analysis. For example, the department within the organization that freed up the 10,000 square feet may no longer have the cost of that space allocated to them. However, the organization as a whole still has to pay. Thus, at a system wide level, the cost is irrelevant to the analysis because the cost will not change whether the 10,000 square feet is used or not.

6)

ALLOCATION OF OVERHEAD/INDIRECT COSTS Overhead costs are costs associated with the operation of the organization as a whole. Examples are interest expense, depreciation, management costs, and computer systems. Their allocation tends to be based on a pooling approach. Under this approach indirect costs are all pooled or added together. For a manufacturing organization, the indirect costs within the facility are added together. The costs are then allocated or apportioned out to production based on what drives or causes indirect costs. Traditionally, most companies have used direct labor dollars as the cost driver, so the formula for allocation would be: Total plant indirect costs = X% indirect per direct labor dollar Total plant direct labor dollars Then, for each dollar of direct labor, a certain percentage would be added on for organizational indirect costs. 23

Task 104

Module 1

As direct labor decreases as a percentage of total cost, an approach many organizations are taking is to use machine hours as the cost driver. Thus, the formula would be: Total plant indirect costs = X% indirect per machine hour Total plant direct machine hours Overhead costs, also known as general and administrative costs, represent the general costs of running the business such as sales, management, and research. These are generally kept separate from the indirect costs of running the organization, but still need to be pooled and allocated. Rather than allocating these costs to product, these costs are allocated to the business unit in multi-business unit organizations, often based on sales. Total company general & administrative costs = $ General & Administrative/dollar of sales Total company sales Problems with the above allocation approaches where organizations produce very different products or services that use different levels of indirect resources do exist. Activity-based costing is an approach to resolve the unfairness of allocation that may occur in some situations. 7) LIFE-CYCLE COSTING Life-cycle costing is a type of total costof-ownership analysis that deals specifically with equipment purchases. Life-cycle costing considers the purchase price of equipment, plus all operating and usage costs of the item over its life. These costs include maintenance, downtime, scrap or loss, energy, training, installation as well as salvage, and disposal costs. For most capital equipment, these additional costs are greater than the price of the equipment. 8) OPPORTUNITY COST This represents the lost opportunity to the organization by spending money or tying up money in one investment opportunity rather than the other. For example, if an organization has a great deal of money tied up in inventory, it loses the opportunity to invest that money elsewherethe opportunity cost. 9) ACTIVITY-BASED COSTING Activity-based costing (ABC) is an approach that recognizes not all activities and processes use the same amount of indirect resources. Activity based costing is an allocation approach that uses multiple indirect cost pools with different cost drivers rather than a single cost pool. An example of this is the allocation of overhead approach shown above. The number of pools used tends to vary from 3 to 8 pools. Use of too many becomes a burden. All indirect costs are identified and costs that have similar drivers are pooled together. For example, in a manufacturing setting all costs associated with the equipment on a particular production line might be pooled: depreciation on the equipment, electricity to run the line, and routine maintenance. There might be 24

Part A: Identifying Requirements

Task 104

another category for changeover costs that include: changeover maintenance, changeover labor, and changeover materials. A general indirect cost pool that remains to capture the costs that are too small or too general to pool is common. 10) FINANCIAL TOOLS Financial tools are used to assess the performance of an organization, a business unit, or a particular investment. The ratios listed below are all profitability ratios (see also Task 111). A) Return on investment (ROI) ROI is calculated as follows: ROI = Annual operating income Total capital invested

For a particular project, such as a capital investment, ROI = Net present value of cash flows from project Capital invested in the project

This shows how well the organization is investing its money B) Return on assets employed (ROAE) Another measure of how the organization is using its assets. ROAE is calculated as: ROAE = C) Net income + interest expense after tax Average capital employed

Return on total assets (ROTA) ROTA = Net income Total assets

D)

Margin analysis Margin analysis represents the profitability of an organization in relation to its sales. This is also known as net operating margin. Net operating margin = Total operating income Total sales

This could be used to compare suppliers to see which is the most profitable and assist purchasers in finding the best suppliers. E) Profitability For publicly held companies, the suppliers financial statements are readily available. Analyzing the suppliers financial statements ensures that the supplier is profitable. If the supplier is not profitable, there could be problems with the supplier remaining in business or giving good service in the long run (see Task 111).

25

Task 104 BIBLIOGRAPHY

Module 1

Ellram, L.M. What Tool to Use When? NAPM Insights, September 1995, pp. 6-7. Ellram, L.M. A Structured Method for Applying Purchasing Cost Management Tools, International Journal of Purchasing and Materials Management, Winter 1996, pp. 11-19. Harding, M.L. The ABCs of Activities and Drivers, NAPM Insights, November 1994, p. 6. Harding, M.L. Understanding Total Cost Of Ownership, NAPM InfoEdge, (1:14), August 1996. Jones, S.K. and M.F. Pohlen. Eliminating Unnecessary Activities, NAPM Insights, December 1994, pp. 8-9. Lere, J.C. and J. Saraph. Activity-Based Costing for Purchasing Managers Cost and Pricing Determinations, International Journal of Purchasing and Materials Management, Fall 1995, pp. 25-31. Ransom, C. The Six Categories of Cost, NAPM Insights, September 1995, pp. 10-11.

26

TASK 105: Review supplier samples and/or demonstrations with the buying organization management and/or user departments.
The underlying principle of this task and the essence of purchasing professionalism is exhibiting ethical behavior and maintaining standards of conduct in the purchaser or supplier relationship. Developing organizational standards of fair dealing with suppliers promotes mutual trust and consideration, and enhances better communication in the relationship. Because it can affect the image and reputation of the organization, it is important to avoid the intent and appearance of unethical or compromising practice in actions and communications with a supplier. Moreover, there can be considerable risk associated with handling a suppliers goods and confidential information. Developing comprehensive policies and procedures surrounding these issues will provide the necessary business and legal safeguards to protect the suppliers property, reduce any liability to the purchasers organization, and provide standards of conduct in the purchaser or supplier relationship (see Task 119). 1) CONFIDENTIALITY POLICIES Most of the transactions relating to purchasing are confidential, especially regarding suppliers and competitors. It is considered unethical and illegal to allow proprietary information about one suppliers quotation to be obtained by another supplier. Confidential information may take a variety of forms such as bids, supplier proposals, pricing, drawings, designs, strategies, wage and salary information, software programs, or scientific formulas. The purchasing professional should ensure that information is never given to one supplier about another supplier unless, as in the case of public procurement, laws and regulations require that the information be made public. The other participants in the purchasing process may not be aware of the need for confidentiality. Therefore, it is purchasings responsibility to ensure the proper controls are established to protect information. One way to protect confidential information is to put it in writing and label it Confidential. Another tool is the non-disclosure agreement that clearly defines the acceptable and unacceptable use of the information in question. 2) TYPICAL POLICIES REGARDING THE POSSESSION, USE, AND RETURN/ DISPOSITION OF SUPPLIERS GOODS The use of supplier samples, prototypes, or demonstrations to assess product quality and/or fitness for use in a particular application can be an inexpensive way to learn about new products or technologies that may be of value to the purchasing organization. Supplier samples should not be accepted unless there is an organizational need for the type of product sampled and a reasonable chance for the supplier to make a sale. Samples should be declined if the organization is not planning on using the product or the requirements are currently being met by longterm contract. If the purchaser requests a sample, the purchaser should pay for it.

27

Task 105

Module 1

When it is necessary to return samples because they are no longer required or they have been rejected, it is the requestors responsibility to identify the items, ensure they are moved to shipping, and prepare a requisition requesting their return. Purchasing is responsible for negotiating the return of the items including restocking charges, obtaining return authorization, and arranging for the disposal of the goods. BIBLIOGRAPHY Baker, J.R., L. Buddress, and R.S. Kuehne. Policy and Procedures Manual for Purchasing and Materials Control, Englewood Cliffs, NJ: Prentice Hall, 1992. Grass, L.A. Confidential Information and the Treatment of Suppliers, NAPM Insights, October 1993, pp. 6-7.

28

TASK 106: Develop/review specifications, statements of work, performance terms, and/or acceptance criteria.
Specifications are a description of the technical requirements for a material, product, or service that includes the criteria for determining whether these requirements are met. A specification may describe the performance parameters that a supplier has to meet, or it may provide a complete design disclosure of the work or job to be done. Specifications for service contracts normally take the form of a statement of work (SOW). Specifications define what constitutes an acceptable product or service. They are required before a purchase takes place to ensure that both purchaser and supplier have the same understanding of what is being bought. After delivery, they become the standard for determining whether or not the product or service is satisfactory. Internally, the need for good specifications gives purchasing important leverage to make sure that the requisitioners are clear about what they want before a purchase is made. Purchasing can invite problems if a product or service has been poorly defined or specifications are non-existent. If the purchasing organization is not clear about what it wants, how can the supplier be expected to deliver a good product or the right service? Purchasing can require their internal customers to focus clearly on what they want and what attributes matter. They have the ability to insist that no quotation activity will occur until the specifications are clearly defined. Externally, specifications are the primary communications documents to potential suppliers that define what is being sought. Suppliers need to have them before they prepare quotations. The specifications help suppliers decide whether they can provide the product or service at all and, if they can, at what cost. When multiple suppliers quote from the same set of specifications, the results provide an apples-to-apples comparison. Good specifications also ensure that the resulting product or service meets the needs of the organization and provides grounds for rejection if it does not. 1) PROCEDURES FOR DEVELOPING AND/OR REVIEWING SPECIFICATIONS

If specifications do not exist, they must be developed. If they already exist, they should be reviewed prior to use to make sure that they are complete and current. Input may come from both internal and external sources. A) Internal input 1.0 Formal Some organizations (especially manufacturing companies) have formalized procedures for specification generation. Technical experts such as research and development or the quality control group often generate specifications for technical products. For complex purchases (such as information systems or software) a team may be formed with representatives from each function affected. Organizations that have many specifications on file may have a department, often called Document Control, assigned the sole function to maintain specifications. 29

Task 106 2.0

Module 1 Informal If there is no formal process for generating specifications, then the obligation rests with the requisitioner to clearly define what they want. Purchasing has the responsibility to see that the requisitioner does this before solicitation takes place.

B)

External input 1.0 Suppliers If the supplier is already working with the purchasing organization in a trusted relationship, then their input to the specification can be very valuable in ensuring that the product or service is deliverable and that all attributes have been clearly defined. This also ensures that when the product or service is produced, both organizations have a complete understanding of how it will be used and what constitutes acceptable quality. Consultants If the expertise needed to properly define specifications does not exist within the organization, consultants who possess such expertise may be hired to assist in generating the specifications. Industry standards, handbooks, and guides Industry standards exist for many commodities. If applicable, they can be used as specifications. This saves time and effort, and ensures that both the supplier and the purchasing organization are using the same definition. Examples of industry standards are fasteners, wire thickness, bar codes, and wood grades (see Task 308). Peers/Professional Purchasing Organizations If consistency across organizations is useful (for example, with EDI), then peers in different organizations may collectively define standards. ISM also provides sample specifications for a variety of products and services (see www.ism.ws). Competitors Standardization within an industry (such as the railroad or petroleum industries) can lead to the use of a competitors specification for a standard item (such as a pump). In other industries, product differentiation is crucial and specifications may be generated to provide a brand-specific look and feel.

2.0

3.0

4.0

5.0

2)

METHODS OF COMMUNICATING PHYSICAL AND QUALITY ATTRIBUTES OF A PRODUCT OR SERVICE In the definition of specifications, there are two components: The first component defines what the product must look like or do. Descriptions differ by the type of product or service being purchased and may include items such as blueprints, materials specifications, performance specifications, and statements of work. The second component is quantitative. Frequency measures will differ with the type of product or service being purchased. Some examples include parts-per-million or parts-per-billion for electronic components, mean-time-between-failures (MTBF) for 30

Part B: Preparation of Solicitations

Task 106

equipment, CpK (process capability) for custom-production, or allowable frequency of defaults in performance of a service. Acceptance criteria define the specifications the product or service must meet upon delivery in order to be accepted and paid for by the customer. For tangible goods, these include the measurements of an incoming inspection process and the allowable results. For equipment, these include the level of performance at which the equipment must operate and for how long it must operate at that level before it is deemed acceptable. For services, these include the definition of the finished deliverable which may be a result, a look, a report, a product, or the performance of equipment. A) Performance and design specifications Performance specifications define what the product or service must do. They are used to define the acceptability of capital equipment and many types of services. The purchaser is interested in the final result. Typically the details of how the performance will be achieved are not specified and rest with the supplier. When performance specifications are used, the supplier has maximum latitude to determine how to go about satisfying the requirement and also assumes the risk for proper performance of the end product. Design specifications provide a complete description of what the product or service must look like and often define the process by which a product will be made and the materials to be used, and step-by-step instructions to carry out a service. Design specifications give the buying organization maximum control over the end result, and the purchaser assumes the risk for proper performance of the end product. B) Internal versus external specifications Internal specifications are specifications that the organization has agreed to use within the organization. Internal specifications that are the same as the external specifications set by industry or government are most desirable. If internal and external specifications are not the same, the product will usually cost more. Correlating quality measurements between purchaser and supplier so that both organizations not only know what is wanted, but also are in agreement about how it will be measured is wise. Building quality into the manufacturing process Quality is best achieved by preventing defects from occurring rather than attempting to detect them later. Detection methods include inspection processes that occur anywhere other than at the point of manufacture (such as outgoing inspection at the supplier or incoming inspection at the purchasers site). Prevention methods involve controls at the point of manufacture. These include automated controls, point-of-manufacture inspection with immediate correction, and Statistical Process Control. 1.0 Statistical Process Control (SPC) Statistical Process Control is a philosophy with accompanying tools that works to keep the process in measured control so that its output is predictable and within desired limits. A key concept is that any process has some variation that is, individual items will not be exactly identical. SPC measures the amount of variation and works to continually reduce it. 31

C)

Task 106

Module 1 The tools of SPC include data collection sheets, histograms, Pareto charts, run charts, cause and effect diagrams, flow charts, and scatter diagrams. In supplier selection, the most important SPC tool is process capability (CpK). Process capability compares the process width (which shows the variation in the items that will actually be produced) with the specification width (which shows the variation in the items acceptable to the purchasers organization). A CpK = 1 means that the variation in the process and the variation allowable by the purchaser are the same. A CpK less than 1 (CpK < 1) means that the process will produce more variation than the purchasers specifications will allow. A CpK greater than 1 (CpK > 1) means that the process is in better control than the purchasers specifications require (see Task 207).

D)

Supplier samples A physical sample can be used as a specification. When the sample meets the purchasers needs, the specification will reference the sample and state that any others should be produced just like it.

3)

SPECIFICATION PROBLEMS/ABUSES A) Over-specification Over-specification means that the developers of the specification have made its provisions stricter than they need to be. A typical result of this practice is higher costs to purchase and/or exclusion of viable suppliers because they cannot meet the too-stringent specification. Under-specification Under-specification means that the developers of the specification have omitted key details or have put limits on key parameters that are too loose. A typical result of these errors or omissions is continual quality problems. Items delivered from the supplier meet the specifications but do not work in the desired application. Slanting specifications Specifications can be written to favor a specific product or organization. Typical results include artificially limited competition, higher purchase prices (since the supplier knows that they have a lock on the specifications), and the likelihood of having to use only that supplier in the future (with the promise of future problems). Non-use of generic specifications Specifying a brand name when a generic product will suffice limits competition and generally results in higher prices. Typically generic equivalents are less costly as in pharmaceuticals. Obsolete/Outdated specifications Since suppliers will use the specifications to quote prices and as guidelines for production of the product or delivery of the service, obsolete specifications will result in all subsequent work being invalid and potentially very costly.

B)

C)

D)

E)

32

Part B: Preparation of Solicitations F)

Task 106

International standards differences It is important that both the purchaser and supplier operate with the same standards conventions. Issues as simple as the use of metric versus English measurements can create problems if the supplier operates with one system and the purchaser with another.

4)

STATEMENTS OF WORK A statement of work (SOW) is used in the purchase of services to define exactly what work is being contracted. All purchases of services, no matter how simple, must have a clear definition stating exactly what is to be done, when it is to be done, and what constitutes an acceptable result. Many disputes between the purchaser and supplier that occur after services are performed, are the result of a difference of understanding regarding what was desired. A simple SOW defines the work to be done, the boundaries of that work (including the timeframe), the expected end result, and criteria for evaluating performance and quality. All important attributes should be defined. As the service become more complex, so does the statement of work. For lengthy and/or very expensive projects, a properly detailed SOW provides the mechanism to manage the project throughout its duration. A) Work breakdown structure For a lengthy or complicated project, the SOW may include a description of the work divided into segments. Each segment can then be managed as a separate sub-project, or the overall project can be quoted and managed by using the work breakdown as a form of project management chart (such as PERT) to sequence the activities (see Task 209 for more information on project management). Hold points/Milestones When the SOW is divided into segments, it may be advisable to condition continuation upon the successful completion of each segment. At completion of a segment, a quality assessment can take place to ensure that specifications or SOW are met to this point and specific approval can be required before work continues. This is a safeguard against the project going too far awry before the deviation is discovered. Performance evaluation factors Every SOW should clearly state all performance and quality criteria, and how they will be measured. When the suppliers performance is evaluated the results should be no secret to either party.

B)

C)

BIBLIOGRAPHY Sickinger, J. Writing a Complete and Effective Statement of Work, NAPM InfoEdge, (3:3), November 1997.

33

TASK 107: Locate and select potential sources of materials or services.

The task of identifying potential suppliers and evaluating them for eventual selection is a core purchasing activity. Identifying potential suppliers starts with locating sources of supply, and continues with the analysis of competition, evaluating various issues, certification of suppliers, and often developing approved supplier lists. 1) DEGREES OF COMPETITION AND THEIR EFFECTS ON PROCUREMENT Many aspects of competition are important to purchasing. These include: A) Full and open competition Full and open competition exists when there are many suppliers to choose from and there is no collusion among them. Competition in this setting typically promotes product or service improvements and places the purchaser in a strong position regarding prices. Broadening the search to include national and international suppliers may increase the likelihood of finding full and open competition. Limited competition Limited competition exists when there are few suppliers, giving purchasers fewer choices in selection and more difficult pricing experiences. Limited competition can exist nationally when only a few organizations sell items in demand. Limited competition can also exist locally when there are only two or three suppliers and they seem to copy each other in behavior and pricing. Technical competition Technical competition exists when, for special product, technology, or patent reasons, only one or a few suppliers are available for selection. For example, this was the case with color printers some years ago when such equipment was only available from limited suppliers. Single source Single sourcing exists when a buying organization actively selects one supplier although more than one is available. This practice is common today in the setting of partnerships, alliances, and just-in-time relationships. Some of the reasons for this are quality improvements, administrative simplification, joint-schedule planning, smooth logistics links, electronic data interchange, early supplier involvement in product design, and joint costing and pricing benefits. This practice runs counter to the traditional approach of using several suppliers to maintain competition among them and to hedge the risk of one of them failing to meet the business needs of the purchaser. Sole source Sole sourcing exists when only one source is available (like a local water company in many cities and towns). Sole sourcing also exists when only one source makes an item that the organization wants to buy. Multiple source Multiple sourcing involves using two or more suppliers for the same or like products or services. By using multiple sources, purchasers can eliminate certain

B)

C)

D)

E)

F)

35

Task 107

Module 1 risks in the acquisition process. These include the disruption of supply due to problems at the suppliers plant and leverage against price increases. Multiple sourcing is an appropriate option for those purchasers who do not wish to become the sole support for a supplier or overly dependent on a supplier. While multiple sourcing tends to keep the chosen sources competitive, a frequent drawback is a short-term orientation and the absence of the kind of strong, long-term commitment required for true partnering. Recent trends in the private sector suggest a movement away from multiple sourcing. Many organizations will continue to have policies that call for a narrowing of the supplier base, to limit purchases with fewer companies that meet high standards of quality, service, and delivery at a competitive price. In some instances, multiple sourcing involves a combination of insourcing and outsourcing (as make and buy). Note that there may be an inherent conflict between the initiative for fewer sources and socially and economically disadvantaged supplier program goals of both public sector purchasers and government agencies.

G)

Integrated supply Competition in integrated supply occurs during supplier identification, qualification, selection, and contract formation. After the arrangement is finalized, competition is limited by the terms of the contract and the switching costs associated with changing suppliers. Integrated supply is a special type of partnering arrangement usually developed between a purchaser and a distributor on an intermediate or long-term basis. The objective of an integrated supply relationship is to optimize, for purchaser and supplier, the labor and expense involved in the acquisition and possession of MRO (maintenance, repair, and operating) supplies. These tend to be items that are repetitive, generic, high-transaction, and have a low unit cost. Integrated supply can take various forms ranging from blanket contracts to outsourcing a total activity, such as the supply room. All integrated supply agreements shift some of the responsibilities normally performed by purchasing to the supplier. Products and services that are non-value added or have low strategic value are excellent candidates for integrated supply relationships. Examples of items included in integrated supply agreements in manufacturing organizations include maintenance parts, equipment repair and overhaul, safety equipment, and equipment rental. Examples in not-for-profit and government organizations include janitorial services, office equipment, temporary labor, and office supplies.

2)

NATURE OF SOURCES AND THEIR EFFECTS ON PROCUREMENT When considering potential supply sources for a product or service, a number of choices are open to the purchasing professional. Each presents distinct advantages and disadvantages. A) Manufacturers vs. distributors When buying in bulk, it is often preferable to buy from manufacturers, whose materials can be obtained at a cost that does not include a distributors mark-up or profit. Manufacturers may also have special designs available. 36

Part B: Preparation of Solicitations

Task 107

On the other hand, if a purchaser has limited warehousing, needs only small amounts of a particular product, or needs to purchase a wide range of products made by many different suppliers, the use of a distributor is preferable. An appropriate example is the use of MRO and janitorial supply distributors rather than sourcing from multiple manufacturers. B) Large vs. small suppliers Small suppliers may be more able and willing to specialize in certain goods than large suppliers. On the other hand, large suppliers are usually better able to keep up with the demands of a buying organization if the volume of business grows. National vs. local suppliers Buying from national sources creates greater competition, offering a wider range of products and better prices. National suppliers may also be better able to provide superior technical service. However, local suppliers offer distinct advantages as well. Local sources can provide faster delivery at lower costs, are usually more willing to tailor their business to the purchasers needs, and will be interested in maintaining a higher level of service. Purchasing from local sources also creates goodwill toward the organization within the community. D) International vs. domestic suppliers Domestic sourcing is usually preferable for most purchasers, as the same laws, transportation links, and communications apply for the purchaser and supplier. However, international sourcing can provide such benefits as greater quality, lower prices, a wider range of goods and services, and greater competition. However, the use of international sources presents a number of special considerations including: 1.0 Exchange rates When buying internationally, the purchaser needs to consider the rate of exchange, which refers to the price at which U.S. currency can be bought with another currency or gold. The relative position of the exchange rate between two nations affects the price level of traded purchases and sales between them, creating either an advantage or a disadvantage for the purchaser. The problem is that currency levels are often unpredictable and therefore constitute a true risk in conducting business overseas. Payment processes Traditionally, there are two major forms of payment for international purchases. The most frequent is a letter of credit, which involves a specific line of credit granted by the importers bank. A second form is a bill of exchange or draft. This is a document issued by the supplier instructing the purchaser to make payment in full at a specified point in time, similar to a check that instructs a bank to pay on a depositors behalf. This becomes a negotiable instrument if and when the buying organization acknowledges its obligations by signing, upon which it becomes a trade acceptance. In general, international procurement can be expected to result in the tying up of capital for longer periods of time than will occur for domestic purchase transactions. 37

C)

2.0

Task 107

Module 1 Increasingly trade occurs between affiliates or subsidiaries of the same corporation. This simplifies the international purchasing process and reduces overhead costs. Rather than purchasing with a letter of credit, an U.S. purchaser with a German supplier would have its German subsidiary execute a domestic German purchase transaction. The subsidiary would then sell to the U.S. organization on open account. Recent surveys have concluded that over onethird of all international trade is now conducted between or among affiliates or subsidiaries, and it seems to be growing. 3.0 Duties Duties are taxes levied by governments on the importation, exportation, or use of goods. Most goods entering into U.S. markets have duties assessed on them. The three major types of duties include: specific, ad valorem, and compound: Specific duties These are charged as a specified rate per unit (for example, $15 for each crate). Ad valorem duties These are duties charged as a percentage of the appraised value (for example, 3 percent ad valorem). This is the type of duty most often applied. Compound duties These are duties that combine specific and ad valorem rates for example, $2.15 per gallon plus 8 percent ad valorem).

4.0

Transportation costs and timing The benefits of international procurement must be weighed against the costs of longer transportation links. Shipments into the U.S. from Canada and Mexico can be transported overland via truck and rail, but overseas shipments must be made by air or ship. Air transport involves relatively high freight charges, yet is the preferred method for overseas shipments of sensitive items like electronic equipment and perishables (such as food, flowers, and the like). The United States can be reached by air within 48 hours from nearly all points in the world. Overseas shipping services include lower costs for the transportation of goods, but at much slower speeds. Water transportation is typically used for large volume purchases and the transport of raw materials. In addition to the transportation charges, inventory carrying costs will increase because of the increased inventory in the supply line caused by longer leadtimes. One of the often-overlooked costs of international sourcing is the additional inventory necessary to support the extended transportation pipeline. For example, it may take up to five weeks for a shipment to move from an Asian supplier via sea to a purchaser in the Midwest. Continuous use of the product requires an uninterrupted flow from the supplier to the purchasing organization. Thus, there may be five separate weekly shipments at various positions enroute to their destination. That five weeks worth of inventory is costly in terms of its investment as well as its transportation. Pipeline inventory costs must be included when comparing total landed cost of foreign suppliers versus domestic suppliers. 38

Part B: Preparation of Solicitations 5.0

Task 107

Applicable laws In international purchasing, the governments of both the purchasers and suppliers countries have laws that will affect the transactions, which can complicate the flow of goods across borders. Governments, for example, place various types of restrictions on imports, including import licenses, customs duties, and quotas. Governments also typically require complex sets of documents, including export licenses, import declarations, certificates of origin, commercial invoices, customs invoices, insurance policies, and bills of lading. In addition, the Convention on Contracts for the International Sale of Goods (CISG) has produced a relatively new body of law that brings some uniformity to the rules governing international sales. The CISG is likely to have a significant affect on international purchasers and suppliers.

E)

Mandatory sources of supply In some instances, a purchaser may be forced to use a certain supply source. Buying from a subsidiary of ones organization is an example of being required to do business with a mandatory supplier. Emergency sources Because production downtime penalties can be extremely expensive and result in lost marketing opportunities, a contingency development program should be part of the overall managerial role of purchasing. Such a program should include the establishment of back-up or alternative suppliers. Small and historically underutilized businesses (HUB) Special purchasing programs for minority and disadvantaged (socially and economically) suppliers continue to grow and develop in the public, private, and not-for-profit sectors. Such purchasing programs are undertaken for a number of reasons, including government legislation, social responsiveness, increased sales, and alternative sources of supply (see Task 216 on developing and implementing a historically underutilized business program). Cooperative/leveraged buying Cooperative buying is typically used by purchasers to increase purchasing effectiveness. This involves joining two or more groups or organizations together for the purpose of preparing specifications and proposals, collectively receiving bids, and making an award to the lowest responsible bidder. Thereafter, each organization issues its own contract and is responsible for administering the remainder of the procurement function, including its own payments. This type of buying arrangement enables smaller users to secure the price and other advantages of large-volume purchasing. Joint ventures A joint venture is a venture or investment undertaken by two or more organizations. For example, two automobile manufacturers may pursue a joint venture to produce a new model vehicle. Joint ventures may enable the partners to share costs, technology, and know-how; reduce financial, technical, and political risks; and achieve economies of scale that would not be possible individually. Risks of joint ventures may include providing technical knowledge to partners that enable them to become competitors, less control over the project, and conflicts among the partners.

F)

G)

H)

I)

39

Task 107 J)

Module 1 Internal vs. external sources An organization should consider which items it buys and which items it makes in terms of strategic and tactical considerations. Strategic considerations should focus on two issues: what business does the organization want to be in and what are its core competencies? In the former situation a manufacturer of personal computers may decide that it does not want to be in the business of making keyboards. Rather, it may decide that it will buy keyboards. In the latter situation, the manufacturer of personal computers may decide that its core competency is in designing, integrating, assembling, and marketing personal computer systems, rather than manufacturing operating systems. Conversely, the manufacturer of operating systems might decide that its core competency is in producing operating systems, not in the assembly and marketing of personal computers. Items that are critical to the success of the product, require proprietary design or manufacturing knowledge, and are within the financial and technical capabilities of the organization will tend to be sourced internally. Tactical considerations focus on the operational efficiency of the organization. Tactical issues include direct and indirect costs, integration of plant operations, availability of internal capacity, the need for direct control over quality, confidentiality, reliability of available suppliers, volume requirements, fluctuations in the work force, and affect on labor relations (see Task 301).

3)

LOCATING SOURCES OF SUPPLY While some purchasers undoubtedly rely on memory and personal experience for knowledge of sources of supply, more appropriate means for obtaining information on suppliers include: A) Buyers guides Buyers guides, trade directories, and registers are reference works that list manufacturers and service providers, their addresses, products/services, branches, financial condition, and other information relevant to the buying decision process. Commodity, manufacturer, and trade name or trademark description of the item index such registers. Examples of guides include the Thomas Register of American Manufacturers, MacRaes Blue Book, and Kompass Publications in Europe. Business directories Many organizations in cities publish directories of local organizations. These publications typically list organization names, addresses, and products or services sold. Telephone directories The yellow pages of telephone directories are another source of information about suppliers. In some cities a separate industrial, or business-to-business, edition of the yellow pages is published apart from the consumer listings for nonmanufacturing entities. The yellow pages give no information on the size or financial standing of an organization. They are, however, often well indexed, and provide a useful starting point if other sources are inadequate. Many telephone directories are available on CD ROM as well as through the Internet.

B)

C)

40

Part B: Preparation of Solicitations D)

Task 107

Chambers of Commerce Supplier information is also available from the Chamber of Commerce, an association of business people and professionals and of trade and professional organizations, formed to promote the interests of the business community. In the United States, there are about 4,000 organizations that belong to the U.S. Chamber of Commerce, which in turn belongs to the International Chamber of Commerce. Trade and professional associations Some trade and professional associations publish magazines, hold supplier trade shows, and otherwise offer information on possible sources. Shows/Exhibits Many industries conduct trade shows and exhibits on a regional and national basis. These provide an excellent opportunity for purchasers to see new products and modifications of old products. Different manufacturers, distributors, and trade organizations sponsor many such exhibits periodically. Trade publications Most industries are covered by one or more journals in the field. Besides containing articles of interest to those in the field, these are valuable resources of new and existing product or service information including sources of supply. Colleagues/Referrals/Networking Professional purchasing colleagues, either known personally or through professional associations, like the Institute for Supply Management and its local affiliates, can serve as another good source of supplier information. Suppliers/salespersons Sales personnel are well informed about the capabilities and features of their own products or services, and are also familiar with similar and competitive products. Sales people will often suggest new applications for their products that will eliminate the search for new suppliers. They can often be sources of valuable information for an alert purchaser. Government sources A number of government agencies exist that purchasers can refer to for information on sources of supply. These include the International Trade Administration, the U.S. Department of Commerce, the U.S. Customs Services, the Federal Supply Service, and state and local agencies. International sources Sources of information regarding overseas suppliers include embassies and consulates of the United States in the countries and cities of interest, foreign trade missions, commercial attaches, world trade centers, import brokers, and the International Federation of Purchasing and Materials Management (IFPMM). Minority supplier sources/Emerging businesses The increase in the number of minority suppliers has introduced an added dimension in the supply equation. The National Minority Business Council represents the interests of minority-owned enterprises and assists in the development of minority purchasing programs including publication of a source directory.

E)

F)

G)

H)

I)

J)

K)

L)

41

Task 107 M)

Module 1 Direct marketing Purchasing departments are constantly receiving mail (both postal and electronic) from suppliers regarding their services or products. Often it is prudent to catalog, date, and file these, and refer to them later when such products are needed. Markets/Merchandise markets Merchandise markets are sites where retail buyers look for products from resellers (wholesalers) at one location. An example is the Dallas Market Center which houses 2,200 permanent showrooms covering a wide variety of items such as gifts, home furnishings, mens and womens apparel, and floral products. For more information see www.dallasmarketcenter.com. Group purchasing organizations Many cooperative purchasing organizations, such as the Educational and Institutional Cooperative Service, Inc. of the National Association of Educational Buyers; Purchase Connections, owned by the Health Resources Institute of Los Angeles; and M.D. Buyline of Dallas, Texas, are good sources of supplier information and provide useful services to their members. User departments (internal departments) In many instances, suppliers approach internal customers directly with information about their products or services. Checking with internal customers (engineering and manufacturing) is often a useful way to obtain up-to-date information about product areas not always available in the purchasing department. Barter organizations These groups serve as swapping clearinghouses for organizations distributing goods or services in ways that do not involve cash payments. Bidders list Government and business organizations maintain lists of suppliers that, in some cases, may be pre-qualified to bid. This type of listing simplifies the sourcing activity for routine purchases. World Wide Web/Internet The World Wide Web provides purchasers with several improvements over other forms of communication. Purchasers may rapidly retrieve information about general economic conditions, industry specific data, specific supplier information, or product data quickly and easily. The Web also gives purchasers access to suppliers around the world. Most suppliers today maintain Web sites that include organizational and product information. Many also maintain ordering capability as well. Using the Web site of key suppliers to place orders reduces administrative costs for both organizations. The Internet enables purchasers to deal directly with suppliers, thereby reducing leadtimes. Purchasers are increasingly employing their own Web sites to inform suppliers of procedures for doing business, to list purchasers and their commodity responsibilities, and to advise potential suppliers of requirements. Some organizations also place their production schedules on their Web site to be viewed by key suppliers who then know what supplies to deliver. This has the potential to eliminate a substantial portion of the administrative costs of ordering.

N)

O)

P)

Q) R)

S)

42

Part B: Preparation of Solicitations

Task 107

Directories such as the Thomas Register are available on the Internet, as are many similar resources. Government data of all kinds are similarly accessible. Web-based purchasing and research is expected to be increasingly central to purchasing strategies. Electronic commerce is the core business-to-business competency that is being universally developed. T) Competitors practices Competitors are also constantly seeking sources of advantage in purchased materials and services. In some instances, insights that a purchaser may gain into their practices may enable the purchaser to identify sources that the purchaser was previously unaware of. Periodically reviewing the buying practices of competitors and non-competitors with suppliers may provide insights into sourcing strategies that can be adapted to the needs of the purchasing organization.

4)

EXISTING VS. NEW SOURCES The decision to continue using existing sources or to try new sources depends on a number of factors and situations that may create both advantages and disadvantages for either alternative. The major considerations are: A) Market Conditions If a purchaser works with only one supplier, he or she needs to maintain greater surveillance of market conditions to be sure that the supplier remains competitive. By seeking new sources for the product in demand, the purchaser can guard against unreasonable increases in price or deterioration in quality by current suppliers. Product complexity/technology changes An existing supplier may be the sole owner of a certain patent or process, precluding the possibility of using other sources. Also, if the product involves costly tool, die, mold, or set-up charges, the expense of duplicating this equipment will also discourage the use of new suppliers. On the other hand, remaining with existing suppliers may result in a purchasers loss in terms of new technology that could be offered by a new suppliers product or service. Urgency of need The establishment of a new supplier will inevitably involve time and expense for training that organization. If the product is needed quickly, the use of a new source may not be practical. Quality expectations An existing supplier may be so outstanding in the quality it provides that buying elsewhere may not be a serious consideration. On the other hand, if a current suppliers quality has been marginal, a new supplier may be a prudent alternative. A new source may be eager to gain new business and might apply special efforts to provide superior service.

B)

C)

D)

43

Task 107 E)

Module 1 Supplier processes How does the supplier produce and distribute the product or service, and to what extent does the supplier outsource? What are their processes for acquiring, producing, and maintaining the goods and services? Adequacy of competition New suppliers may represent opportunities for expanded supply options and competition. For example, a new supplier may be able to remove the purchaser from a sole source situation. A new supplier may offer technical or other support not available from current sources. However, the purchaser must be prudent when considering new sources. Is the new supplier underbidding to earn business? How might this kind of supplier behavior affect the buying organization at a later date? The more critical the product or service, the more carefully the potential new source should be evaluated. Use of thorough specifications and statements of work, appropriate contract clauses for future price negotiations, and careful evaluation of supplier cost data, are just some of the tools available for use by the purchaser when a new source is being considered. Cost versus value of sources The purchase price of a product may be as little as one third of the total cost of ownership. Continuity of supply is the first concern of purchasers, while purchase price may be a lesser issue. Such things as quality, service and technical support, and supplier innovation all contribute to total cost of ownership. Responsiveness and problem resolution, maintenance and operating costs, and salvage value are also factors that must be considered when determining total cost. Long-term needs By seeking new sources of supply, a purchaser works to protect the organizations supply lines in case one of the existing suppliers is unable to perform as promised. However, remaining with existing suppliers is advantageous if such companies have proven they can and will meet standards of quality, service, and delivery at competitive prices over the long term. Such a supplier may be a good candidate for some type of partnering arrangement. Long-term relationships A fundamental objective of purchasing and supply management is the creation of competitive advantage through development of a world-class supply base. The close, collaborative purchaser-supplier activities that characterize these relationships are usually developed in context of long-term involvement. Rapid changing of suppliers typifies a concentration on price to the exclusion of total cost. Changing suppliers is an expensive activity. Most purchasing professionals indicate that total cost differentials must be significant to make changing worthwhile. The better a supplier knows the purchasing organization, and the longer the focus of the relationship, the more willing a supplier will be to invest in cost saving activities on behalf of the purchaser. Need for modification of supplier base The identification of potential suppliers and development of new sources is important to maintaining an assurance of supply. In spite of precautions in the supplier selection process, there will always be sources that perform less than satisfactorily. Usually, such suppliers should be put on notice

F)

G)

H)

I)

J)

44

Part B: Preparation of Solicitations

Task 107

and given the opportunity to correct poor performance before being dropped. There are , however, when replacing suppliers who continue to perform below expectations with new suppliers is the only feasible course of action. K) Change in the suppliers organization If an existing supplier undergoes a major change, such as the retirement of key personnel, a merger, or a takeover, the likelihood of discontinuity in supply or quality may increase. When one person creates and manages an organization, the organization often grows too large for the individual to handle and smooth operations may be disrupted. Such circumstances may warrant seeking new suppliers. Supply continuity Supply disruption is an important consideration when deciding whether to use existing sources or buy from a new source. Disruptions of supply with existing suppliers may be due to strike, fire, acts of nature, capacity constraints, quality or production problems, problems with suppliers sources, financial problems, and changes in ownership. Supply continuity with existing suppliers can be enhanced if realistic disaster contingency plans, multiple production facilities, effective production and quality control systems, and succession plans for management are in place. Supply disruption with new sources may result from an inability to provide promised price, quality, and service due to a number of factors. These may include: poor communication of requirements to the supplier, an inability of the supplier to meet requirements, capacity limitations, and an unexpectedly quick phase-out of the previous supplier. In some instances, supply continuity problems with a current supplier may not be solved by seeking a new source. Working with the existing supplier may be the best alternative.

L)

BIBLIOGRAPHY Anderson, R. and K.E. Macie. Use Co-operative and Consortium Buying for Better Purchasing, NAPM InfoEdge, (2:4), December 1996. Curtis D. and J.D. Etheridge.Integrated Supply Strategies, NAPM InfoEdge, (4:4), December 1998. Finn, S. Launching an Effective Global Purchasing Program, NAPM InfoEdge, (2:12), August 1997.

45

TASK 108: Prepare and solicit competitive bids, quotations, and proposals with pertinent specifications, terms, and conditions.
Methods of soliciting information and pricing from a supplier include the issuance of requests for quotation (RFQ), requests for qualifications (RFQ), requests for information (RFI), invitations for bids (IFB) or requests for proposals (RFP). Although some purchasing departments may define these terms differently, the following definitions and criteria state the basic concept behind each. Request for Quotation (RFQ) This procedure is generally used to obtain only pricing, delivery information, and terms from suppliers. RFQ is normally used for lower dollar volume purchases or other minimal criteria established by the purchasing department. Occasionally, there may be no intention of an immediate purchase. Requests for Qualifications (RFQ)/ Requests for Information (RFI) These procedures are generally used when a large or complicated purchase is being considered and the potential pool of suppliers must be pre-qualified. In this case an RFQ or RFI, is a questionnaire or inquiry into the suppliers background. This is used to determine if the supplier meets the minimum standards needed to successfully bid on the project and, if awarded, successfully complete the project. Note that the term of RFQ can have two meanings; care must be taken to distinguish between them. Invitation for Bids (IFB) This procedure is generally used when the purchasing department knows exactly what is to be purchased and has exact specifications, delivery schedules, quantities, and other purchasing matters determined. The only factor usually to be decided is price. Request for Proposals (RFP) This procedure is generally used when the user does not have exact specifications or procedures finalized. An RFP is worded so that the suppliers (proposers) may offer suggested manufacturing processes, or services, or alternate proposals to be considered by the purchasing organization. Price is usually not the determining factor in evaluating RFPs. TYPES OF SOLICITATIONS/BIDS Solicitation of information can take many forms. The most frequently used are: A) Sealed bidding/formal advertising A sealed bid is a bid that has been submitted in a sealed envelope to prevent its contents from being revealed or known before the deadline for the submission of all bids. This type of solicitation is frequently used by purchasing for the purchase of services such as building or maintenance contracts, construction, and equipment, but it may also be appropriate for selling scrap and surplus. Competitive proposals Competitive proposals are a procurement practice that: (1) is initiated by a request for proposals, and sets out the organizations requirements, and criteria for proposal evaluation; (2) contemplates the submission of timely proposals by the maximum number of possible suppliers; (3) usually provides discussion with those suppliers found to be within the competitive range; and (4) concludes with the award 47

1)

B)

Task 108

Module 1 of a contract to the one supplier whose proposal is most advantageous to the organization, considering price and the other factors included in the solicitation. To ensure competitive bidding is handled effectively and fairly, most organizations have specific policies addressing procedures to be followed before and after issuing (RFQs)

C)

Restricted competition In some instances, restricted competition may prohibit the purchaser from obtaining more than one proposal. Some of the reasons for restricted competition include specialization of the resources required to deliver the product or service, lack of competition in a specific geographic region, and regulatory restrictions. A bid by a multi-functional team should be carefully analyzed, using benchmark data from comparable requirements, to ensure that the bid submitted is competitive based on available information. Two-step bidding This technique is used when inadequate specifications preclude the initial use of competitive bidding. In the first step, bids are requested only for technical proposals without any prices. In the second step, bids are sent to only those suppliers that submitted acceptable technical proposals, and are then asked to submit an updated bid with pricing. Informal bids/quotations Informal bids are generally manifested in two ways. First, informal bids refer to telephone, written, and electronic quotations whose dollar values are less than a pre-established monetary limit. Second, informal quotations may also be used to solicit budgetary information from suppliers for estimating purposes. In this instance, it is critical that the supplier mark the bid, and that the internal organization understand clearly, that the submitted proposals for budgetary processes and is subject to change. Offers to buy vs. offers to sell A contract must have an offer and an acceptance. A purchase order may be either an offer to the supplier to buy the specified goods or it may be an acceptance of a suppliers offer to sell the specified goods. Commonly it is advantageous for purchasers to solicit suppliers offers to sell. This retains the power of acceptance with the purchaser. Otherwise, an offer to buy may be sent to a supplier who fails to respond. Without the suppliers acceptance, there is no contract and no supply of products or services. Alternate and innovative proposals There is no single best way to write an RFQ, RFI, RFP, or IFB. The structure, content, and method of managing the information before, during, and after submission of the bid by the supplier should be guided by the principles of ethical and fair purchasing practice and organizational policy. The purchaser should also understand the business culture in the applicable country or industry and that some forms of bidding may not be appropriate in all places. In some forms of solicitations such as IFBs, alternate proposals may not be allowed and may disqualify the bid. This should be specifically pointed out in the bid document. Alternate proposals are generally accepted in RFPs.

D)

E)

F)

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48

Part B: Preparation of Solicitations H) I)

Task 108

Automated/Electronic solicitations Many organizations today solicit bids or proposals via fax, e-mail, and EDI. This can greatly speed up the process. Non-competitive negotiations In situations where specifications are not yet clear or complete, it may be most advantageous to negotiate with a supplier. Similarly, if a performance specification has been developed, negotiation may be appropriate. In either of these or other situations where one supplier is clearly superior it may be appropriate to negotiate with only one firm. Critical skills, capabilities, or technologies from a supplier are characteristics of such a situation. Online bidding A developing method of bidding in electronic commerce is online bidding. Organizations are not only posting RFQs and RFPs on their Web sites, they are encouraging or even requiring suppliers to submit their quotes electronically.

J)

2)

REQUESTS FOR INFORMATION This stage of activity is often used to gather information about potential suppliers and gain some marketplace intelligence. RFIs give the purchaser the opportunity to obtain information about supplier capabilities and make decisions about potential future relationships. A) B) When to use An RFI is used to obtain general information about products, services, or suppliers. Potential benefits The RFI or RFQ results are generally in the form of brochures, catalogs, or price lists. Because this is an informal request, the information is not binding on the purchaser or supplier. It is a quick survey and is responded to easily. The process may help the purchaser in budgeting or in selecting an alternate process or product of which they were not previously aware. Potential problems A drawback to an RFI or RFQ is that if the method is used too often, potential suppliers may refuse to respond.

C)

3)

PRE-BID OR PRE-PROPOSAL CONFERENCES A) When to use Some bid proposals are simple. Others are more complex due to specifications, the number of suppliers bidding, the amount of business to be awarded, the critical nature of the resulting contract, and so on. For those bid situations that are more complex, a pre-bid or pre-proposal conference may be an appropriate way to communicate information to the supply base. How to arrange and conduct At the pre-bid conference, the purchasers team meets with all potential suppliers who attend. Usual topics at these meetings include blueprints and specifications; SOWs; quotation due dates,; terms and conditions of quotation; delivery schedules and materials; releasing procedures; invoicing procedures and documentation (including incentives); requirements if awarded business (such as reporting, insurance, background checks, security clearances, and permits); 49

B)

Task 108

Module 1 and other purchaser and supplier requirements. If changes to the solicitation result from conferences, the purchaser issues a written amendment to the solicitation.

C)

Selection of participants - All potential bidders should be invited to the pre-bid conference. Attendees from the buying organization include purchasing and affected departments. Potential Benefits Pre-bid meetings are advantageous because they establish a forum for two-way communication between the purchasers and suppliers organizations to discuss the details of the RFQ, RFI, RFP, or IFB package at the beginning of the bid process. Be sure that bid packages have been obtained by all attendees well in advance of the meeting so that they will have had adequate time to review the contents. By meeting in an open forum, the purchaser will quickly learn of any discrepancies or errors in the bid package. Any corrections should be made as an addendum to the original bid package and should be done in writing. This can serve to expedite the bid process, as well as ensure that the information received complies with all requirements. Potential problems A potential disadvantage to the pre-bid meeting is the time it takes to meet with potential suppliers that will be quoting. Over use may also discourage some suppliers from attending, especially in peak seasons for their trade or industry. Mandatory vs. non-mandatory conferences Purchasers may make the pre-bid conferences mandatory. The greater the proposal complexity, the newness of the technology, or the less clear the specifications, the greater the need for pre-bid conferences to ensure the purchaser receives useful and comparable bids. If a pre-bid conference is mandatory and attendance is made a condition for bidding, it is important that the bidders are advised of this in any pre-bid notices that are sent to them. When planning a mandatory pre-bid conference, adequate time must be allowed for the suppliers to receive the material and make plans to attend.

D)

E)

F)

4)

GENERAL SOLICITATION PROCEDURES AND CONCEPTS A) Comparability To provide a common baseline for evaluating bids, all suppliers must receive the same information in the original quotation package. If additional information is provided to suppliers during the quotation process, it is important that all quoting suppliers receive that information. Fairness/business ethics The nature of the competitive bidding process assumes that the business will be awarded to the supplier providing the lowest price unless the solicitation specifies the award criteria in addition to price. Therefore, it is critical to confirm before the bid requests are issued that all suppliers receiving a bid are equally qualified to receive the business. In those situations where business is not awarded to the lowest bidder, a written memo explaining the decision criteria should accompany 50

B)

Part B: Preparation of Solicitations

Task 108

the quote in the file. All suppliers who submit quotes should be notified whether or not they are the successful bidder. Information submitted by a supplier to a purchaser as part of a quotation response should remain confidential except in the public sector where statutes may require that it become public information. C) General format/content of bid requests Generally, a solicitation should include the following information: A complete specification of the item or SOW of the service to be quoted. The quantity to be quoted. Where and when the items are to be shipped or installed, or where and when the services are to be performed. The due date of the quotation. Product or service due date.

An EOI, or expression of interest, may be issued as a preliminary step to formal solicitation. An EOI will contain sufficient information from the above list, although not at the same level of detail, to allow an organization to decide whether or not it wants to be a prospective bidder. D) Fair response time The analysis and bid preparation process required by suppliers should be considered when stipulating the response time. The purchaser should not make it unduly short so as to eliminate potential suppliers. Issue dates Care must be taken as to when a solicitation package is issued. The issue date affects the receipt date and the opening and closing dates. If possible, do not issue a solicitation on dates that will place the closing date on a holiday when mail delivery may be affected or the purchasers office may be closed. Also, if possible, do not issue solicitations during the affected suppliers peak season. This may reduce the number of responses and increase prices. Appropriate planning by the internal customers and purchasing staff can remedy these situations. On the other hand, issuing solicitations during off-seasons for the affected suppliers may result in better pricing and other concessions. Opening/closing dates One of the key pieces of information in the solicitation proposal is the due date of the quotation. RFQs and IFBs normally have opening dates while RFPs have closing dates. The purchaser needs to consider the complexity of the bid, the timing constraints within the buying organization, and the number of bids concurrently issued to the same group of suppliers. Bid due dates should be realistic and enforceable.

E)

F)

5)

PROCEDURE FOR CANCELLATION OF SOLICITATIONS Each quoting supplier should be notified in writing as quickly as possible if the buying organization decides to cancel an in-process solicitation to avoid unnecessary work for the supplier. 51

Task 108 6) REGULATIONS AFFECTING THE BIDDING PROCESS A)

Module 1

Oral vs. written quotes Oral bids (telephone quotations) are generally used only for low-value purchases and typically, the request is made by phone. The supplier is given an identifying order number, and is advised that no confirming written document will be forthcoming. However, under a law known as the Statute of Frauds, such an oral arrangement may not be enforceable. If the order is for goods, under the Uniform Commercial Code (UCC) such an oral agreement may not be enforceable if the goods are valued at $500 or more. If services are involved, an oral agreement may not be enforceable if the services cannot be performed within a year from the date of the agreement (see Task 113 for a discussion on the Statute of Frauds). Existing product compatibility In cases where the item to be purchased must work with existing items, for example equipment or software, it may be appropriate to limit the bidders to only those authorized as providers of the desired item. Another exception may be to maintain standardization of a product or product line. For example, keeping one brand of pumps to reduce the spare parts requirements and increase maintenance productivity. Electronic solicitations (FAX, EDI) As a general rule, documents transmitted by facsimile are considered as valid as the original documents. Establishing beforehand acknowledgement and acceptance of the purchasing organizations terms and conditions as a part of business transactions conducted via fax with suppliers is important. Purchasing must ensure a process is in place to ensure terms and conditions are sent. Similar conditions apply with e-mail processes.

B)

C)

7)

REGULATIONS INFLUENCING PRICES AND CONTRACTS Many federal, state, and local regulations or laws affect how business is conducted and that are applicable to purchasing activities in varying degrees. The most frequently cited are: A) Uniform Commercial Code (UCC) Article 2, Sales This law, first proposed in 1954, and its several revisions, have generally been adopted by all states in the United States except Louisiana. This law includes a variety of default provisions that take effect if the contracting parties are silent on those particular issues. With regard to pricing, the Code provides that where the parties do not settle the price, the price is a reasonable price at the time for delivery (see Task 113). Article 2A addresses Leasing and an Article 2b is in development that will cover Licenses. Antitrust and Trade Regulation The following are federal laws regulating commerce. 1.0 Sherman Antitrust Act This Act prohibits contracts, combinations, and conspiracies that result in a restraint of trade. Whether a business arrangement or agreement can be construed as a conspiracy in restraint of trade depends on the facts and circumstances involved. In most cases, the courts apply the rule of

B)

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Part B: Preparation of Solicitations

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reason. The court will decide if the facts show a reasonable and understandable business arrangement, or a conspiratorial arrangement designed to impair the free market system. Purchasing activities potentially covered by the Sherman Act include reciprocal buying and group boycotts (including consortium buying arrangements). 2.0 Clayton Act The Clayton Act deals with (among other things) trade practices like tying arrangements, full-line forcing, and exclusive dealing, which are unlawful where the effect may be to substantially lessen competition or to create a monopoly. Tying occurs when a supplier requires the purchaser to buy one product in order to obtain another. Such arrangements are expressly forbidden, including when a manufacturer makes pricing for two items so unreasonably attractive relative to the items individual prices that the purchaser must buy the total package. Robinson-Patman Act The Robinson-Patman Act prohibits price discrimination for goods of like grade and quality where the end result may be to substantially lessen competition or tend to create a monopoly. Discriminations in services and promotions that are connected with the sale of a product can be unlawful even where there is no injury to competition. The provisions of the Act that apply to purchasing are: Prohibition of direct and indirect price discrimination where those price differences substantially lessen competition. Prohibition of a supplier from paying a commission to a purchaser and prohibiting a purchaser from accepting it. Requiring that payments made by a supplier to a purchaser for any facilities or services furnished by the purchaser be equally available to all other customers. Requiring that facilities or services furnished to a purchaser by the supplier be equally available to all of the suppliers other customers. Prohibition of a purchaser from knowingly inducing or receiving price discrimination.

3.0

The law allows the supplier to offer lower prices if it is done in good faith to meet an equally low price of a competitor. Discriminations are also permitted where there is cost justification for the differences. Typically, these differences apply to the cost of production and distribution, and to deteriorating, perishable, or seasonal goods. Thus, quantity discounts must be offered equally to all purchasers, and traceable to the economics of quantity production and distribution. RobinsonPatman does not prohibit price reductions, only discriminatory and preferential pricing. Additionally, if goods are made specifically to a purchasers specifications, a supplier may offer a lower price to one purchaser than another because the products are not of like grade.

53

Task 108 4.0

Module 1 Federal Trade Commission (FTC) Act This Act created the FTC in 1914 and gave it the power to determine the meaning of restraint of trade. The FTC is charged with uncovering unfair methods of competition and unfair or deceptive practices in commerce. All proposed corporate mergers must undergo the FTC test for unfair competition.

C)

Regulation of Federal Procurement and Public Projects 1.0 Federal Acquisition Regulations (FAR) This is the body of primary regulations used by all federal executive agencies in the acquisition of supplies and services with appropriated funds. The FAR are a compilation of all the laws and policies governing the federal procurement process. As part of federal procurement policy Congress also created the Federal Acquisition Regulatory Council, which consists of the head of the Office of Federal Procurement Policy and the heads of three major procuring agencies: the Department of Defense, the General Services Administration, and NASA. The Council is given authority to assist in the direction and coordination of government-wide procurement policy. 2.0 3.0 Defense Acquisition Regulations (DAR) This set of regulations constitutes a further refinement of the FAR for use specifically by the Department of Defense. False Claims Act This Act provides for the recovery of damages and remedies upon proof of loss to the government sustained through fraud in the award or performance of government contracts. Davis-Bacon and related acts These Acts are intended to give local laborers and contractors a fair opportunity to participate in federal building programs and to protect local wage standards. Some state and local governments have similar laws. Prompt Payment Act This law provides requirements to government procurement offices that ensure that federal contractors supplying goods and services are paid on time. Many state and local governments have similar laws. Service Contract Act The Wage and Hour Division of the Employment Standards Administration is responsible for predetermination of prevailing wage rates for federal service contracts, and for a continuing program for determining wage rates for such contracts. Walsh-Healey Public Contracts Act This Act, adopted in 1936 and amended in 1994, is similar to the Davis-Bacon Act and applies to federal government purchasing and contracts for material, supplies, and equipment exceeding $10,000. In addition to minimum wage specifications, the law

4.0

5.0

6.0

7.0

54

Part B: Preparation of Solicitations

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requires no more than 40-hour workweeks and minimum age limitations for workers. The Act also outlaws unsanitary, hazardous, or dangerous working conditions. Contractors who breach these requirements have their names listed and distributed, and are ineligible for federal contracting for three years. 8.0 Small Business Act Congress passed the Small Business Act to ensure that small businesses receive a fair share of the governments procurement expenditures. Two types of procurement from small business exist: (1) those assigned solely to small business, and (2) those divided between small and large business. Before solicitation packages are issued, the government purchaser determines if the purchase has small business application. Bid packages are issued to suppliers accordingly. In the case where the business is to be divided, small businesses are given an opportunity to match the bids submitted by large businesses, since the government does not pay a premium price to source from small ones. Amendments to this Act extend its coverage to women-owned businesses and to businesses owned and controlled by socially and economically disadvantaged individuals. Buy American Act This Act requires that government purchases for public use consist only of raw materials mined or produced in the United States, or manufactured items that are made in the united States from materials or items mined, produced, or manufactured in the United States. Exceptions to this requirement are: Items that are not available in the United States in commercial quantities of good quality. The cost of the domestic items is unreasonable (generally, if the cost of the domestic items is greater than 6 percent more than the cost of comparable foreign items). A small purchase with a value of $100,000 or less. The head of the department decides that it is in the public interest to waive the requirement.

9.0

Note that various government agencies might have different dollar thresholds. D) Regulation of International Commerce 1.0 Trade Agreements Act of 1979 This law facilitates the approval and implementation of various trade agreements, fosters growth and maintenance of an open world trading system, expands opportunities for U.S. commerce in international trade, and improves the rules of international trade and provides for their enforcement. Foreign Corrupt Practices Act Adopted in 1977 and amended in 1988, this law prohibits the bribing of foreign officials. In more specific terms, it prohibits any payment, offer, gift or promise to foreign officials meant to influence the 55

2.0

Task 108

Module 1 award of business. The law allows payments for reasonable expenses incurred by foreign officials in connection with the promotion, demonstration, or explanation of products and with the execution or performance of a contract. 3.0 North American Free Trade Agreement (NAFTA) The major provisions of this law define the regulations for breaking down trade barriers between the United States, Canada, and Mexico. Negotiations are now taking place with Chile to perhaps become the fourth country to join. Major provisions include: tariffs and customs, import and export restrictions, industry-specific provisions, emergency actions, and dispute settlement. General Agreement on Tariffs and Trade (GATT) GATT, the organization, was replaced by the World Trade Organization (WTO) in 1995. GATT, the agreement, is now part of the WTO agreements. GATT deals with trade in goods, the General Agreement on Trade in Services (GATS) deals with trade in services, and the Agreement on Trade-Related Aspects of Intellectual Property (TRIPS) deals with such issues as copyright, trademarks, patents, industrial designs, and trade secrets (see www.wto.org for more information). United Nations Convention on Contracts for the International Sale of Goods (CISG) This treaty was designed to bring some uniformity to the rules governing international sales transactions. The treaty represents a compromise of the diverse laws and philosophies found in the legal systems of the United States, Europe, and Latin America. Some of its provisions are in conflict with the provisions of the Uniform Commercial Code. The U.S. Senate ratified the CISG in 1986, and as of this writing it has been ratified by over 40 nations including Canada, Mexico, many European countries, and a number of other countries from around the globe. Additional nations may join the Convention as their legislatures act. Because the United States has chosen to abide by this law, purchasing officers and legal counsel must observe the terms of the CISG unless the parties have agreed beforehand to waive it and apply the law of the country in which either the purchaser or the supplier is located. Like the UCC, the CISG is not intended to cover the sale of services. Recognizing that some contracts could cover a combination of goods and services, the law does not apply to contracts in which the provision of labor or other services outweighs the supply of goods. The following Internet site provides useful information about the CISG: www.cisg.law.pace.edu

4.0

5.0

E)

Americans with Disabilities Act This law and the regulations promulgated under it set forth standards for access in and around buildings and facilities, and to services provided by the private and public sectors. Department of Agriculture rulings The Department of Agriculture is responsible for rulings that may affect prices and contracts. For example, implementation of the Hazard Analysis and Critical Control Point (HACCP) Systems in meat and poultry

F)

56

Part B: Preparation of Solicitations

Task 108

plants may increase costs of a supplier and could be relevant when a purchaser is creating a specification for the purchase of a product covered under this regulation. G) Government price support regulations Purchasers, especially those involved in the food industry, need to be aware of federal and state regulations that may affect prices and contracts. For example, peanut butter and nut prices continue to be affected by a depression-era program that props up peanut prices. Similar subsidies influence the price of sugar. Other federal/state/local law In addition to federal, state or local regulations thamay affect the purchasing professional, the courts and various government agencies have expanded legal requirements through their interpretation and application of these various acts.

H)

8)

TERMS AND CONDITIONS OF SOLICITATIONS AND OFFERS A) Types A contract consists of both custom and standard terms and conditions. Standard terms and conditions are those that an organization desires to apply to every contract. Potential issues standard terms and conditions may deal with include: changes to the contract, cancellation, subcontracting, confidentiality, delivery, shipping, indemnity, legal venue, applicable laws, inspection, payment terms, packaging, and warranties. Custom terms and conditions are those that are unique to the specific contract or purchase order. Custom terms and conditions may address things such as acceptance testing, updating service information, emergency services, financing, installation, training, initial provisioning, maintenance, spare parts, and contract renewal. B) When to use It is appropriate to include all terms and conditions on all solicitations. It avoids surprises and disagreements later in the award process.

9)

BONDS AND OTHER TYPES OF SURETY In general, bonds increase the cost of bidding and tend to reduce competition. The use of bonds does not guarantee financial recovery. Failure of suppliers to meet the performance requirements of a contract can generally be handled by the purchasers legal department. A) Bid bonds Bid bonds, sometimes used by government agencies and in construction bidding, bring a third party into the transaction. A bid bond guarantees that if the order is awarded to a specific bidder, it will accept the purchase contract. If the bidder refuses, the extra costs to the purchaser of going to an alternative source are borne by the insurer. Performance bonds Often used in international sourcing and construction bidding, the purchaser can, as a condition of doing business, require the supplier to post a 57

B)

Task 108

Module 1 performance bond guaranteeing prompt delivery of goods that meet specifications. In the case of construction projects, a performance bond guarantees that the work done will be completed according to specification and time requirements if the supplier fails.

C)

Payment bonds The payment bond protects the purchaser against liens that may be filed by employees or subcontractors against the purchasing organization if the prime supplier does not pay its suppliers or employees. Deposits Bid deposits may be requested for certain substantial bids as a device to discourage financially unstable suppliers. Bid deposits generally cover the amount in liquidated damages to which the purchaser would be entitled should the supplier not perform to the terms of the agreement. Letters of credit A letter of credit, normally used in international business transactions, is a document that assures the seller that payment will be made by the bank issuing the letter of credit once the terms of the agreement have been met. Real estate The purchaser could require the supplier to put other assets, such as real estate, into an escrow account as a form of surety that the supplier will meet its obligations or forfeit the asset. Cash Cash is another asset that can be required to be set aside to guarantee performance. Normally this would not be a good approach since it may affect the suppliers liquidity and its ability to performance because it may not be able to purchase the necessary materials and services.

D)

E)

F)

G)

10)

PROBLEMS RELATED TO THE SOLICITATION AND RECEIPT OF OFFERS During the course of competitive quoting, problems may arise that require action on behalf of the purchaser. These problems typically include one or more of the following: A) Time extensions and amendments to solicitation If one supplier is granted a time extension to respond to a bid, all suppliers must be notified that they are granted the same extension. Changes to the original bid must be communicated to all suppliers bidding in a consistent and timely manner. Late bids (without time extensions) The purchaser must make clear the organizations policy relative to late bids before issuing a quotation. The practice of not accepting late bids and returning them unopened is common. Offers with errors, irregularities, or omissions If a supplier identifies a mistake in a bid after submission, it is good practice to allow that supplier to cancel or withdraw the bid. Courts allow the withdrawal of bids only after determining: (1) that the mistake was mechanical or clerical in nature not an error in judgment, and (2) that the bidder was not guilty of blame-deserving negligence in making the error or in 58

B)

C)

Part B: Preparation of Solicitations

Task 108

delaying notification to the purchaser of the error. Take caution to ensure that a supplier does not repetitively make these types of mistakes. If an error, irregularity, or omission is so out of proportion as to indicate a mistake, the purchaser should seek confirmation of the bid from the bidder before proceeding with the award. If a mistake is confirmed, the bidder should be allowed to cancel or withdraw the bid without penalty. D) Conflicts of interest Fundamental ethical practice requires that no employee of an organization who has any authority to purchase goods or services or is in a position to influence decisions in any way with respect to purchases, should be employed by, hold any position with, serve as a director of, have a financial interest in, or business relationship with any outside concern that is a supplier of goods and services to the buying organization. Protests Suppliers are entitled to a reasonable explanation if not selected. However, take care not to disclose the information contained in competitors bids unless, as with a public purchase, such disclosures are required by law. General information provided to the supplier will assist in better meeting the needs of the purchaser during the next quotation process. In the public sector, if a supplier or prospective supplier disagrees with an action or decision of the purchaser, it may file a protest and request an administrative review of the action or decision. Confidentiality/security As with all purchasing documents, files containing bids should be secured to prevent unauthorized access. Confidential information about one supplier should not be shared with others. Alternate proposals Suppliers often propose work (products or services) that is different from those specified by the purchaser. Many of these proposals have merit, and a policy of whether and how to consider these is often implemented by organizations. Debriefing process When the award is made and the contract has been signed, some organizations have a policy of advising all suppliers of the name of the successful organization. The debriefing process should also include internal customers. The end-users must be advised as to whom the successful organization is and any necessary arrangements made for introductions of staffs that will be working together. Depending on the project, the appropriate internal customers may also need to be debriefed. Any thirdparty organizations that will be involved in the contract should also be advised as soon as practical.

E)

F)

G)

H)

BIBLIOGRAPHY Caffrey, B.G. Electronic Commerce: Putting Information Technology to Work Today, Proceedings of the 1997 NAPM International Purchasing Conference, NAPM, Tempe, AZ, May 1997, pp. 148-153.

59

Task 108

Module 1

Cafiero, W.G. Using the Internet for RFQ Management, Proceedings of the 1997 NAPM International Purchasing Conference, NAPM, Tempe, AZ, May 1997, pp. 442-446. Hendrick, T.E. Looking to the Future, Purchasing Today , August 1997, p. 54. Hirst, J.F. An Invitation for Success, NAPM Insights, June 1995, p. 5.

60

TASK 109: Manage and develop lists of recommended sources.

Purchasing departments, other than those in the public sector, often categorize suppliers according to certain criteria for purposes of selection. This categorization entails a major commitment of time and effort, but it can reduce the work of purchasing personnel. Terms such as preferred, partnered, certified, and pre-qualified suppliers have various meanings in practice, but they generally indicate that the organization has evaluated these suppliers as possessing the quality and operating systems that meet the needs of the purchasing organization. In the evaluation process, a purchasing organization may evaluate not only its primary suppliers but also second- or third-tier suppliers that support its primary suppliers. This type of evaluation gives the purchasing organization a higher level of confidence in its primary suppliers capabilities. Purchasing organizations that have established lists of recommended suppliers may also have a process to recognize supplier performance over a period of time. When a suppliers performance remains high over a period of time, they achieve a higher level of recognition by the purchasing organization. As the supplier achieves each level, a higher level of trust, improved integration into the purchasers organization, and an increased use of quality systems or SPC to monitor performance results are achieved. Purchasing organizations may use these categories in different order to meet their specific needs. 1) TYPES OF SUPPLIER LISTS A) Approved suppliers An approved supplier is one who has passed the necessary technical requirements. This may include submission of samples for testing or other steps to approve the item or service to be purchased. It may also include inspection of the suppliers manufacturing and quality systems. Preferred suppliers A preferred supplier is one that provides desirable quality, delivery, or prices for a purchaser, and reacts positively to unforeseen needs such as changes in business volume, changes in specifications, service problems, and so on. Such suppliers take the initiative in suggesting better ways of serving the customer, finding ways to enhance products or services to better suit customer needs, and warn customers in advance of factors that might affect the purchasers operations. In public purchasing preferred sources might include prisons, handicapped workshops, and other social program organizations. Partnered suppliers The term partnership or partnered supplier refers to a close relationship with a supplier. Such relationships are usually built around longterm arrangements, large-volume commitments, and joint product or service development and production-planning efforts. Electronic links between the organizations may automate ordering and delivery scheduling. Such arrangements generally work best where there is a mutual benefit in forming a relationship (i.e., to compete with another set of organizations for the same customers).

B)

C)

61

Task 109

Module 1 Many organizations are moving away from use of the word partner because of its specific legal meaning. In many organizations, terms such as strategic alliances and special relationships are used to indicate a supplier association that is based on more than the traditional price-based, arms-length model (see also Task 212).

D)

Certified suppliers A certified supplier is one whose enterprise-wide quality-control system is integrated with a purchasers enterprise wide quality-control system, and through which a larger quality assurance system is established. In this way, total costs associated with quality are reduced through the elimination of duplicate efforts and use of Statistical Process Control and other quality control processes and information sources. The purchasing organization typically defines the standards suppliers must meet to become certified. Pre-qualified suppliers Pre-qualified suppliers are added to an organizations approved supplier list when they have passed a purchasing organizations preliminary screening. This consists of examining them closely to determine such factors as financial strength, facilities, location, size, technology, labor status, management, costs, terms, references, and other factors. Such suppliers are thereby pre-qualified to do business with the purchasers organization. Certifiable suppliers A certifiable supplier is one that is not currently certified by the purchasing organization but is either in the process of becoming certified, may already be certified by another division of the same organization, or may be certified by another organization. Disqualified suppliers A disqualified supplier is one that has failed to meet the standards required by the purchaser or failed to perform on past contracts. Typically, a supplier would not be disqualified until several corrective steps had been taken to attempt to correct the underlying performance problems. Disqualifying a supplier is a last resort.

E)

F)

G)

62

TASK 110: Evaluate competitive offerings to determine the overall best offer for a product/service.
The evaluation of supplier quotations to determine the best overall competitive offering for a product or service is one of the primary responsibilities of purchasing. Each situation should be handled in the manner best suited to the circumstances at hand, but it is sound practice to adopt an overall framework within which to work. 1) RECEIVING, CONTROLLING, AND ABSTRACTING OFFERS As quotes are received by mail, courier, fax, or e-mail, the purchaser should log them in according to the date received, and should file them with the original bid package. When all of the quotes have been received against a specific bid, or on the bid due date, the purchaser should prepare a brief summary of the quotations, noting the salient information in a comparison chart or spreadsheet, and identify the most likely supplier to be selected. 2) OFFER RESPONSIVENESS A) Specifications/statements of work Perhaps the most critical aspect in evaluating bids offered by suppliers is to ensure that the quotation, or the statement of work within the bid response, meets the specifications and requirements of the initial RFQ, RFP, or RFI package. This is important for two reasons: The purchaser needs to ensure that the supplier will meet the specifications, requirements, or statement of work defined in the solicitation. If not, the purchaser must be aware of the implications in accepting the bid. Not meeting specifications or submitting an alternate statement of work can have either a positive or negative affect on the purchasers business. At best, it can result in an alternate design or service at a lower cost, which may be acceptable to the purchasers organization. At worst, it may cause quality concerns or it may not meet the minimum requirements defined by the buying organization. Purchasers have the responsibility to ensure that: (1) suppliers are quoting to specification, or (2) the quoted exceptions are acceptable to the total organization. To fairly evaluate all quotes received, suppliers must quote based on a comparable set of specifications or a comparable statement of work. Otherwise, it is extremely difficult to determine which supplier offers the most competitive package.

B)

Quality requirements As with the base specifications and statement of work, suppliers must be aware of the quality requirements and all other terms and conditions for the goods or services as part of the initial solicitation package. In their responses, suppliers must acknowledge that they will meet these requirements. If suppliers quote exceptions, it is the purchasers responsibility to ensure that the organization fully 63

Task 110

Module 1 understands the affect of each exception, and the purchaser must determine whether the alternative proposals are acceptable.

C)

Terms and conditions Most solicitations include a set of contract terms and conditions that the purchaser has developed to match the risks and issues related to the product or service being considered. Suppliers typically respond with alternative language to reduce their risks. Including these contract terms and conditions in the solicitation allows the purchaser to consider contractual issues along with other aspects of the evaluation. Product/Service substitutions Purchasing organizations often will not consider an alternative proposal unless the supplier has also quoted the specific item or service requested. Use of technical proposals (un-priced) Pre-sale technical service is offered by some companies as a part of the quotation process, particularly when technical products or services are being purchased. Purchasing must ensure that it does not take unfair advantage of suppliers offering pre-sale technical assistance, but at the same time ensure that it receives all of the assistance to which it is entitled prior to award. Acceptance of more pre-sale service than is customary in the industry may obligate the organization to more than is anticipated.

D)

E)

3)

TECHNICAL ANALYSIS Technical analysis involves determining if the suppliers proposal will satisfy the specifications or statement of work. Purchasing should actively involve the engineering, manufacturing, materials control, operations, and other using departments in the technical analysis of the bid. This is a natural extension of involving these departments in the initial definition of specifications or statement of work.

4)

OPERATIONAL ANALYSIS This consists of evaluating the feasibility of the product or service being purchased. Though it might be technically capable of the work, organizations often conduct an operational analysis to verify the economics, ease of use, and functioning feasibility of the product or service.

5)

COST AND PRICE ANALYSIS A comprehensive cost analysis begins with an understanding of the industry that the potential suppliers represent as well as an understanding of each suppliers supply chains. This analysis is completed prior to the solicitation and provides industry-wide data on which the competitive offerings will be evaluated. This analysis includes: The structure of the industry such as monopoly or open competition. The market structure, such as global versus domestic. 64

Part C: Supplier Analysis Cost drivers and price trends. Technology trends and barriers to entry by new competitors.

Task 110

Cost or price analysis is frequently the most important element of the bid evaluation process. Cost or price analysis is often done by purchasing, sometimes with the involvement of finance, using an engineering estimate, or sometimes by a cross-functional team. Several types of cost/price analysis can be applied, but generally only one method is used to evaluate a specific quotation. A) Price analysis methods Price analysis is the examination of a suppliers price proposal (bid) by comparison with reasonable price benchmarks, without examination and evaluation of the separate elements of the cost and profit making up the price. Some form of price analysis is required for every purchase. Price analysis can be accomplished by analysis of competitive price proposals, comparison with catalog or market prices, comparison with historical prices, or use of independent cost estimates. Profit analysis To maintain good supplier relations, it is important to provide the supplier with a reasonable profit to pursue the business in the first place and to continuously deliver future products or services. Analysis of costs versus profits is important to assess the viability of the supplier and subsequently their quotation. Total cost vs. unit price Price is just one element of total cost. Total cost includes other costs of ownership of the product such as acquisition, transportation, duty, brokerage fees, cost of quality, cost of accounting practices, cost of late delivery, and cost of customer support. Analysis of total cost provides a clearer picture of the complete financial implications of a purchase. The use of total cost for evaluating quotations is an increasingly accepted purchasing practice in both the public and private sectors. 1.0 Activity-based Costing Activity-based costing is an approach that recognizes that not all activities and processes use the same amount of indirect resources. Activity-based costing is an allocation approach that uses multiple indirect cost pools with different cost drivers rather than a single cost pool (see Task 104).

B)

C)

D)

Learning curve At the outset of manufacturing a new product, it is reasonable to assume that the supplier will use extra time or material while learning how to produce the product efficiently. As time progresses or as volume increases, the supplier has the opportunity to capitalize on manufacturing efficiency to reduce overall manufacturing costs. This learning curve helps the supplier become better able to offer more attractive pricing once a product is in production. The learning curve concept also applies to purchased services. Life-cycle costing A cost-analysis tool is a tool which incorporates not only the purchase price of a piece of equipment, but also all operating and related costs over the life of the item, including maintenance, down time, energy costs, and salvage value. Prior to calculating costs in terms of net present value, the purchaser must first define the key operating cycle for the equipment, and all the other factors that affect costs. Life-cycle costing assists in evaluating equipment purchases with different initial purchase prices and different operating costs over the useful life of the equipment. 65

E)

Task 110 6) OFFEROR CAPABILITY/OFFEROR RESPONSIBILITY

Module 1

Purchasing should review the following aspects of a suppliers ability to meet the requirements of the contract should the supplier be awarded business by the purchasing organization. A) B) C) D) E) F) Past Performance The past performance of a supplier on similar jobs and implications for performance on future contracts should be carefully evaluated. Capacity What is the suppliers capacity to take on additional business? Skills The skills the supplier has to manage the specific product or service in question. Integrity What has been the suppliers integrity and conduct in past business dealings? Time in business/market How long has the organization been in this line of business, and what track record and evidence of sustainability does it have? Certification and licensing Confirmation may be necessary in order to verify that a supplier has the appropriately documented certifications and licenses. For example, these could include rights to use for software or other intellectual property that is part of a proposal, or that the suppliers facility has an ISO 9000 or other certification(s) that indicate a certain level of quality, technical competence, or other qualification. Financial factors A variety of financial factors may influence the final selection of a supplier. When financial information will be required for analysis by the purchaser, it is prudent to ask for the information in the RFP or RFQ (see Task 111).

G)

7)

TRANSPORTATION TERMS Transportation costs often comprise a significant portion of the cost to obtain a product and consequently should be carefully evaluated. A) International transportation terms The most frequently used international terms are the INCOTERMS. These terms are controlled by the International Chamber of Commerce and determine: (1) who will pay the freight, (2) who will be liable for customs duties, and (3) who will bear the risk of loss of the cargo. Thirteen INCOTERMS define the different points where responsibilities are transferred from the seller to the purchaser. See www.iccwbo.org for a discussion of the INCOTERMS. The INCOTERMS are: EXW EX WORKS (... named place) FCA FREE CARRIER (... named place) FAS FREE ALONGSIDE SHIP (... named port of shipment) FOB FREE ON BOARD (... named port of shipment) CFR COST AND FREIGHT (... named port of destination) CIF COST, INSURANCE AND FREIGHT (... named port of destination) CPT CARRIAGE PAID TO (... named place of destination) CIP CARRIAGE AND INSURANCE PAID TO (... named place of destination) 66

Part C: Supplier Analysis B)

Task 110

DAF DELIVERED AT FRONTIER (... named place) DES DELIVERED EX SHIP (... named port of destination) DEQ DELIVERED EX QUAY (... named port of destination) DDU DELIVERED DUTY UNPAID (... named place of destination) DDP DELIVERED DUTY PAID (... named place of destination)

Domestic transportation terms The four key issues related to the domestic transportation terms used between a purchaser and supplier are: title transfer of the goods, filing of claims if necessary for loss or damage, administrative processing of the freight invoice, and responsibility for the transportation costs.

The chart shows the responsibility between the supplier and purchaser for six major sets of shipping terms. FOB stands for Free on Board. Primary Shipping Terms 1. FOB Origin, Freight Collect Ownership Transfer Purchaser owns goods in transit. Title passes to purchaser at sellers dock. Purchaser owns goods in transit Title passes to purchaser on sellers dock. Purchaser owns goods in transit. Title passes to purchaser on sellers dock. Seller owns goods in transit. Title passes to purchaser at purchasers dock. Seller owns goods in transit. Title passes to purchaser at purchasers dock. Seller owns goods in transit. Title passes to purchaser at purchasers dock. Files Claims for loss or damage Purchaser Processes Freight invoices Purchaser Responsible for freight costs Purchaser

2. FOB Shipping Point, Freight Allowed 3. FOB Origin, Freight Prepaid and Charged Back 4. FOB Destination. Freight Collect 5. FOB Destination Freight Prepaid 6. FOB Destination Freight Collect and Allowed

Purchaser

Seller

Seller

Purchaser

Seller

Purchaser

Seller

Purchaser

Purchaser

Seller

Seller

Seller

Seller

Purchaser

Seller

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Task 110 8) OTHER FACTORS A)

Module 1

Availability Do the materials or services currently exist? How might availability affect the decision to buy? Will other materials or services be available in the market place shortly? Leadtime Leadtime in purchasing is the time between the recognition of a need or a suppliers receipt of an order, and the receipt of the goods by the purchaser. Individual components of a total leadtime can include planning, manufacturing testing, and delivery leadtime. When multiple links between purchasers and sellers exist the leadtime includes the sum, or total, of all the organizations leadtimes. Logistical concerns Unique items may require special planning and permits examples of these are large reactors or tanks, fabricated steel items, and dangerous chemical materials.

B)

C)

BIBLIOGRAPHY International Chamber of Commerce, Paris, France, www.iccwbo.org. Locke, D. Global Supply Management, McGraw-Hill, New York, NY, 1996. Porter, M.E. Competitive Advantage, The Free Press, Division of Simon Schuster, New York, NY, 1985. Woods, P. Adding it Up: Performing Effective Supplier Price and Cost Analysis, NAPM InfoEdge, (3:10), June 1998.

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TASK 111: Conduct supplier visits/evaluations to determine suitability.

Information generated during a supplier visit or evaluation enables purchasers to ascertain the suppliers capability to meet forecasted needs for a quality product or service, on-time, at a competitive price. Visits also show support for a continuing relationship and help with the joint development of suggestions for process and quality improvements. 1) FACTORS USED TO ANALYZE A SUPPLIERS ABILITY TO PERFORM Purchasers should visit potential suppliers early in the development phase of the product or project to suggest improvements and perhaps trigger a need to review alternative sources if the audit results are not favorable. Suppliers who appear to be good candidates on paper may actually have old facilities in disrepair, outdated technology, or an overall inability to meet a purchasers needs. Some of the items to be considered when analyzing the suppliers ability to perform include: A) Frequency and/or volume of orders How important will the purchasers business be to the supplier? If his or her business occupies a major portion of the suppliers overall work, the purchaser is more likely to get favorable treatment and higher priority. Length of time to process orders How long does it take, on average, for the supplier to process orders? Long order processing leadtimes increase total leadtime which could result in a great deal of follow-up or expediting. Delivery Does the supplier have sufficient facilities or the capacity to deliver ordered materials on a schedule that is acceptable to the purchaser? Quality Is there evidence of a Total Quality Management (TQM) philosophy? What mechanisms does the supplier have in place to maintain quality? What is its record with regard to quality? Do many of its products need to be returned? How have other purchasers found the quality of materials produced by this supplier? Product/service expertise Is this product one in which the supplier has extensive experience or expertise, or is it merely a side-line activity? What is the level of regular and special service provided by the supplier? Order backlog Is the organizations productive capacity over-booked? Is it operating efficiently? Is there a great backlog of orders? Have leadtimes been lengthening or shortening? Contractors make-or-buy program To what extent does the supplier acquire items already produced from its suppliers, or will the items being purchased be solely produced by the supplier?

B)

C) D)

E)

F)

G)

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Task 111 H)

Module 1 Cycle-time/leadtime How long will this be? Can this be improved by giving advanced scheduling notice? Will the prospective supplier agree to a stocking program to provide short cycle deliveries? Productivity Productivity can be defined as the relationship between the organizations output and input. Productivity will vary based on the amount of capital investment, systems, and skill level of the workforce. Mathematically it is calculated as follows: Productivity = Output/Input To maintain and enhance competitiveness, it is essential that productivity be continually improved. This can be achieved in three ways: Improved efficiency or same output with less input. Improved effectiveness or greater output with the same input. Improved or greater output with less input.

I)

J)

Flexibility Flexibility is the willingness and ability to make or adjust to changes. This skill is important in a supplier because it enables the working relationship to be dynamic and responsive to marketplace shifts. Flexibility is both an operational and a mental dimension. As an operational dimension, it means that an organization is capable of frequent adjustments. As a mental dimension, it refers to a mindset that is customer-oriented, one that views change as an opportunity. As with any operation, constant, sudden, and frequent changes can lead to inefficiencies. A good purchaser provides a supplier with as much advance notice as possible about upcoming changes. Flexibility in a supplier is characterized by an open mind, a strong customer focus, and an empowered culture. References A list of other customers the supplier has done business with can serve to verify the quality, delivery, and service the supplier will provide. Electronic capabilities Does the supplier have a Web site? Can they handle EDI or e-commerce transactions? Are they conducting e-commerce with other customers? Do they make use of bar-coding? The investment in electronic capabilities will facilitate business-to-business transactions, reduce administrative costs, and make each party more efficient. Soon the ability to conduct business electronically will be a required criteria. Breadth of product line Does the supplier have the ability to make multiple items or provide a variety of services? The ability to place more business with one supplier facilitates supply base reduction, allows for volume leveraging, obtaining better prices, and improves transportation efficiencies. Available capacity Current operating capacity is the output level at which the organization is currently running. This should be compared to theoretical capacity.

K) L)

M)

N)

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Part C: Supplier Analysis

Task 111

Theoretical capacity is the optimum output under ideal conditions. Comparing theoretical to current level will provide an idea of the excess capacity available. Most organizations can expand capacity in the short term through overtime or working additional shifts. When this ratio of current operating capacity to theoretical reaches 90 percent or above, the organization is fairly close to reaching its practical capacity. O) Supply base What is the extent of the suppliers relationships with its key suppliers? What strategies does it have in place for managing its suppliers? How many suppliers does it have? What percentage of its supply base is certified? What percentage of its purchases come from certified suppliers?

2)

FACTORS USED TO ANALYZE A SUPPLIERS FINANCIAL STATUS A comprehensive review of the suppliers financial data provides the purchasing manager with good information on where the organization has been, and where it is going (see Task 104). A) Balance sheets This shows the financial position for an organization at a given point in time. Organizational assets, or what the organization owns (assets) and what it owes (liabilities) are shown. Assets are composed of money the organization has, money that it is owed, and property that it owns. Liabilities are comprised of debts, including bonds and notes. Careful analysis of the balance sheet will tell the purchasing manager the current state of the organizations financial condition. Income statements This shows earnings for a given period (usually one year) and will reconcile earnings from sales against cost of goods sold to produce net income. Net sales, the first item on the income statement, is calculated by reducing gross sales by the amount of returned goods to produce net sales. Gross profit is computed by subtracting cost to produce the goods from net sales. Gross profit minus total expenses (sales expense, interest, and taxes) equals net income. Cost control history What steps has the supplier taken, if any, to reduce costs? A purchaser should analyze such information as well, to determine if the supplier is adding costs to the selling price that could be reduced or eliminated. Credit ratings Excessive debt, large accounts payable, declining sales, and poor cash flow suggest that a supplier has a poor credit history and is not likely to get additional loans, and therefore may not be able to come up with the resources to meet the purchasers needs. They also suggest that a supplier is on shaky ground, and may go into bankruptcy in the near future. Annual reports (audited) An annual report is a document generated by all publicly held companies at the end of the fiscal year. The annual report contains a substantial amount of financial information for beginning a supplier evaluation, including balance sheets, income statements, and other statements of financial performance (retained earnings and cash flow) for the previous three or four years. These reports typically

B)

C)

D)

E)

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Task 111

Module 1 contain information on how the business fared in the past year, its outlook, new products, new developments, and data on outstanding stock, acquisitions, and debt.

F)

10-K reports The Securities Exchange Commission (SEC) requires that all publiclyheld companies issue a10-K report annually and a 10-Q report quarterly. These reports provide greater detail on items of interest to purchasers such as earnings, assets, and liabilities than the annual report. If the data is electronically filed it may be available at www.sec.gov/edgarhp.htm. Financial advisory reports The business section of a public library has information on the industry with which each supplier operates, its ranking within that industry, and the long- and short-term factors affecting that industry. Examples include Moodys, Standard and Poors, and Hoovers online (www.hoovers.com). Dun and Bradstreet reports Dun and Bradstreet (D&B) reports provide credit information about the suppliers payment history such as whether the payments were made in full and whether they were on time, history about the organization, and the educational level and experience of key management staff. Because privately held organizations have no public disclosure requirements, reports from these organizations are limited in many cases by the amount of information that an organization is willing to provide. D&B provides reports on over 50 million domestic businesses in both traditional and Web-based formats. Other factors Additional financial evaluations can be made through ratio analysis. Using balance sheet and income statement data gained from annual reports and other sources, purchasing managers can calculate profit ratios, leverage ratios, returns on sales, and earnings per share ratios that can be compared to those of other organizations in the same industry. A few of the more commonly used ratios are presented in the following discussion. Current ratio is the ratio of current assets or current liabilities. This indicates the ability of a supplier to meet its short-term obligations. Debt to assets is calculated by taking an organizations longterm debt obligations and dividing this by its total assets. This provides an indication of how much of the business is owned by creditors and is often termed the leverage ratio. Profitability is calculated by net profits divided by sales. This indicates how much profit the organization generates on each sales dollar. Profit divided by stockholders equity indicates how much profit the organization is returning on its shareholders investment.

G)

H)

I)

3)

FACTORS USED TO ANALYZE A SUPPLIERS COST SYSTEM For an organization to know whether they are operating within the identified strategic direction is becoming increasingly more important. Central to this strategic thrust are measurement systems designed to track an organizations costs. Accounting systems are a major element 72

Part C: Supplier Analysis

Task 111

of this because of their ability to segregate costs by jobs, tasks, product lines, customers, and so on. Furthermore, from a purchasing standpoint it is important for the system to treat costs consistently from job to job and customer to customer. A) Capability of segregating costs by task Does the suppliers accounting system have the ability to segregate costs by tasks? This segregation will allow both the purchaser and supplier to focus on reducing high-cost tasks. Consistent treatment of cost Are costs allocated fairly across all work? What system is used to allocate these costs? Does the supplier use traditional cost accounting allocations or activity based costing? Activity-based costing is a tool that attempts to more accurately identify and allocate indirect costs to the products they support. ActivityBased Management is an extension very similar to activity-based costing that attempts to identify what factors drive these indirect costs and then identify methods to reduce them (see Task 104). Compliance with cost accounting standards Does the organization use generally accepted accounting principles and abide by the standards of internal costing from such organizations as the National Association of Accountants?

B)

C)

4)

FACTORS USED TO ANALYZE A SUPPLIERS QUALITY ASSURANCE, QUALITY CONTROL, AND RELATED SYSTEMS Close examination of the quality-control side of a suppliers operation is critical for two reasons: the quality of the suppliers product or service directly affects the quality of the purchasers organizations final product, and purchasing is responsible for ensuring the quality of supplies and services. Perhaps the most obvious indicator of a suppliers attention to quality is the existence of a Total Quality Management (TQM) program. TQM is a philosophy whereby there is a never ending quest on the part of all employees to meet or exceed customer expectations by improving quality. Four key indicators highlight the TQM philosophy. They are: The level of top management commitment through policies and actions. The emphasis on educating and training all employees. The evidence of statistical methods to ensure good quality. The seeking and using customer feedback to improve operations and processes.

In addition to the overall TQM philosophy, the quality audit team will examine quality-control procedures, its record keeping, and its compliance with regulations. These details provide proof that the organization embraces an overall commitment to producing a high-quality product. The quality member of the audit team should lead this portion of the site visit with a review of incoming, in-process, and outgoing quality inspection procedures, documentation, and gauge calibration logs and procedures (see Task 207). A) Acceptance/rejection history What do the records indicate about the suppliers performance? Acceptance or rejection history should be readily available and reviewed, 73

Task 111

Module 1 along with traceable records. A check should be made to ensure that measuring device calibration dates have not expired.

B)

Testing capability What abilities does the organization have to detect correct and incorrect work by both the workers and equipment? A batch-sampling technique or some form of statistical sampling procedure will probably be used instead of 100 percent inspection of the incoming components. Final examination of finished product will probably take place in a secured area awaiting final release. Quality control personnel should do the examination and the inspection procedures should be in writing. Test methods, procedures, and instruments should be the same as those used by the purchasers incoming quality-control department to ensure compatibility. All gauges and test devices should be reviewed to ensure calibration dates are current. Shop floor quality checks should be conducted at regular intervals by members of the quality control staff to verify those performed during the process by production floor employees. 1.0 Workers Indicators of worker capability to look for might include the number of hours of SQC or TQM training, worker certifications held, and the use of process control charts by the equipment operators, Machines The equipment capability can be monitored in several ways. The purchaser could look at the maintenance history of key elements in the process for frequency of breakdowns and preventive maintenance activity. The presence of process control charts (see section C below) is another way to monitor machine capability.

2.0

C)

Process control What type of quality detection and correction systems are used? Primary ones in effect today include statistical process control (SPC) and Six Sigma/Cpk Process Bounds. Validation of the manufacturing process should be properly documented. If the organization has a program of Statistical Quality Control or Statistical Process Control (SQC/SPC) in place it should be reviewed. 1.0 Statistical Process Control (SPC)/Statistical Quality Control (SQC) SQC/SPC involves checking products while they are being produced. Samples are periodically taken by line employees and compared to the range of existing tolerance. If a process is out of its tolerance range, it is stopped and corrected. This ensures that no additional out-of-tolerance products are produced. There should be control charts at individual workstations indicating that checks are being made during production. Six sigma/Cpk Process bounds Six sigma is a program that permits only three defects per million parts and it reflects an outstanding commitment to quality. Cpk refers to a comparison of the purchasers specification to the suppliers process capability. Suppliers should have better or equal process capability when compared to the purchasers requirements (see Task 207).

2.0

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Part C: Supplier Analysis D)

Task 111

Organization and management of quality systems What are the overall organizational systems in place for quality? Is it the traditional check after an item was made, or is it a proactive system that checks the work as it is being produced? Documented systems/procedures All inspection procedures should be in writing, and a solid training program with periodic updates should be in place. System certification/validation Purchasers today are applying various types of quality certification upon suppliers. These range from being qualified, to certified, to complete quality assurance. Many forms and distinctions are in use. Quality certification involves a high degree of integration of the suppliers and purchaser quality systems that permit the bypassing of incoming inspection at the purchasers facility. Process certification (ISO) The International Organization for Standardization (ISO) has guidelines on the process necessary to produce quality goods. The major standards in this area are in the ISO 9000 series. If a supplier has attained ISO certification or applied Malcom Baldridge National Quality Award standards to its internal operations then the need for a complete and comprehensive quality audit is reduced (see Task 207).

E) F)

G)

5)

FACTORS USED TO ANALYZE A SUPPLIERS ORGANIZATION AND MANAGEMENT A) Top management commitment and involvement A purchasing organization should carefully analyze a suppliers management staff and available information about its relative turnover, educational background, policies, and future plans. Management is ultimately responsible for the performance of a business and its commitment to keeping the organization a leader in its industry. Stability The prior work experience, length of employment with the organization, and educational background of the suppliers personnel are useful indicators of the organizations technical competence and stability. Suppliers are proud to display this talent in front of a prospective purchaser. Clearly technical capability is a factor when the purchasers organization seeks ideas and input concerning design or operations. Training and certification of personnel A well-documented training program is further evidence of top managements commitment to being an industry leader. The purchaser should inquire about the level and frequency of training throughout the organization. Continuous training implies continuous improvement in skills. Technical competence/Service support An organization that has high-tech, stateof-the-art equipment, plus the talent to support it, and is demonstrating its desire to remain a leader in its industry is an important factor to be considered when analyzing a supplier. Service support is a necessary ingredient to any continuing relationship. The purchaser needs to determine the type of support provided from technical or engineering activities to administrative order follow up work.

B)

C)

D)

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Task 111 E)

Module 1 Equipment capabilities What is the general age and condition of the equipment used in the operations and testing? Has the capability of the equipment kept pace with the technical changes required in the item purchased? General reputation/Ethics Does the organization enjoy a good reputation in the marketplace? Do they have an ethics policy and treat their customers employees and suppliers ethically? Industry status Purchasing managers should be aware of the suppliers standing within the industry. General reputation can be verified by checking references. Customer commitment Good suppliers will support partnerships with customers and will be willing to commit engineering support and other forms of service to a good customer. EEO (Equal Employment Opportunity) program commitment Does the supplier support and reflect diversity in its workforce? Has it been cited for any EEO violations? Violations could hurt supplier employee morale. Also, a perception may exist that the purchasers organization is insensitive to these matters. Subcontractor management If the supplier plans to employ subcontractors to perform any major portions of the work, audits of subcontractors should be made by the supplier and records reviewed by the purchaser. If possible, and within the confines of ethical and legal requirements, it can be beneficial to encourage the supplier to use suppliers who are suppliers to the purchasers organization.

F)

G) H)

I)

J)

6)

FACTORS USED TO ANALYZE A SUPPLIERS LABOR STATUS A) Employee skills A purchaser needs to analyze the skill levels of the suppliers employees. Are they well trained? Do they have the experience and competence for meeting the purchasers needs? How long have they been on the job? Is the workforce stable? Unionization Unionization provides employees with an organization to collectively represent their concerns to management. Many employees are not represented by a union and address their concerns directly to management. If relations are good between labor and management there is much less need for a union. The Taft-Hartley Act of 1947 is a labor law that set up certain guidelines for unions and management. The Act allowed states to pass right to work laws which create an open shop. An open shop is a condition whereby workers do not have to join the union but share in the benefits won by the union through strikes as well as negotiation. This contrasts to a union shop where an agreement exists between organized labor and the management of a unionized organization requiring employees to join the union within 30 days following employment. The union shop has been outlawed in some states due to right-to-work laws. However, the agency shop, which requires non-union members to pay union dues and fees, has been approved in some of these states. 76

B)

Part C: Supplier Analysis C)

Task 111

Labor contract expiration date If a supplier does have a unionized labor force, the purchaser should know the contract expiration date, since this may significantly affect the ability to have materials shipped from the supplier. Obtaining information about the last contract negotiations is important. This information will let the purchaser know key information, including whether there was a strike, how long the strike lasted, whether production continued during the strike with supervisory personnel, whether there was an inventory build-up prior to the strike, whether there was violence or picket lines prohibiting deliveries, whether there was damage to the facility, the results of the negotiation, and what type of back-up plan the organization has in mind in case of another strike. Employee turnover What is the average tenure of the workers? What is the turnover rate among management employees? Training programs and initiatives As the workplace becomes more complex higher level skills are necessary for all employees. Each department or unit should have training goals. Some organizations set this as a minimum number of hours per year, or a set dollar amount per employee. Industrial relations policy Does the purchasers organization also sell to the proposed supplier and are there any problems with purchasing from them?

D) E)

F)

7)

ISSUES IN CONDUCTING SUPPLIER PLANT VISITS/SITE INSPECTIONS A) Reasons for conducting visits A supplier visit, audit, or evaluation is a technique employed by purchasing departments to determine if business should be placed with a new or previous supplier. A supplier visit gives the purchasing organization a first-hand look at the organizations facilities, and will answer for the purchaser the majority of questions about the level of technology at the facility, the education and training of the staff, the employees attitudes toward their work, and the overall effectiveness of the supplier. If the organization does not make a sincere effort to show its best side during this visit and cooperate fully, it can be assumed that the organization probably will not do so for the purchaser in the future. Costs vs. benefits of visits Although such visits may be costly in terms of time, airfare, food, and lodging, such expenditures are sound investments against future problems. An un-audited supplier with poor facilities, old technology, insufficient capacity, or an under-qualified staff may experience increased down time and or lost production. Such an organization is also likely to have limited assets for future growth. Such factors will affect the supply continuity to the purchasers organization. Site inspection team A carefully selected cross-functional audit team consisting of individuals from purchasing, quality assurance, operations, and engineering will provide the expertise necessary to recognize problems at the suppliers plant and make suggestions for corrective actions. 77

B)

C)

Task 111 D)

Module 1 Factors appraised at site visits Approved suppliers should be visited at intervals commensurate with their performance. A superior supplier will not be visited as often as one that frequently ships late and experiences quality problems. During on-site visits, talks should be centered on process enhancements aimed at lowering the cost of business for both parties. Process improvements can result in reductions in leadtimes, back orders, late shipments, early shipments, over shipments, and rejection rates. It should be impressed on the supplier that process improvements should lead to higher quality that could lead to increased future business, and the renewal of contractual commitments. Tours of the actual plant facilities should be performed, particularly if a new capacity or technology has been added. The purchaser should make an audit checklist to ensure that all issues of importance are addressed during the visit. Such a checklist should include plenty of space for additions especially for soft indicators such as perceived employee morale. When auditing a new supplier, questions and procedures may be more detailed than those asked of an existing supplier. 1.0 Housekeeping Housekeeping is an indicator of discipline and pride in the workplace. The best way to compare housekeeping is to look at two suppliers making the same product. Housekeeping can affect quality and efficiency. At times a normally well-kept plant may be unorganized due to a surge in business or an emergency order. Process/material flow Efficient process and material flow are required to keep a supplier competitive. Where inefficiencies exist, suggesting improvements could help reduce costs for both parties and make the supplier more competitive. Employee morale Morale is most influenced by upper managements treatment of its employees. Almost always there will be some malcontents in any organization but in the truly good ones, employees feel they are treated fairly and that management cares about them. Morale has a great affect on quality, timeliness, and efficiency of any operation. Morale also is reflected in employees willingness to put in extra effort to serve a customer. Good morale is a very important attribute that affects all organizations performance. The purchaser must be very aware of major management shifts and their affect on the suppliers employees.

2.0

3.0

E)

Timing of visits The purchaser must determine how frequently visits should be made and determine if there is a particular time of the month or quarter in which the visit might be more effective. Purchasers often develop plans for timing visits (during busy or slack periods), and the frequency of each visit, to ensure that each visit provides maximum information and input.

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Part C: Supplier Analysis BIBLIOGRAPHY

Task 111

Adding It Up: Performing Effective Supplier Price and Cost Analysis, NAPM InfoEdge, (3:10), June 1998. Aspuro, M. Supplier Financial Analysis: By the Numbers, Proceedings of the 1998 NAPM International Purchasing Conference, NAPM, Tempe, AZ, 1998, pp. 323-327. Estrada, M.U. and M. Harding. Developing an Effective Source Evaluation and Selection System, NAPM InfoEdge, (1:12), June 1996. Hollingsworth, B. How to Effectively Rate Your Suppliers, NAPM InfoEdge, (4:3), November 1998. Stubbings, D. Supplier Evaluation Matrix Establishing Supplier Objectives and Motivate Improved Performance, Proceedings of the 1999 NAPM International Purchasing Conference, NAPM, Tempe, AZ, 1999, pp. 344-349.

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TASK 112: Measure supplier performance using rating systems and/or predetermined standards.
Measurements of supplier performance are critical to the selection of the best supplier and to the improvement of a suppliers performance over time. Measurements also tell the supplier what is valued by the purchasers organization (and by exclusion, what it does not). If an issue matters, then it must be measured. Without a measurement, it is not possible to tell if something is getting better or worse. Subjective judgments can be swayed by specific events and are at best a highly unreliable way to evaluate performance. 1) ITEMS TYPICALLY ANALYZED USING SUPPLIER PERFORMANCE RATINGS Any issue can be measured. Almost all issues fall into one of three categories: cost, performance, or policy issues. Cost issues include price and all other ancillary costs (for example, transportation). Performance issues include any attribute of supplier performance the organization cares to measure (for example, on-time delivery). Policy issues include matters of compliance to those policies the organization chooses to enforce regarding supply (an example might be disadvantaged business status). The first step in establishing a supplier rating system is the selection of attributes valued enough to measure. The second step is to develop a valid measurement method for each attribute. The third step is to collect the data and determine performance. The fourth step is to use the findings to select a supplier or improve supplier performance. Because a suppliers status may change over time, these factors need to be reviewed regularly. Some attributes frequently used in supplier performance rating systems include: A) B) Supplier capabilities Does a supplier have the capability to do what is asked of them? Do they have capabilities that the purchaser could use in the future? International, national, and local capabilities Does the suppliers geographic distribution of product and services coincide with the organizations needs? Are there local, national, or international capabilities that should be taken into consideration? Pricing methods To measure acceptability of pricing, there must be a basis for comparison. These typically include: prior prices (trend), competitive prices, industry standard price indices, or cost-based pricing. Financial strength Is the supplier profitable? What is their stability for the longterm? Are the suppliers current and quick ratios acceptable? Is the debt to equity ratio appropriate? (See Task 111 for a discussion on the financial analysis of suppliers.) Inventory locations and methods Does the supplier have the right inventory in the right places to service needs within the leadtime required? What are the inventory levels?

C)

D)

E)

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Task 112 F)

Module 1 Delivery performance For the delivery of goods, performance is usually measured as percent on-time. On-time typically includes both the delivery meeting the scheduled arrival period and the goods or service being defect free. To establish a delivery performance measurement: Define the on-time window (the due date plus or minus a period within which delivery is allowed and considered to be on time). For each receipt, compare the actual receipt date to the due date on the purchase order. If the receipt is within the on-time window, then the delivery was on time. Calculate the percent on time by dividing the number that were on time by the total number received (and multiplying by 100 to convert the fraction into a percentage).

Measuring service delivery performance is a bit more subjective because there is no receipt of goods transaction. Compare the time the service was scheduled to be performed with the time that it actually was performed, then calculate the percentage as described above. G) Quality history Quality performance is typically measured by a percent defective or reject rate. Quality performance is calculated as a ratio in the same manner as ontime delivery ratios by comparing the number that were found to be defective to the total that were received. Service history To measure any factor of a suppliers service, first define what constitutes acceptable performance. Second, measure events as they happen. Did each event meet the defined expectations or not? Calculate service performance as a percentage in the same manner as quality or delivery. Margin performance and inventory turnover Is the supplier moving inventory? How do the suppliers inventory turns compare to its competition and the industry in general? What are the suppliers margins? Although any organization can suffer periods of slow business, if the downturn is prolonged, the signs of increasing inventories and shrinking margins may indicate trouble ahead for that particular supplier. Innovation history and performance Does the supplier provide creative solutions to problems? Is the supplier a leader in new-product development? How many patents does the supplier hold? These attributes are worth measuring and including in the purchasers selection criteria.

H)

I)

J)

2)

SUPPLIER PERFORMANCE RATING METHODS A) Benchmarking Benchmarking is the comparison of a product or a process to the best available. To use it for supplier measurement, compare a suppliers performance to the best-known performance for the attribute being measured.

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Part C: Supplier Analysis B)

Task 112

Weighted-point The weighted-point method is a quantitative measurement that allows purchasers to put different levels of importance (weights) on the various factors. To use this method: Step 1. Choose the factors to be measured. Step 2. Establish a weight for each factor that reflects the importance of that factor in relation to the other factors. Step 3. Determine a suppliers actual performance on each factor. Step 4. Multiply the actual performance data for each factor by its weight and sum the results. The total score for a supplier reflects both their performance and the relative value the purchasing organization places on that performance. Example: The Contract Administrator for the contract with Resources, Inc. is evaluating Resources performance in supplying clerical personnel. The Administrator decided to weight and measure the three performance factors as follows: Weight 50% 25% 25% Factor Quality Service Price Measurement Formula 100% percentage of no shows 100% 7% for each failure Lowest price offered Actual price paid

Resources, Inc. performed as follows during the past month: 5percent of the requested clerical personnel never showed up, three unqualified workers were supplied, and Resources price was $100/hour compared with the lowest offer of $90/hour. The following summarizes the total performance evaluation calculation for Resources, Inc. Weight 50% 25% 25% C) Factor Quality Service Price Actual Performance 5% no shows 3 failures $100.00 Performance Evaluation 50 x (1.00 .05) = 47.50 25 x [1.00 (.07 x 3)] = 19.75 25 x $90.00 $100.00 = 22.50 OVERALL EVALUATION = 89.75

Categorical The categorical method is a qualitative measurement of supplier performance. To use this method: Step 1. Determine the factors to be evaluated. Step 2. Assign a grade that reflects supplier performance on each factor. Grade systems commonly used include A, B, C, D, or For plus minus neutral. Grades can be assigned by individuals or by team evaluation. Step 3. Determine an overall grade average and share that information with suppliers. The categorical method is less dependent on numeric data than other methods, and it can become highly subjective. Example: Exhibit 1 shows an example categorical evaluation form.

83

Task 112 EXHIBIT 1 SAMPLE SUPPLIER PERFORMANCE EVALUATION SUPPLIER _______________________________________ SUMMARY DEPARTMENT EVALUATION: Contract Administration Internal Customer Accounting _____________________________________ DATE _______________ Positive Neutral Negative

Module 1

PERFORMANCE FACTORS CONTRACT ADMINISTRATION: Performs on schedule Performs at quoted prices Representative is available Prompt and accurate with routine documents Anticipates needs Helps in emergencies Does not unfairly exploit a single source position Does not request special consideration Furnishes specially requested information promptly Advises of potential problems Performs without constant follow-up Fixes problems promptly Invoices correctly INTERNAL CUSTOMER: Performs per instructions Provides quality service Responds to requests Has ability for difficult work Readily accepts responsibility Provides quick and effective action in emergencies Furnishes requested data promptly Replies with corrective action ACCOUNTING: Invoices correctly Issues credit memos promptly Does not ask for special financial consideration

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Part C: Supplier Analysis D)

Task 112

Cost-ratio The cost-ratio method determines a total cost of acquisition for each shipment by adding all identifiable procurement and handling costs to the purchase value of the shipment. The lower the ratio of added cost to shipment value, the higher the rating of the supplier. To use this method: Step 1. Determine the factors to be included (such as delivery, quality, or service). Step 2. Determine the purchasing organizations costs for non-performance in any of these areas. Step 3. For a given shipment, calculate the costs actually incurred. Calculate the ratio of each incurred cost to the purchase value of the shipment. A ratio for each factor will exist Step 4. Total the ratios for all factors to determine a total for that shipment (and, by extension, that supplier). This is the suppliers overall cost ratio. Step 5. Calculate an adjusted price as follows: Adjusted Price = Price x (1 + Overall Cost Ratio). Step 6. Use the adjusted price to evaluate suppliers for future business. Example: Two current suppliers have been asked to bid on a new service item. Supplier A bid $150.00 and supplier B bid $152.00. Past experience in dealing with these suppliers has indicated that different additional costs will be incurred during contract performance. This fact is reflected in different cost ratios. Supplier A has had minor quality problems that resulted in a cost ratio of three percent of purchases. Supplier B has constantly delivered excellent quality, resulting in a cost savings of one percent. supplier A has invoiced incorrectly a few times but has given excellent service otherwise. Supplier B has had a nearly perfect record on both factors. As shown below, the overall cost ratios amount to +5 percent for supplier A and +2 percent for supplier B. This means that supplier B, in spite of its higher initial bid price, is likely to perform the contract for less money than supplier A. Cost Factor Quality Invoicing Service OVERALL COST RATIO Original Bid Price Adjustment Factor Adjusted Bid Price Supplier A +3% +4% -2% +5% $150.00 1.05 $157.50 Supplier B -1% +2% +1% +2% $152.00 1.02 $155.04

E)

Total acquisition cost Total acquisition cost is the sum of price plus all other identified costs of acquisition such as delivery performance; overhead costs of handling the transaction and delivery; and cost of working capital, and the costs of nonconformance (such as inspection costs and costs caused by defective products).

85

Task 112 3) FACTORS THAT CAN DISTORT RATINGS

Module 1

A variety of factors can result from ineffective supplier performance measurement systems. These include: Inaccurate data. If the databases from which the performance numbers are calculated include errors, the resulting measurements will be wrong resulting in no credibility with internal customers and suppliers. Improper weighting of factors. Weights assigned to factors must reflect accurately the value the organization places on them. Subjectivity. Measurements that are subjective can be affected by selective memory of the evaluators and can be skewed by an unusual recent event.

4)

ISSUES IN THE DISSEMINATION OF RATINGS When ratings are shared with suppliers, the purchasing organization must pay attention to the following: A) Confidentiality Rating information should be shared with the supplier whose performance was measured and not with anyone else outside the purchasers or suppliers organization. Revealing a suppliers performance data to a competitor would very likely result in a significant breech of trust and relationship damage. This does not preclude recognizing top suppliers as part of a supplier certification or supplier recognition program. Supplier reaction to ratings A suppliers reaction to its performance measurements may be affected by: The credibility of the numbers. Suppliers may react negatively if they are recipients of evaluations based on inaccurate data. The attitude of the purchasing organization. Sometimes poor performance originates inside the purchasing organization. Unclear specifications or fluctuating schedules can cause a supplier to look bad despite its very best efforts. An attitude of judgment and condemnation (rather than problem solving) can provoke resistance to accepting the evaluation results. However, if the purchasing organization presents accurate data in a problem solving mode, and the supplier still does not respond, then their lack of response can be taken as a signal of their unwillingness to work on improvement. Management attention. Providing suppliers with regular reports on performance serves to focus the attention of the suppliers management on the contract. This, in turn, usually results in enhancing the purchasing organizations status as a customer. Use of ratings. The supplier and the purchaser both can use the ratings as a tool for communication and supporting work on the contract. Objective, accurate evaluations combined with a positive reaction on the part of the supplier can lead to improved performance or can encourage good performance. 86

B)

Part C: Supplier Analysis BIBLIOGRAPHY

Task 112

Estrada, M.U. and M. Harding. Developing an Effective Source Evaluation and Selection System, NAPM InfoEdge, (1:12), June 1996. Hollingsworth, B. How to Effectively Rate Your Suppliers, NAPM InfoEdge, (4:3), November 1998.

87

TASK 113: Prepare and/or issue purchase orders and contracts.

1) ELEMENTS OF A CONTRACT An agreement is the bargain of parties as evidenced and defined by their language or actions, or by implication from other surrounding circumstances. A contract, on the other hand, refers to the total legal obligation that results from the parties agreement. The parties may agree to and create a contract for anything as long as it is legal and meets the basic obligations of good faith, diligence, and reasonableness. There are four essential elements of a contract: A) Mutual assent A contract must result from the mutual agreement of the parties to the contract. Mutual assent is often reflected in an offer made by one party (the offeror) and the unconditional acceptance of that offer by another party (the offeree). Preliminary discussions and correspondence about price, quality, quantity, and so forth do not constitute a contract, nor do price quotations and advertisements. These are only preliminary steps to a contract. The issuance of a purchase order or submission of a price quotation, however, may constitute an offer to contract and be binding on the party making it when the other party accepts it. 1.0 Counteroffers A counteroffer is an offer to enter into a transaction on terms different from those originally proposed. That is, a counteroffer is an offer made by an offeree to an offeror accepting some terms and changing others. It terminates the original offer and proposes a new and different offer. Acknowledgment/Acceptance An acknowledgment refers to a form used by a supplier to advise a purchaser that the order has been received, and generally implies acceptance of the offer. If it is the supplier who has made an offer, such as by price quotation or response to a Request for Proposal, the purchasers purchase order may constitute acceptance of the suppliers offer. Genuine assent The contract must show the true agreement, cannot be based on fraud or misrepresentation, be made under duress, or as a result of one partys undue influence over the other. Unilateral versus bilateral contracts A unilateral contract is one based on an offer by one party, with acceptance formed by actions of the other party. In such a case, there is only one promise (the offer), but performance by the other party serves as acceptance and creates the contract. Bilateral contracts are those containing two promises, such as an offer to buy and agreement to sell under conditions of the contract.

2.0

3.0

4.0

B)

Consideration Consideration refers to an exchange of value for value to make a contract promise binding. Giving up an existing right or with money, goods, an act or service, or an exclusive dealing promise may satisfy the requirement for consideration.

89

Task 113 C)

Module 1 Competent parties Both parties must be capable of contracting. That is, they must not have been incapacitated at the time of agreement, as would be the case with a minor, someone who is mentally ill, or an intoxicated person. If they are acting as agents for another person or organization, the parties must also be authorized to act on behalf of that person or organization. Legality of purpose Both the subject of a contract and the consideration offered must be legal. That is, the agreement must be consistent with federal and state constitutions and cannot violate statutory law or public policy. Contracts that do not meet this requirement are not enforceable.

D)

2)

TYPES OF OBLIGATION DOCUMENTS A) Written versus oral contracts A contract may be formed orally or in writing. As long as it can be shown that an agreement was made, either format may be binding under the law. However, only in rare instances is it acceptable for a prudent purchaser to issue an oral contract. Such commitments may be made for relatively low dollar purchases with approved suppliers to meet important deadlines, but they should be validated by a confirming purchase order (see Section 2-B below). 1.0 Reasons for written contracts For obvious reasons, existence of an oral agreement is difficult to prove. Therefore, it is generally preferable to have a written contract. 1.1 Statute of Frauds The Statute of Frauds is a law designed to prevent fraud and perjury by requiring that certain contracts be in writing. This area of contract law is designed to protect persons from false testimony. Evidence in writing reduces the possibility of such an occurrence. Under the Statute of Frauds contracts for goods worth $500 or more as well as any contract that cannot be fully performed within one year and all contracts involving real estate, are not enforceable unless there is written evidence that they exist. With some exceptions the party against whom the contract is to be enforced must sign the writing. For example, a contract document signed only by the purchaser may be enforceable against the purchasing organization, but not against the supplier. Multiple documents may be used to meet the writing requirement, however, an acknowledgment signed by the supplier and sent in response to a purchasers order could be used to enforce the contract against the supplier. (Note: The $500 amount currently found in UCC Article 2 would be increased to $5000 under revisions to the law that are now pending. Such a change could take effect over the next few years as state legislatures adopt the proposed revisions.) 90

Part D: Contract Execution, Implementation, and Administration 2.0

Task 113

Circumstances where oral contracts are acceptable Oral contracts for goods worth $500 or more may be acceptable if any of the following are true: If one of the parties to the oral contract documents it in writing and sends a copy of the writing to the other party who then has 10 days to object. If the goods are made specifically to the purchasers order and are not readily salable to others such as custom-made or purchasers-labeled goods. If both parties behave as if a contract exists and actually perform their obligations under the oral contract. If the party against whom the contract is to be enforced admits under oath in a legal proceeding that a contract existed.

In addition the doctrine of Promissory Estoppel holds that if one party makes a promise, even orally, he or she cannot renege on that promise if the other party has acted in reliance on it. Accordingly, while an unwritten contract might be unenforceable under the Statute of Frauds, it may be enforced under the theory of Promissory Estoppel if there is sufficient evidence of the agreement. 3.0 Electronic purchasing Because of the Statute of Frauds, purchasing transactions that are accomplished electronically without the use of traditional written contract documents may pose problems similar to oral contracts. 3.1 Trading partner agreements In advance of transacting business electronically it is advisable for parties to agree on the ground rules for such business. A trading partner agreement is actually a contract establishing the electronic relationship and covering the basic contract requirements, including standard terms and conditions that will apply to any transactions completed under the agreement.

B)

Purchase orders The most common vehicle used to facilitate a commitment for materials, facilities, or services between a purchaser and a supplier is a purchase order. The purchase order (paper or electronic), may function as either a contract offer or an acceptance and sets forth an organizations terms and conditions. Purchase orders are normally released to suppliers with unique purchase order numbers. In larger organizations, purchase order numbers carry a code that identifies the issuing purchaser. While a purchase order evidences some relationship between the parties, by itself it usually does not constitute a contract. Often the purchase order merely shows that the purchaser has made an offer. Thus, the purchaser should request the supplier to sign and return an acknowledgment copy of the purchase order. On the other hand, the purchase order may function as an acceptance if it is issued in response to a suppliers response to a RFQ or IFB.

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Task 113

Module 1 Terms and conditions vary by organization, but at a minimum the purchase order will typically strive to protect the purchasers interests with regard to the following areas: Fixed prices and quantities, including all taxes. Right of inspection and rejection. Warranty period if not specifically agreed upon with the supplier. Right to make specification and/or design changes. Indemnification against injuries or damages caused by the suppliers actions and other legal considerations. The suppliers right to assign the contract to third parties or to generate publicity. Instructions regarding shipping and deliveries.

C)

Letters of intent 1.0 Purpose A letter of intent may be used between purchaser and supplier to confirm certain agreements in connection with a procurement action. It may serve as an interim purchase order or contract, and provides immediate documentation of the more salient features of an agreement. It anticipates that it will be superseded by subsequent documentation containing the same terms and conditions with additional terms and conditions. The purpose of a letter of intent is to gain time in a commitment to a supplier prior to the issuance of a more complete purchase order or contract. Situations where a letter of intent may be used include: Reserving a place in line for standard equipment when the formal purchase document approval system may require more time. Basing volume discounts on future business without giving a firm order for the whole quantity (note that prices are usually renegotiated if actual volume does not satisfy the discount structure). Encouraging a seller to stock items of interest to a purchaser. Providing supplier with evidence to secure bonding.

2.0

Types There are two types of letters of intent: binding and non-binding. The distinction depends primarily on the language used in the letter. 2.1 Binding letters of intent A purchaser may be bound by a letter of intent, even if he or she does not wish to be, unless steps are taken to prevent it. For example, if both parties sign a memorandum confirming negotiations or agreement in principle, they would likely be bound by contract unless the memorandum clearly and explicitly states that neither party intends to be bound and that the memo is not intended to be a contract. The same is true of minutes of negotiation meetings, as the parties can be held to have a contract for the points on which they have already agreed. Indeed, memos of agreement or negotiations that are expressly made conditional on legal approval 92

Part D: Contract Execution, Implementation, and Administration

Task 113

may be viewed as a contract on the premise that legal points not specifically approved by an organization lawyer may still be clarified by default provisions in the law. Any letter of intent, given as authorization to begin producing goods or the like, will certainly be regarded as binding. 2.2 Non-binding letters of intent If a letter of intent is to be non-binding, it must include an explicit and clear statement to that effect, with the understanding that such a letter cannot be binding on one party and non-binding on the other. A letter of intent between the parties without authority to bind their organizations would typically be held as non-binding if it contains a condition of approval by management or other authority. However, one needs to be careful that the party truly does not have such authority and that there is no precedent of having treated prior, similar letters as binding, in which case the party may be considered to have apparent authority (see Task 114 for a more detailed discussion on authority). The best practice is to have the letter spell out, in simple language, whether or not the parties intend it to be binding. D) Types of contracts The contract form used in a specific case will depend upon environmental factors such as the intensity of competition; availability and accuracy of pricing data; relative risks, as perceived by the purchaser and supplier; and the relative strength of the purchaser or supplier positions. 1.0 Fixed price contracts Fixed price contracts are based on a price that will not differ from that agreed upon or understood to apply at the time of ordering. Fixed price contract forms are generally more desirable to the purchaser. As contract terms lengthen or as complexity of development or performance increases, supplier risk rises in fixed price contracts. Common fixed price contract types include the following: 1.1 Firm fixed price This is an agreement for the purchaser to pay a specified price to the supplier when the latter delivers what is purchased. It requires minimum administration, and from the standpoint of risk-avoidance, is the most preferred by the purchaser. In addition to transferring financial risks to the supplier, it provides supplier incentive to improve efficiency and to hold costs down. Fixed price with adjustment/escalation For contracts involving a long period of production and large amounts of money, a supplier is usually reluctant to quote firm prices due to certain risks (such as inflation or deflation). In such cases, a purchaser may wish to use an adjustment/ escalation clause, which provides for both upward and downward changes in price as a result of changes either in material or labor costs. 93

1.2

Task 113

Module 1 Adjustment or escalation clauses are typically tied to recognized indices. Because escalation and de-escalation are often considered, the term adjustment is frequently used to cover both concepts. Such contracts are generally used during periods of economic uncertainty or when the contract is long term. Another situation where adjustment or escalation clauses are useful is for items where the market prices are erratic such as for precious metals or copper (see also Task 115). 1.3 Fixed-price with redetermination Redetermination contracts are used when both future costs and amounts of labor or materials are uncertain. They differ from adjustment or escalation, in that with adjustment or escalation, the amounts of labor and materials required to complete the contract are known, but the labor rates or the prices of material are unknown. In cases involving redetermination, the amounts of labor or materials are initially unknown, but they become known with limited production experience. Typically, the contract starts with a temporary fixed price that is adjusted after experience is gained and costs are known. Maximum redetermination contracts provide only for adjustment downward from the temporary price. Flexible redetermination provides for price adjustment either upwards or downwards. Fixed-price with incentive This type of contract provides the supplier with an incentive to control costs by establishing a target cost, a target profit, a ceiling price, and a final profit formula. The final profit formula allows a supplier to participate in any cost savings that accrue below target costs, thereby increasing supplier profits. Typically, if the supplier can lower its costs, the purchaser and supplier share in the savings at pre-negotiated rates, with the suppliers profit increasing as costs go down. The greatest application for this contract form is in high-cost, long lead-time projects. Firm fixed price per unit level of effort Such contract forms are used when neither the work nor results can be specifically defined before performance. Therefore, the parties agree on a specific level of effort at a specific rate per unit of effort (such as number of hours of testing at a fixed rate per hour) after which they will assess the results and decide if additional effort is required. Typical applications for such contracts include research and development work and laboratory testing. Fixed price with downward price protection This type of pricing agreement provides maximum protection for the purchaser. It is similar to the fixed-price with adjustment or escalation except that the price may only be adjusted downward due to changes in costs.

1.4

1.5

1.6

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Part D: Contract Execution, Implementation, and Administration 2.0

Task 113

Cost reimbursable contracts Cost reimbursable contracts guarantee the supplier a price sufficient to cover allowable costs plus whatever additional amount is negotiated. Suppliers are guaranteed reimbursement for all allowable costs up to a predetermined figure. Beyond that point, they will do no additional work unless the purchaser agrees to provide more money. The suppliers are also usually guaranteed a fee in addition to their costs. Because financial risk falls on the purchaser, the purchaser must carefully monitor such contracts. These types of contracts should contain incentives for supplier efficiency or improvement. Common types of cost reimbursable contracts include: 2.1 2.2 Cost plus a fixed fee This form guarantees the supplier reimbursement for allowable costs plus a negotiated fixed fee. Cost plus percentage of cost This is the most undesirable form for the purchaser, as it provides no incentive to control costs. Indeed, higher costs lead to higher profits for the supplier. In fact, most public sector purchasing does not permit this practice. Cost plus an incentive fee This form is similar to a fixed-price with incentive contract in that the parties establish a target cost. If the suppliers costs are below target both parties share in the savings, and if above target the suppliers fee is reduced accordingly. If costs significantly exceed target, the supplier can lose all of its fee but not its costs. Cost plus award fee This has a profit element included in a fee that is stated up front. Cost without fee These contracts are sometimes used between nonprofit organizations such as research groups or universities, and usually provide payment for overhead, remuneration of faculty, and reimbursement of costs but no profit. Cost sharing A cost-sharing contract provides for both purchaser and supplier to share the costs and benefits. For example, the buying organization may have equipment developed for its use that the supplier may place in its line for sale to others. On a larger scale, an oil-drilling organization might share with the land-owning country or organization a percentage of the output of a well it had developed.

2.3

2.4 2.5

2.6

3.0

Indefinite delivery contracts An indefinite delivery contract is employed when the purchaser is not sure of the production schedule or timing of a service activity, or the quantity of material or frequency of service required. The appropriate type of indefinite delivery-type contract may be used when the exact times and/or quantities of future deliveries are not known at the time of contract award.

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Task 113 3.1

Module 1 Indefinite delivery/Indefinite quantity Indefinite quantity contracts provide that during a given period of time, the purchaser will place requirements with a specific supplier. Quantities and delivery dates are unknown but minimum and maximum quantities are usually given. Task order and delivery order Under an indefinite delivery contract, the method of initiating a specific delivery order is a written or oral delivery order. The format of a written order is essentially the same as a purchase order except it should reference the indefinite delivery contract it is written against. It will not include the standard terms and conditions associated with a purchase order because the delivery order is backed up by a contract. This will also be the case for a task order written against a service oriented, indefinite delivery contract. Time and material contracts Time and material contracts generally provide payment for labor and overhead at a given rate per hour, plus the sales price of parts, supplies, and materials. Most automobiles, for example, are repaired under time and material contracts.

3.2

3.3

4.0

Letter contracts A letter contract is sometimes used as an authorization by the purchaser for the supplier to start work, often before complete details of the deal are finalized. Good practice dictates clearly stated limits to the purchasers liability (in the event the whole deal cannot be satisfactorily concluded) and to assert purchaser terms and conditions of purchase (see to Section 2-C above on Letters of Intent). Dealers agreement An agreement or contract, expressed or implied, oral or written, by and between a supplier and a dealer by which the dealer is granted the right to purchase, sell, distribute or service the suppliers merchandise.

5.0

3)

EXCHANGE OF STANDARD FORMS AND BATTLE OF THE FORMS A) Use of Purchase Orders As discussed earlier, purchase orders may function as either the offer or the acceptance document in formation of a contract. When emergency situations necessitate oral agreements (although these should be avoided whenever possible), it is sound practice to follow up by sending a written purchase order confirming the agreement. When a purchase order is used in this manner, most courts will, in the event of conflict, consider the purchase order terms to reflect the parties contract, provided that the purchase order form is sent within a reasonable time after the oral agreement and the supplier does not object in writing within 10 days after receipt (see UCC Section 2-201(2)). Additionally, the purchase order provides an audit trail and, in many cases, may clarify the deal. However, a court may disallow any terms in a purchase order sent after the fact if they were not agreed upon when the contract was formed, particularly if the 96

Part D: Contract Execution, Implementation, and Administration

Task 113

supplier does not have the purchase order before it ships. Good practice dictates, making any oral contract conditional upon supplier acceptance of the purchasers terms and conditions of purchase contained on the formal purchase order to follow. B) Exceptions to terms and conditions As just discussed, when a written confirmation is sent in response to an oral agreement, the recipient of that confirmation has 10 days in which to object to the terms expressed in the confirmation. In other situations the law provides no hard and fast rules for dealing with exceptions. Where the offeree objects to the terms offered by the other party, such objection may be reflected in either rejection of the offer or a counteroffer made by the offeree. A counteroffer may say, in effect, We will do business with you but we do not agree to the following terms in your offer . . . This type of exception to terms and conditions must be clearly communicated to the offeror before the transaction is consummated because once goods are shipped or services performed, the party receiving such goods or services may be deemed to have accepted the original terms on which they were offered. Often in the process of offer and acceptance, rather than specifically objecting to the terms offered, the parties exchange standard forms containing terms that are not the same. This situation leads to the well-known battle of the forms. C) Battle of the Forms The so-called battle of the forms arises when contracting parties exchange contracting documents (such as purchase orders and acknowledgments) that do not agree with one another. The legal question becomes, Is there contractual agreement or is there not? The answer is different depending on the type of contract involved. 1.0 Services contracts Under the common law of contracts that governs contracts for services, the Mirror Image Rule holds that the offer and acceptance must substantially match (that is, they must be mirror images of one another) in order for a contract to be formed. Each subsequent non-matching document is treated as a counteroffer, and that counteroffer is accepted when the parties thereafter complete the transaction. If, for example, the purchase order for services contains one set of terms and the suppliers acknowledgment of that order includes other terms, there is no agreement. If the parties go forward with the transaction, there is a presumption that the purchasing entity is agreeing to the terms of the supplier who sent the last document. The reverse could also occur. If a supplier makes an offer by responding to an RFP, including its own terms and conditions in that response, and the purchaser accepts the offer by issuing a purchase order containing its own terms and conditions, the latter terms and conditions will control if the supplier performs without further objection. Goods contracts The UCC Section 2-207 does away with the Mirror Image Rule. Instead, it provides that if parties deal as though they have a contract, then they are deemed to have one even if their terms and conditions do not completely

2.0

97

Task 113

Module 1 agree. If one party says it accepts an offer ([a] definite and seasonable expression of acceptance), such expression is treated as an acceptance even though it states terms additional to or different from those offered or agreed upon, unless acceptance is expressly made conditional on assent to the additional or different terms. In other words, the suppliers inclusion of additional terms in its acknowledgment of the purchasers order may be considered an acceptance of that order, in spite of additional terms. 2.1 Inclusion of additional terms The foregoing does not mean, however, that the purchasers terms necessarily will completely control the transaction. Section 2-207 also provides that where both parties are merchants (routinely doing business in goods of the kind), the additional terms become a part of the contract, unless: The offer itself expressly limited acceptance to the specific terms of the offer. The additional terms materially alter the contract. The offeror objects to the additional terms within a reasonable time after finding out about them.

In any of the above cases, the sales acknowledgment terms would not become part of the contract, but a contract would exist on the purchasers terms. If none of these conditions applies, the terms of the acknowledgment would be added to the purchasers terms to form the contract. 2.2 Acknowledgment as counteroffer Under Section 2-207, purchasers making offers to buy are generally protected from having the contract ruled by the suppliers acknowledgment terms unless the supplier clearly makes acceptance conditional on the purchasers agreement to the suppliers terms. Only in the situation where the acknowledgment contains such language of assent will the suppliers form be treated as a counteroffer rather than as an acceptance. Then the purchaser must be wary of going forward with the transaction and thereby accepting the suppliers counteroffer. Contract by conduct Even if the forms exchanged by the parties do not establish a contract in and of themselves, a contract may be created if the parties conduct themselves in a way that recognizes the existence of a contract. In such cases, the terms of the contract will consist of those on which the writings of the parties agree. Conflicting terms in the purchase order and sales forms will essentially cancel themselves out, and the default provisions of the UCC will govern any remaining gaps.

2.3

98

Part D: Contract Execution, Implementation, and Administration 4) CONSIDERATIONS IN PREPARING OBLIGATION DOCUMENTS: A) Legal Issues 1.0

Task 113

Intellectual Property Rights Intellectual property refers to various types of intangible personal property that have an inherent commercial value and are protected by the government in different ways. When preparing contract documents, purchasers must be alert to the intellectual property rights of their organizations as well as those of their suppliers and others (see Task 114). 1.1 Patent A patent is, in effect, a monopoly created by law, which gives the patent holder the sole right to make, use, and sell the patented item as well as the right to prevent others from doing so. Purchasing managers must be aware of the relevance of patents to their activities. They should attempt to obtain patentable rights wherever possible for customized products developed by suppliers. They should also be alert to the potential liability for infringement when using a product that may be patented by someone else. A patent indemnity clause is customarily included in purchasing contracts and on purchase order forms to protect an organization against the consequences of infringement suits. Copyright Copyrights grant to the author(s) of a literary, artistic, or audio-visual work (including software) the exclusive right to publish, reproduce, and sell the work. As with patents, purchasers should attempt to obtain rights to work produced for their organizations that are as broad as possible and include indemnification provisions to protect the organization in the event the material being acquired infringes on some other partys copyright. Trademark A trademark (or service mark) is a name, symbol, or design, registered by the U.S. Trademark Office for exclusive use in association with a given product (or service). The purchasers main involvement with this type of intellectual property will likely be the acquisition of rights to use (or an attempt to avoid using) a suppliers trademark in the promotion of the purchasing organizations own products. For example, a computer manufacturer may or may not want to use the trademark associated with its suppliers processor chip in promoting its computer. Unlike copyrights or patents, trademark rights can last indefinitely if the owner continues to use the mark to identify its goods or services. The term of a U.S. federal trademark registration is 10 years, with 10 year renewal terms. However, between the fifth and sixth year after the date of initial registration, the registrant must file an affidavit setting forth certain information to keep the registration alive. If no affidavit is filed, the registration is cancelled.

1.2

1.3

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Task 113 1.4

Module 1 Royalties A royalty is a payment made in return for some privilege or right, often associated with intellectual property. For example, a purchasing organization may make payments to an author for publishing and selling his or her works, or to the holder of a patent for the privilege of using it. Licensing A license issued by the owner of intellectual property grants the licensee the right to use the protected property, often in exchange for payment of a one-time fee or an on-going royalty, usually a percentage of sales or a fixed amount per unit produced.

1.5

2.0

United Nations Convention on Contracts for the International Sale of Goods (CISG) As discussed under Task 108, the CISG is a treaty governing international sales transactions. The CISG is having an affect on U.S. organizations engaged in international sourcing. This law automatically applies when both contracting parties are in countries that have accepted the CISG unless the parties specifically opt out of the laws coverage. Right to subcontract Purchasers typically reserve the right to prior approval of subcontractors planned by the prime contractor. Although not typical, in some situations purchasers may wish to and can prohibit subcontracting altogether. In the absence of such reservation, however, contracts permit the supplier to subcontract as necessary to satisfy performance requirements. Typically, the subcontractor clause is enforced in all cost-plus contracts and in fixed-price with incentive contracts. If a prime contractors purchasing system is government approved, certain parts of the subcontractor clause (including the requirement for enforcement in firm-fixed-price contracts) are waived.

3.0

B)

Notice of awards Whether or not a notice of awards is sent to all bidders typically depends upon the organizations policy, and on the nature and value of the pending contract. Such procedures may be common practice for large dollar value or construction contracts, but not for more routine types of contracts. The key is that the organization can decide to engage in total notice and debriefing based on what is considered good purchasing practice. In public purchasing, except when a bidder gives justifiable advance notice that a part of its bid is proprietary, bid and award records are public. A bidder and any other party, therefore, may have a right under the federal Freedom of Information Act or similar state and local laws to review the records upon request.

C)

Notification/debriefing of unsuccessful bidders The notification and debriefing of unsuccessful bidders is an important responsibility. Effective communication with each unsuccessful supplier can be an effective tool in the reduction and elimination of protests. Protest resolution procedures are briefly discussed here.

100

Part D: Contract Execution, Implementation, and Administration 1.0

Task 113

Resolution of protests Procedures for resolution of protests vary for private, state and local, and federal procurement. 1.1 Private Protest resolution is generally an administrative matter until there is sufficient damage to a party to warrant resolution under a formal protest or appeal process, applicable mediation or arbitration clause, or through litigation. State and local Protest resolution is generally an administrative matter until there is sufficient damage to a party to warrant resolution under a formal protest or appeal process, applicable mediation or arbitration clause, or through litigation. Statutes in some states require formal resolution under the Administrative Procedures Act, which calls for decision by an administrative judge or contracts review board with justifiable appeals to the courts. In other states, resolution decisions are made at the local and state level, as appropriate. Federal Federal government contracts contain a dispute clause that requires that all disputes be resolved under the clause rather than in the courts. Often the contracting officer makes a decision, with appeals directed to the Board of Contract Appeals or to the Court of Claims.

1.2

1.3

BIBLIOGRAPHY Whittington, E.M. Types of Contracts, Proceedings of the 1994 NAPM International Purchasing Conference, NAPM, Tempe, AZ,1994, pp. 354-357.

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TASK 114: Obtain legal review and approval of a contract when required.
The skill set required for this task suggests that the purchaser understand general contract principles that are outlined below, and have the ability to keep that legal knowledge current regarding any legal issue involved in a purchase. The purchasers ability to make well-reasoned decisions regarding a contract and to protect the organization involves balancing the business and legal issues in a transaction. Many of these issues are complex and require more than a general awareness of the law. It is just as important to understand when to obtain legal advice from an attorney as well as why an attorney needs to be involved in writing a contract. Generally, it is a good idea to seek legal advice and interpretation of the law before the fact. Good practice dictates that the purchaser define the business issues involved and determine courses of action, and then discuss the business issues and results wanted in the contract with the attorney so that the appropriate legal language may be drafted. 1) LAW OF AGENCY A) Definition of agent An agent is an individual who has been given authority by a principal (person, corporation, or institution) to act on its behalf. When this happens, the principal is bound by the commitments of the agent. The legal concepts governing the relationship between and among the principal, the agent, and the third parties with whom they deal are referred to as the law of agency. Fiduciary duty The principal-agent relationship is based on the trust and confidence of the principal and is termed the agents fiduciary duty. The purchaser acting in the role of an agent is expected to act in the best interest of the organization (principal) in carrying out the purchasing responsibilities. Thus, it is imperative that purchasers conform to a strict code of ethics, striving for fairness in buying, and wisdom in expending the principals funds. Limits of authority Agents may differ in the scope of their authority. Special agents have limited authority to perform only specific tasks. They have limited discretion in determining how to carry out their duties. As a result, the principal will usually not be liable for the act of a special agent when that agent is acting in areas outside the assigned duties for which special agency was granted. Many sales representatives are special agents with authority to solicit business but without authority to bind the organizations they represent to contracts. General agents have much broader powers and greater latitude in using their judgment to carry out duties assigned to them by their principals. When an organization delineates authorized buying limitations in a written document passed in resolution form by the Board of Directors, the agreement expresses a general agency. A principal often delegates buying limitations and authority specifically by name and job title. If a general agent engages in unauthorized acts, the principal may be liable because the general agent acts for the principal on a continuous basis.

B)

C)

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Module 1 Actual versus apparent authority Agency relationships can be created in several ways. Actual authority is the authority given to the agent by the principal and may be either expressed (as in the case of the Board of Directors resolution mentioned above) or implied. Apparent authority is created when the principal permits a party to operate in a fashion that allows persons dealing with that party to have good reason to believe that he or she is an authorized agent of the principal. For example, if a purchaser has authority to spend only $50,000 (actual authority) but nevertheless places an order for $65,000 with a supplier, the organization may be bound to that $65,000 contract by virtue of apparent authority, especially if the organization has previously honored $65,000 contracts made by the same purchaser. Note that an agent who operates under apparent authority may be liable to the principal for the unauthorized action. Ratification Under certain circumstances when an agent acts without authority specifically delegated by the principal, the principal may later validate the resulting contract. Ratification differs from apparent authority in that the principal actually accepts the contractual obligation and thereby releases the agent from any personal liability.

E)

2)

ROLE OF LEGAL COUNSEL A purchasing managers decisions must be legally as well as economically sound. The prudent purchaser utilizes legal counsel primarily to avoid difficulties in the discharge of duties as agent for the organization. Major areas that may require advice from counsel are: Standard purchase order terms and conditions. Applicable federal and state statutes that affect standard terms and conditions. Standard and customized requests for quotation (RFQ) or requests for proposal (RFP) terms. Purchase orders and solicitations for goods or services where UCC applicability or law of a specific state is desired. Warranty disclaimers and subsequent strength of express and implied warranties. Financially troubled or bankrupt suppliers. Bid or performance bonds, or progress payments added to the terms of a contract. Supplier acknowledgments materially changing the terms and conditions of the contract. Supplier alliance agreements.

A purchaser should consult with a lawyer whenever there is a doubt on any questions dealing with antitrust implications, risk of loss and indemnification, or the rights and remedies of the organization, including limitations of liability. Responsibility lies with the purchaser to maintain an appropriate balance between the legal and business issues for each decision. 3) EXAMPLES OF ISSUES REQUIRING LEGAL ADVICE A) Force majeure Force majeure may be translated as a superior or irresistible force. In contracts, it refers to major (and usually uncontrollable) events that excuse a party, 104

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in whole or in part, from performance of obligations. For example, a party may be excused from performance in case of a fire, a war, or a strike. The contract provision is referred to colloquially as the Act of God clause and is normally included in standard purchase order forms to protect both the purchaser and supplier. To protect an organizations interests, purchasers should take the precaution of including a force majeure clause when negotiating bilateral contracts. If the supplier or purchasing organization cannot perform because of some intervening force that was not foreseeable when the contract was made, performance of the contract will be excused and there will be no liability. The law does not automatically provide force majeure protection; it must be specifically written into the contract terms in order to apply. B) Choice of law/Choice of forum Choice of law refers to the determination of which states laws will apply to a contract while choice of forum determines where a case will actually be litigated. The parties may negotiate both choice of law and choice of forum if the purchasing organization and supplier are located in different states. With assistance of legal counsel, a purchaser should make a determination as to which states laws favor the purchaser and which favor the seller and attempt to negotiate the best alternative. If the parties do not include such terms in their contract, the courts will make the determination by applying a somewhat complex set of legal rules. Intellectual Property 1.0 Patents As mentioned in Task 113, a patent is a monopoly created by law, which gives the patent holder the sole right to make, use, and sell the patented item as well as the right to prevent others from doing so. A patent is issued after often-lengthy proceedings on and consideration of an application to the U.S. Patents and Trademark Office in Washington, DC, and offers protection for a limited period of time. Most patents are effective for 20 years (if filed after June 8, 1995). There are three types of patents. Utility patents cover the invention or discovery of a process, machine, or method of manufacturing. Design patents cover ornamental features or other attributes of appearance. Plant patents apply to invented or discovered varieties of plants. Patents may cover new and useful processes, machines, methods of manufacture, composition of matter, or any new or useful improvement thereof. The patent owner may license others under the patent. If no license is granted and an infringement of a patent occurs, not only the maker or supplier of the infringing item may be liable but so too the user of that item. Thus, in negotiating purchases involving articles or processes that could involve patents, purchasing personnel should protect their organizations against financial loss due to possible infringement by including a patent indemnity clause in any agreement. (Many organizations purchase order forms include these clauses.) When the article purchased is to be added to an organizations product line for resale or lease to others, the purchaser should endeavor to obtain as broad a patent indemnity from the supplier as his or her organization intends to pass on to its customers. In these instances, patent indemnity provisions should be reviewed with legal counsel. 105

C)

Task 114

Module 1 The terms patent pending or patent applied for mean that the patent is before the Patent Office for consideration. While the application is pending, even before the final patent is issued, the law protects the idea of the patent applicant. Although many applications are rejected, a patent pending notice should be a red flag to purchasers. In seeking a source for a patented item, a purchaser should never buy from a non-licensed supplier on a copy or equal basis. Purchasing personnel should also attempt to gain patent rights for their organization whenever possible. An invention can become a valuable asset to an organization. The purchasing department should consider each purchase thoroughly prior to the award of a contract to decide whether Purchasing should consider whether or not the rights to a by-product invention are subject to negotiation. It should be made policy that the purchasing organization receives all rights, title, or interest in any invention or process that was discovered by a supplier with the use of organization funds. 2.0 Copyrights Copyrights are rights granted by law similar to those of patents, except they grant monopolistic rights to an author, artist, or composer for the publication, production, or sale of rights to literary, dramatic, musical, or artistic works. Copyright law (rather than patent) is typically used to protect software. A copyright generally lasts for the life of the author plus 70 years. If it is a work for hire, the copyright lasts for 95 years from publication or 120 years from creation, whichever is shorter. These rights are automatically secured when the work is fixed into any medium of expression. This means the work is protected even though no copyright application has been filed. As with patents, it is essential to acquire all necessary rights to copyrighted materials as will be necessary for the purchasing organizations intended use of such materials, either through the acquisition of the copyright itself or through licensing. As information services increase in importance, purchasers must beware not to violate copyrights on published reports, software manuals, training materials, and so on. Source code escrow accounts When acquiring software or the rights to use it, the purchaser may request an escrow account. The escrow agent (an independent third-party) physically stores the property (e.g., source code) and has title to it and authority to release the code under specified conditions. Such an arrangement can be critical to continued use of software in the event the supplier goes out of business, has financial difficulties, or discontinues support of the product.

3.0

D)

Restraint of trade/antitrust Purchasers should keep in mind that the purpose behind all antitrust legislation is to protect the free enterprise system of the United States. The four primary laws dealing with antitrust are the Sherman, Clayton, Federal Trade Commission, and Robinson-Patman Acts (see Task 108). Purchasers frequently need to seek advice of counsel on these laws.

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Assignability provisions Assignment refers to a transfer of ones rights and/or duties under a contract. In their standard terms and conditions, many purchasers ask the supplier to secure purchaser approval prior to assigning its performance under the contract to another party. Assigning all or part of the work without the purchasers approval would be cause for cancellation of the contract. A typical assignment clause is: Supplier shall neither assign its performance under the Purchase Order or any part thereof, nor delegate any obligations hereunder without the prior written consent of Purchaser. The purchaser may assign rights such as the right to damages for breach or payment of an account under UCC Section 2-210. Domestic versus international legal relationships More terms are becoming standardized between nations, as worldwide market dealings become more common for both purchasers and suppliers. For example, there are Uniform Customs and Practice for Documentary Credit for handling letters of credit, and the INCOTERMS establishing standards of responsibility and title for international transportation (see Task 110). But many other terms and conditions are less standardized. The courts of certain foreign nations may recognize or accept the laws of another nation (comity), but international transactions may be governed by the CISG (refer to Task 108). Understanding the application of law is especially important when placing purchase orders with overseas suppliers. When dealing with international suppliers, the issue of court jurisdiction is frequently a major stumbling block during negotiations. Using legal counsel to determine whether the laws of the suppliers country recognize the laws of the United States may resolve this negotiating issue. Often, purchasers prefer to deal with offshore suppliers who have U.S.-based assets. If a dispute occurs, these assets can be tied up in court and provide a basis for compensation.

F)

G)

Protests Suppliers may protest if they believe they have been unfairly treated. In the private sector, the process is informal and involves a discussion between the supplier and purchaser and possibly managers from each organization. The intent is to explore the reasons for the suppliers protest. In the public sector, the process can be more formalized. Sometimes an administrative hearing board may listen to the suppliers complaint and decide if an appropriate remedy is required. During the hearing process, the award may be held in abeyance until the suppliers protest is ruled upon. Public sector purchasers in particular are advised to consult with legal counsel on how to handle a bid protest properly (see also Task 113).

H) I)

Claims Claims include any right to payment or to receive any equitable remedy, such as specific performance of a contract. Insurance and indemnification In certain contracts, the supplier should be required to carry a certain amount of insurance and to indemnify the organization against injuries. Most purchasers specify in the contract the type and the minimum amount of insurance required, such as The supplier shall carry insurance protecting the purchaser

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Module 1 in not less than minimum limits of property damage of $1,000,000 and public liability of $500,000/$1,000,000. This is but one example of the type of insurance that may be required. Others include builders risk, errors and omissions, and workers compensation. The organizations risk management team best determines appropriate types and levels of insurance. In addition to obtaining certificates of insurance, it is important that the purchasing organization be named as an additional insured on any such insurance policy. The terms hold harmless, indemnify, and defend commonly refer to indemnification clauses used to protect a purchaser or supplier from loss or damage. Hold harmless (or save harmless) and indemnify refer to being reimbursed for penalties or liabilities incurred by one party because of anothers actions, and normally pertain to financial or monetary loss. The term defend imposes an obligation on one contracting party to defend the other in a legal action and to incur the cost of such legal action. Such clauses are standard boilerplate in most purchase order forms. They are especially useful in construction contracts to protect the purchasing organization against claims by suppliers laborers (see Task 117).

J)

Limitation of liability Suppliers will frequently try in contract language to limit their liability for damages and loss in the event of warranty claims or other breaches of contract. Such limitations may restrict the purchasers remedies or the amount of damages recoverable in a lawsuit. One of the most common limitations is the requirement with warranty claims that the supplier be permitted to repair or replace defective goods. Under such a term the purchaser who chooses to assert a breach of warranty claim is not permitted to cancel the contract and seek damages for its loss. Another common limitation may be found in the suppliers disclaimer of consequential damages. Consequential damages are special damages unique to a given situation. Distinguished from incidental damages, such as inspection, transportation, and replacement expenses, consequential damages relate to lost profits, lost sales, and injury to property or persons.

K)

Merger/integration clause By including a merger or integration clause in their contract, the parties agree that the written contract constitutes the final expression of all terms. When such a term is used, any representations, promises, warranties, or oral statements made by either party prior to contracting are not part of the agreement. This term in the contract is sometimes labeled Entire Agreement, and typical wording would be: This purchase order, together with any attached drawings or specifications incorporated herein, sets forth the entire agreement of the parties, and no other terms and conditions in any document, acceptance or acknowledgment shall be effective or binding unless expressly agreed to in writing by the purchaser. Parol evidence rule Even when the parties have not included a merger or integration clause in their contract language, a legal concept known as the parol evidence rule may apply. The parol evidence rule restricts the introduction of oral testimony to change

L)

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the terms of a written contract. The law presumes that all aspects of the contract and everything that took place prior to the execution of it are incorporated into the written document. Therefore, only the written document itself is permissible evidence of the agreement. Applying this rule means that any statements about product quality or other representations made by the suppliers agent during negotiations which are not put in writing, would not be enforceable. Also, changes to the contract after it is executed must be in writing. M) Collusive activities Collusion is a secret agreement and cooperation for a fraudulent or deceitful purpose. Federal antitrust laws are designed to prevent collusive activities on the part of suppliers. Purchasers need to seek the advice of counsel in cases where collusion is suspected. Suspension and termination clauses Suspension and termination clauses protect the purchaser against unforeseen funding problems, delays on the part of internal personnel, or changes in management thinking. A suspension clause allows the purchaser to stop all or part of the work under the contract on a temporary basis. The assumption is that work will be restarted at some time in the future. In the public sector, suspension (or default) applies when a supplier is found to be in non compliance regarding performance of the contract. The suspended supplier has a certain time period to correct its performance. A termination clause, often referred to as termination for convenience, provides that the purchaser may put an end to the contract altogether, even though the supplier is in complete compliance with all contract terms. Payment for expenses incurred up to the time of suspension or termination typically are reimbursable if properly documented (see Task 117). O) Exception to approved terms and conditions In cases when a suppliers terms differ from the purchasers and a dispute arises, a determination may have to be made as to whose terms apply. Different legal concepts apply depending on whether the contract is for goods or services. Consultation with legal counsel is advisable in making this determination (see Task 113). Special contractual circumstances 1.0 Large contracts These contracts receive high visibility within most organizations and thus should be subject to a review by legal counsel. Additionally, any changes to the scope of work during the course of the contract should also be reviewed. Such orders should be double-checked for proper signatory authority on the purchase requisition and purchase order. Because they may require a long period of time in bidding, negotiations, and contract management, the purchaser must maintain constant vigil over large contracts. Single/sole source contracts When an organization places 100 percent of its business with one supplier, issues of supply assurance are of extreme 109

N)

P)

2.0

Task 114

Module 1 importance in such contracts. The contract should be written to emphasize delivery and quality initiatives on the suppliers part.

Q)

Reservation of Rights The purchaser should reserve all rights to contract performance in accordance with stated terms and conditions. A modifications clause prohibits suppliers from making any changes in the contract without the consent of the purchaser. A waiver clause may be used to protect the buying organization against possible loss of contractual rights in the event it inadvertently fails to enforce certain rights. Hazardous/regulated materials Several federal and state laws apply to hazardous or otherwise regulated materials. In 1976 the Toxic Substances Control Act was designed to control the manufacture, distribution, and sale of chemicals. The EPA maintains a list of all existing chemicals considered toxic, and can limit the use of chemicals shown to present unreasonable risk to health or the environment. The Resource Conservation and Recovery Act, also passed in 1976, focuses on the management of hazardous waste, and its generation, storage, transportation, and disposal. The EPA uses four criteria for identifying such waste: (1) ignitability, (2) corrosivity, (3) reactivity, and (4) toxicity. Currently, more than 700 substances have been categorized as hazardous. Purchasers will typically need to consult with legal counsel or environmental specialists on the interpretation of these and related environmental laws.

R)

S)

Liquidated damages In an attempt to avoid the problems of calculating and proving damages in a lawsuit, contracting parties will often state a predetermined amount of damages, known as liquidated damages, in their agreement. Because punitive damages are not allowed in contract law cases, it is important to ensure that the liquidated damage amount be reasonable in light of actual damages suffered. Use of the term penalty should be avoided.

BIBLIOGRAPHY Ritterskamp, Jr., J. and D. King. The Purchasing Managers Desk Book of Purchasing Law, 3rd ed., Prentice Hall, Englewood Cliffs, NJ, 1997. Wests Business Law, Interactive CD-ROM Edition, West Publishing Company.

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TASK 115: Administer contracts/purchase orders from award to completion.

1) CONTRACT ADMINISTRATION CONCEPTS Contract administration is a partner with purchasing activities. Together the two actions form a partnership. Through effective negotiations, one side arrives at fair pricing and terms and conditions for the organization. The other ensures the organization receives full value for its expenditures. Each function acts to produce mutually beneficial goals for the purchasing organization. Contract administration is the management of various aspects of contracts and purchase orders to ensure the contractor provides all goods and services stated in the contract, and in the timeframes and delivery manner specified. In essence, contract administration involves all actions taken concerning a particular contract or purchase order after it is signed until final delivery, acceptance, and close out procedures are completed. In some cases, the administration does not cease upon completion of the contract depending on any survivorship clauses that may be in the document. The term encompasses steps taken by both organizations in achieving the following objectives: A) Ensuring that the purchasing organization fulfills its part of the contract agreement. Ensuring that the suppliers performance complies with the contract. Protecting the purchasing organizations interests by prompt and fair resolution of any problems that arise during performance. Determining whether increased costs of contract performance should be borne by the supplier, and negotiating equitable adjustments of the contract terms when warranted. Taking all administrative actions necessary to document contractual transactions. Work Control Some types of contracts (such as indefinite delivery contracts, time and material or labor hour contracts, and cost reimbursement contracts) defer the ordering and work authorization processes until after the award. In those circumstances, ordering becomes a post-award or contract administration matter. Work ordering under an indefinite delivery type or time and materials or labor hour contract generally follows a similar pattern. For an indefinite delivery contract, the customer activity initiates a standard work order form with the line-item description of the desired items copied directly from the contract, along with the unit-price, directly from the contract schedule. The desired quantity is multiplied by the unit-price to arrive at a total. This work order is generally routed to a purchaser for signature and distribution to the supplier, the customer activity, and the finance office. Work completion, work inspection and acceptance, invoicing, and payment follow normal procedures. A flow diagram for a typical ordering and payment cycle is shown in Exhibit 1. The process for time and material or labor hour contracts follow a similar pattern, except that the customer activity-prepared statement of work is generally accompanied by an in-house estimate.

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EXHIBIT 1 Work Order and Payment Procedures Flow Chart for an Indefinite Delivery Type Contract

Task 115

Customer Activity Initiate Work Order IAW Contract Issue Work Order Distribute Work Order Sign and Distribute Work Order Perform Work IAW Work Order

Inspector /QAE Purchaser Supplier

Purchasers Representative

Finance Office Establish Accounting Record

Initiate Work Order IAW Contract

Distribute Costs to Individual Job Order Distribute Numbers for Cost Work Order Report Provide Evidence of Work Completed and Copy of Work Order Signed Order or Report Acknowledging Receipt or Inspection/Acceptance INVOICE Pprepare Invoice Monthly for All Accepted Work

Distribute Wor k Order

112
CERTIFY PAYMENTS Prepare Voucher and Forward to Finance Office

ACCEPT WORK Verify Hours and Materials Used and Sign Order or Receiving Report Consolidated Invoice Including One Copy of Each Accepted Work Order

VERIFY PAYMENTS CONTRACT DOCUMENTS 1) Proper unit price 2) Work IAW contract scope 3) Appropriate deductions taken 4) Check for duplicate billings or work orders 5) Check arithmetic

Verify Payments And Issue Check

Satisfied Supplier

Module 1

Part D: Contract Execution, Implementation, and Administration

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Cost reimbursement for contract work-control procedures are often considerably more complex than controls for other types of contracts. These procedures are used in large cost-reimbursement contracts extending over several years. Many cost-reimbursement contracts require the establishment and maintenance of the following: process of annual work plans, work authorizations, and Notices to Proceed (NTPs) as a means to assist in cost and schedule control. Upon purchaser receipt of preliminary funding guidance, the supplier can be informed of the expected levels of funding (for the ensuing (budget) and subsequent fiscal years), milestones based on the current master program schedule, and relevant scope information. This guidance enables the supplier to prepare an Annual Work Plan (AWP). AWP is central to the total process in that it provides the initial definition of tasks to be performed in the budget year and a schedule for accomplishment. The AWP provides for a balance of funding guidance and program schedule requirements. During the AWP review, the supplier resource projections are approved and the tasks to be undertaken are scheduled. The specific elements of an AWP generally include goals and assumptions, work authorization review results, a schedule, staffing plan, and cost estimate for the budget year. The AWP should be updated at the middle of each fiscal year. Work authorizations generally cover a variety of duties. These include Work Breakdown Structure designations for the work, information regarding the duration of the work authorization, the baseline cost estimate for the work, and references to the existing AWP and NTP to be issued subsequent to the work authorizations. Tasks to be accomplished during a certain period or phase of contract performance will be described in NTP documentation and issued to the supplier prior to the suppliers undertaking any work. The NTP normally includes a statement of work, the key schedule milestones for task accomplishment, and the total amount of funds allotted to the tasks. Upon receipt of the NTP, the supplier will begin work and start cost and scheduling reporting for the tasks concerned. B) Compliance Contract compliance is a primary responsibility of purchasing, however, the actual day-to-day monitoring and administration may be done by other organization departments or third-party entities. Extremely complex contracts, very specialized purchases, or highly technical contracts may require the assistance of the internal customer using the product or service, or a third-party administrator to ensure supplier compliance. In these cases, these individuals may be aware of the technical aspects of the contract, but they may require training as to the legal and purchasing aspects of the contract. These individuals must be given basic instructions in the following areas: 113

Task 115

Module 1 Reading the contract; a must if the administrator is to understand the whole scope of the undertaking. Developing a mutually beneficial, arms-length relationship with the supplier. Understanding the basic requirements of the contract. Recognizing potential problems. Actions they can take before notifying the contract administrator. Actions they must not take. Areas of authority and responsibility.

For a successful contract compliance program, the end-user and third-party administrator must understand not only the contract, but also organization operating policies and procedures. The purchasing department has first-line responsibility to get this information to the administrators. Well-established bilateral communication lines will assist in developing outstanding contract administrators for the organization and the purchasing department. Obviously contract compliance involves having a plan of action or actions to take if the supplier fails to perform or the purchasing activity has a change of requirements. Contract compliance monitoring involves several techniques and procedures for determining, in a timely manner, if satisfactory delivery or contract completion will occur. A contract is monitored to determine if it will be performed in accordance with the contract requirements and if problems are developing that need to be addressed. The purchasers aim in compliance monitoring includes reviewing the following areas: C) Can performance on schedule be expected? Will the cost be within the estimate? Are resources being applied at originally predicted levels? Will the quality of the end-products be consistent with the specifications? Are progress payments warranted? Will new components need to be incorporated in major equipment? Will the suppliers own progress monitoring system be adequate? Are all contractual provisions (including those not relating to the work itself) being followed? Is the purchasing organization receiving all goods and services contracted for at the price, time, place, and quality contracted? Are requested changes properly documented and fairly resolved?

Financial responsibility From the award of a contract to final close out, the suppliers primary concern is to receive payment in as timely a manner as possible for work done. The different types of contracts used by the purchaser create different financial relationships between the purchaser and the supplier. The supplier with a firm-fixed-price contract has a strong incentive to perform in the most economical way, since every penny saved below the contract price is additional profit. Under most labor hour, time and materials, and cost reimbursement contracts, however,

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the supplier has little incentive to perform in the most economical way. Under these latter types of contracts, the supplier is generally entitled to compensation for either a fixed amount per hour or the costs incurred in doing the work, provided that the expenses are not unreasonable. The work description in such contracts is usually broad because it is difficult to predict just what the supplier is required to do. This gives the supplier wide contractual authorization, which can permit the supplier to perform (and charge for) effort along lines other than those specifically desired by the purchaser. Under these latter types of contracts, the purchaser needs to monitor and guide the suppliers efforts to prevent waste of funds and to ensure the organization gets the services needed within the amount budgeted (see Task 113). D) Approving systems The federal government relies upon a number of formalized programs to determine whether its major suppliers conform to law, regulation, good business practice, and the federal norm. Many other governmental, quasi-governmental, and institutional clients impose similar, although generally less rigid, requirements. This section deals with the full-blown requirements imposed on federal government prime suppliers, particularly those that contract with the Department of Defense (DOD). The major formalized programs are identified in Exhibit 2. EXHIBIT 2 Approval Requirements REQUIREMENTS Subject to Subcontract Consent Process Subject to Supplier Purchasing System Review Subject to Employee Compensation and Other Review Programs FFP NO NO NO CONTRACT TYPE FPI T&M/LH YES YES YES YES YES YES Cost R YES YES YES

NOTE: FFP is Firm-Fixed Price; FPI is Fixed-Price-Incentive; T&M/LH is Time and Materials or Labor Hour; Cost R is Cost Reimbursement The most common of these formalized programs is the subcontract consent review process that is explained in the subcontracts clause of most major contracts. This clause requires suppliers performing other than firm-fixed price contracts to follow the federal norm in their award of subcontracts and purchase orders, and to request specific written consent to place certain larger subcontracts and purchase orders. Close scrutiny of subcontracts and purchase orders is generally necessary in the following circumstances:

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Module 1 When the suppliers purchasing system is considered inadequate. When subcontracts are awarded without competition or the proposed prices seem unreasonable and the dollar amounts involved are large. When close working arrangements or affiliations with subcontractors may result in higher than normal subcontract prices. When the price proposed by the subcontractor is less favorable than prices quoted by the subcontractor for comparable jobs. When the subcontract is placed on other than a firm-fixed-price basis. Purchasers should be especially skeptical of the repeated award of subcontracts on a cost reimbursement or time and materials/labor hour basis.

A typical subcontracts clause permits the purchaser to perform Contractor Purchasing Systems Reviews (CPSRs) whenever a prime suppliers negotiated defense sales are expected to exceed $10 million. This type of review samples the total universe of subcontracts and purchase orders awarded by the prime supplier in order to draw conclusions about the degree to which the supplier has protected the taxpayers interests. E) Administrative responsibilities It is not possible for a contract administrator to be an expert in all areas of purchasing, contract law, transportation, health and safety regulations, and other factors that come into play in the life cycle of a contract. What is possible is for the administrator to know the areas of knowledge to get the job done and effectively administrate the contract to a successful closeout. The following highlights some of these areas. 1.0 Price adjustment clauses Economic price adjustment clauses are generally of three distinct types: Established price clauses These clauses appear in different forms depending on the types of materials purchased and the types of suppliers involved. In all cases, however, adjustments are made in two ways: - In accordance with the fluctuations in the suppliers applicable established prices. - In accordance with applicable labor and material price indices. Adjustment clauses based on actual cost methods This type of clause generally permits adjustments to labor or material costs where no major elements of design engineering or developmental work are involved in producing the item being procured, and where one or more identifiable labor or material cost factor involved is subject to change. The contract schedule should describe in detail the types of labor or material subject to the actual cost adjustment. Adjustment clauses based on published cost indices The third type of clause includes clauses based on adjustments to labor or material costs using a published cost-index method. For several reasons, including ease of administration and the ability to base the adjustment on readily 116

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available published economic data, this type of clause is preferred over an actual-cost clause. This type of clause should be used when: - An extended period of performance with significant costs to be incurred will exist normally beyond one year after commencement of contract performance. - The contract amount subject to adjustment is substantial. - The economic variables for labor and material are determined to be too unstable to reflect a reasonable division of risk between the parties without economic price adjustment provisions. 2.0 Administration of change orders Ideally, a contract contains all provisions necessary for completion of the work and discharge of both partys obligations. Modifications of the agreement are not contemplated when the contract is signed. In practice, however, few contracts are completed without some type of modification. Some are simply administrative changes that do not affect the substance of the contract. Others involve substantial changes to the price, quantity, quality, delivery, or other terms originally agreed to by the purchaser and the supplier. Because the purchasers authority under any given contract is defined by the contracts clauses, it is necessary that those clauses contain provisions that allow flexibility to alter the contract after award. It is also necessary that there be provisions requiring the parties to equitably alter the delivery schedule or the price to be paid in correspondence with other changes in the contracts terms. Consequently, contract provisions must give the purchaser the authority to make changes. These provisions should also give the supplier or the purchaser relief if the other party does something not contemplated, or fails to do something contemplated, by the original agreement. The provisions should also allow equitable adjustment of performance time or price when changes are made. F) Contract closeout The term contract closeout refers to the actions taken by both parties in a contract upon completion of their respective obligations. These actions may include verification that all work has been duly performed, accepted, properly invoiced, and fully paid for. The supplier delivers all warranty documents, and bond agreements are terminated as appropriate. In most complex contracts, a checklist for closeouts is recommended with appropriate parties signatures or initials signifying work or action is complete. Contract terms and conditions The contract administrator needs to know the terms and conditions of the contract to ensure that both parties are in compliance. Terms and conditions include information on quantity, price, delivery, shipping requirements, payment terms, quality specifications, engineering drawings and other related documents, sampling plans, conditions of acceptance, other important factors affecting acceptability of the product or service, and standard boilerplate terms and conditions. These are 117

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Module 1 intended to give legal protection to the purchaser on matters such as contract acceptance, delivery performance, contract termination, shipment rejections, assignment and subcontracting, patent rights, and payment procedures.

H)

Documentation requirements Each contract will have its own documentation requirements. It is the contract administrators responsibility to determine what they are and see that they are met. Example documentation includes work orders, invoicing, work plans, and performance measurements. Supplier insurance forms, bond requirements, verification of tax payments, and verification of material payments by the supplier also show the wide range of documentation that may be necessary. The procedure can be formal with written checklists or can be handwritten notes in the contract file. The point is to document all actions and verify all requirements. Statement of work The statement of work (SOW) is the detailed portion of a service contract that states exactly what is to be done, by whom, when, and how it is to be done. The SOW describes as precisely as possible what is expected of the supplier. This can be a simple paragraph in a purchase order or it can be a multi-page separate exhibit in a more complex construction or manufacturing contract (see Task 106).

I)

2)

SUPPLIER MANAGEMENT CONCEPTS Professional supplier management is a vital ingredient in large dollar volume contracts, construction contracts, most service and maintenance contracts, and in a just-in-time environment. A) Standards of performance The foremost prerequisite to successful supplier management is a sound understanding by both parties of the contract requirements regarding standards of performance. The purchaser or contract administrator should hold a conference with the prospective supplier either immediately prior to or after the award of the contract. The standards of performance (performance measures) are delineated in the specifications or statement of work, including the measurement methods where appropriate. The measures are regularly monitored and reviewed with the supplier during the contracts execution. Supplier feedback An often overlooked aspect of successful supplier management is the solicitation of supplier feedback. This process involves requesting answers from suppliers to the following types of questions: How knowledgeable are our purchasers? How accurate are our engineering specifications? How clearly do we state our quality requirements? How timely are our payments?

B)

Organizations that use supplier surveys usually find that the feedback plays a significant role in improving supplier relations, and ensuring that high quality materials and services are received on time. 118

Part D: Contract Execution, Implementation, and Administration C)

Task 115

Supervision of supplier When evaluating a suppliers progress, the purchaser is interested in actual progress toward completing the work. Data about progress may be obtained from a variety of sources: production progress conferences, field visits to the suppliers plant, and periodic progress reports by the supplier. In smaller organizations, the same individual may perform the purchasing and supplier supervision function. In larger companies and government organizations, the functions may be separated within the purchasing department or a separate administration or supervision department may exist. In those cases where non-purchasing staff is serving as administrators or supervisors, the organizations policy on ethics must be covered with them. Some employees may not be aware of policies against gifts and gratuities. Other internal policies concerning software or hardware replacement, release of information, or other points of concern should be brought out in training sessions. 1.0 On-site On-site supervision means the purchaser or purchasers representative is either located at the site of the project (suppliers plant, purchasers facility, or separate location) or makes frequent visits to the site to oversee the project. In the case of construction contracts, it also means visits to the construction site to oversee progress. In other words, on-site supervision takes place at the actual location the work is being accomplished. Remote Remote supervision can take many forms. Analyses of the suppliers invoices for price compliance from the purchasers accounting office, review of work flow charts from the purchasers office, and teleconferencing with the supplier are examples of remote supervision.

2.0

D)

Management by exception Suppliers are responsible for the timely and satisfactory performance of their contracts. In reality, a contract administrator cannot rely entirely on the supplier to ensure that work is progressing as scheduled and that delivery will be as specified. Poor performance or late deliveries disrupt production operations and result in lost sales. Accordingly, purchasing must monitor supplier progress closely to ensure that desired material is delivered on time. This method of monitoring depends on the leadtime or period of performance, complexity, and urgency of the order. The contract administrator should employ the concept of management by exception at the time that a contract or purchase order is awarded to determine whether routine or special attention is appropriate. Simply monitoring the receipt of receiving and inspection reports may be adequate on many orders for non-critical items. On others, telephone confirmation that delivery will be as specified may be adequate. Orders for items critical to the scheduling of operations, more detailed procedures are appropriate.

E)

Progress reports In some instances, the supplier is required by the terms of the contract to submit a phased production schedule for review and approval. A phased

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Module 1 production schedule shows the time required to perform the production-cycle planning, designing, purchasing, tooling, plant rearrangements, component manufacture, sub-assembly, final assembly, testing, and shipping. In most cases, the purchaser may include a requirement for production progress information in the RFP and in the resulting contract. The ensuing reports frequently show the suppliers actual and forecasted deliveries as compared to the contract schedule, delay factors if any, and the status of incomplete pre-production work (such as design and engineering, tooling, and construction of prototypes). The reports should also contain narrative sections in which the supplier explains any difficulties and the action, or actions, proposed or taken to overcome them. Production progress reports do not alleviate the requirement to conduct visits to the suppliers plant or the work site on crucial contracts. The right to conduct such visits must be established in the RFP and resulting contract. On critical contracts, where the cost is justified, it may be desirable to establish a resident plant monitor at the supplier facility to oversee the quality and timeliness of the work being performed. When it is determined that an active system of monitoring the suppliers progress is appropriate, the first step in ensuring timely delivery is to evaluate the suppliers proposed delivery schedule for attainability. In their planning and control activities, most suppliers utilize a variety of graphic methods including Gantt charts and PERT or CPM diagrams to portray the proposed schedule and to monitor progress. These are useful management tools that can also be reviewed and evaluated by the contract administrator.

F)

Customer feedback Contract administration is not performed in a vacuum or by sitting in an office. Every action taken by a contract administrator affects many internal and external customers of the organization. A vital key in the successful performance of the contract is to get feedback from the customers. This is a method of self-verification to ensure the contract is performing within acceptable parameters. 1.0 Internal Internal customers are the end-users of the services or goods purchased by the contract. They represent the finance department that must pay the invoices, the quality control department that might be required to inspect goods received, the warehousing department that might store and re-ship goods received, and senior management officials. External External customers are the prime supplier of the contract. They represent sub-contractors, governmental agencies (local, state, and federal levels), and possibly partner organizations of the purchasing activity.

2.0

G)

Statement of work Careful development and communication of each statement of work, in conjunction with user departments, plays an important role in supplier management, since a clear understanding of responsibilities is more likely to result in satisfactory performance by each party.

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Part D: Contract Execution, Implementation, and Administration 3) CONFLICT/DISPUTE RESOLUTION

Task 115

Contract administration is an art, but it is an art that follows a set of specific guidelines and procedures it follows a plan. When a contract is given to the contract administrator to maintain, certain functions are to be followed in accordance with the following: organization policy and regulations, the contract terms, and generally accepted UCC procedures. Part of the plan is to see that the internal customer gets the goods and services required and as needed. Contract administration also involves acting as an emissary between the end user and the supplier to resolve disputes. Often the administrator is the last resort for both parties to reach agreement on disputes prior to seeking legal redress. As things change, it may become necessary to terminate a contract or re-negotiate the terms. The administrator may take on the role of negotiator to settle liquidated damages and lost profit claims by the supplier. The administrator may also assist in problem resolution for the suppliers internal matters that may affect contract performance. Contract administrators are often looked upon as an impartial source that both the suppliers and purchasers organizations can look to for fair and just resolution of conflicts. It is vital that the conflict resolver listen to both sides of disagreements before determining a course of action. Although the purchasers organizations position must be considered, the contract administrator must resolve issues in an ethical, legal manner so that both parties believe a win-win solution has been found. The over-riding factor for the administrator is to remain focused on the objective and to ensure completion of the contract terms and obligations within the allowed timeframe and budget. Flexibility, willingness to compromise, and operating under the contingency approach are good indicators the purchasers organization has a successful conflict resolution program in place. In todays expanding international business environment with trade agreements like NAFTA (North American Free Trade Agreement), associations like ASEAN (Association of South East Asian Nations), and the combining of countries into economic units like the EC (European Community) it is important to understand conflict resolution practices and plan for conflicts that may arise from contracts that cross international borders and cultures. Business as usual is unlikely to prevail when purchasing internationally. Social and business cultural differences must be accounted for. Concepts such as a pre-award conference and frequent post-award follow-up become even more important to reduce the potential for conflict. Purchasers are responsible for understanding and identifying areas of potential conflict, remembering that not everyone thinks as Americans think. Matters that may be clear between the purchaser, or contract administrator, and supplier in the United States. may take on a different connotation when business is transacted internationally. Consequently, the likelihood for conflict increases. The experienced contract administrator understands that other cultures place different values on matters such as time, quality, and payment due dates. Purchasing professionals and contract administrators should take such matters into consideration during

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initial phases of contract development and throughout the business relationship to ensure conflict is minimized (see Task 117 for more on conflict resolution). BIBLIOGRAPHY Anderson, R. and M. Aspuro, Effective Contract Administration, NAPM InfoEdge, (2:10), June 1997.

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TASK 116: Expedite deliveries and conduct follow-up procedures when necessary.
After an order has been placed, there are many situations that might cause the purchaser to need to change delivery timing. In addition, it may be prudent for the purchaser to follow up with the supplier periodically to ensure on-time delivery. Collectively, these actions taken by the buying organization to work with suppliers to meet existing schedules and to adapt to changing schedules are called expediting. This activity may include periodic supplier contact to assess the progress of the order, to effect early delivery, or even to delay delivery as business conditions and schedules change. 1) CIRCUMSTANCES REQUIRING FOLLOW-UP AND EXPEDITING A) Adequacy of supplier delivery schedules Responsibility falls to the purchaser to ascertain that the suppliers promised delivery date will meet the required internal customer due date. When circumstances arise for the purchase of products or services outside of the normal supplier delivery schedule, the purchaser is responsible for working with the supplier to ensure on time delivery. Open orders One of the objectives of follow-up is to ensure that open orders, especially long leadtime orders, receive periodic review. The longer the leadtime, the more likely it is that if the purchaser does nothing during the interim, the order will arrive late. In this case, the expediting objective is adherence to the original delivery schedule. Periodic review assures the buying organization that if supplier difficulties arise, the purchaser will learn of them in time to take appropriate actions. These actions will ensure delivery as close to the original schedule as possible. Back orders When a supplier delivers only part of an order on the due date, the remaining undelivered portion is classified as back ordered. In this situation, expediting is necessary to determine the reason for the back order and to schedule the delivery of the balance. Late orders A late order is one not delivered by the promised date. Expediting will determine the cause of the delay and will help set the new delivery date. Communication is then necessary with the requisitioner to determine the affect of the late delivery and the acceptability of the new delivery date. Short-cycled requests Whenever an order is placed inside of a suppliers normal leadtime, it is defined as RUSH. Negotiation is likely needed with the supplier to determine if it is possible to meet the time requirement. In some cases, alternate suppliers may need to be contacted to find one able to meet the rush requirement.

B)

C)

D)

E)

2)

RATIONALE FOR EXPEDITING Expediting adds no value to a product it only adds cost. The objective of all purchasing organizations should be to decrease the need for expediting (and thus its costs) by selecting 123

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suppliers who are reliable and responsive. In addition, internal planning and forecasting should be emphasized to minimize expediting requirements. In situations such as those described in the preceding section, it may be necessary to work with suppliers to change schedules or resolve delivery problems. In this situation, the following follow-up procedures apply. 3) FOLLOW-UP PROCEDURES There are many reasons for expediting and follow-up activities, and many means by which they may be accomplished. Methods range from postcard requests to suppliers for order status, to electronic communication, although the most common method is by telephone. Depending on the severity of the problem, supplier site visits and meetings with senior executives may be necessary. A) Early deliveries Receipt of materials substantially before they are needed often causes significant inconvenience and additional cost to the buying organization. Goods will be stored for longer than normal, and may need to be moved several times before use. Damage or loss during storage or handling may result. For goods and services that are received ahead of schedule, payments may need to be made before schedule as well.. All of these are additional costs that follow-up strives to avoid by arranging delivery just when needed. Especially with long leadtime items, it is important that follow-up be done regularly during the acquisition cycle to avoid these potential early delivery costs. Late deliveries There are many reasons why suppliers fail to meet promised delivery schedules. Regardless of the cause, expediting activity focuses on problem resolution. With planned follow-up actions, the buying organization can identify a problem order quickly and work with the supplier to put the order back on the original delivery schedule. Experienced expediters acknowledge that often suppliers problems are created, at least in part, by the purchasing organization. Rather than focusing blame, the key issue in the late order situation is to resolve the difficulty and receive delivery at the earliest possible time. After the order has been received, expediters should work with the supplier to identify and remove the cause of the delay. Future deliveries When following up on a specific order, an expediter often will review with the supplier all of the other open orders the buying organization has with that supplier. This analysis may identify other orders that, although not yet past due, are behind schedule. Cooperative problem solving may then be applied with the supplier to regain the schedule. Short leadtime requisitions Many organizations find a significant portion of the orders processed each day are labeled RUSH. Internal causes for these short leadtime orders should be examined. Excess administrative leadtime, including approval signatures, internal mail routing, and absence of key individuals are some of the internal causes worth examining. Supplier quality problems usually require extensive 124

B)

C)

D)

Part D: Contract Execution, Implementation, and Administration

Task 116

expediting efforts involving other departments (such as quality control and production) from both organizations. There are other causes (such as machine failures, inaccurate inventory and other errors, and impatience), each of which leads to expediting effort and additional cost. After the rush requirement has been met, it is useful to review the transaction to determine its cause. Every effort should be made to eliminate as many rush transactions as possible, since these usually result in significantly increased transaction, transportation, and other costs. It is also useful to review, on a quarterly basis, all rush orders processed during the period. From these, common requirements may be identified, such as repeated rush orders for a specific product. Addition of that item to inventory may reduce total cost by eliminating rush order and expediting costs. E) De-expediting It is not unusual to find situations where, due to production or activity schedule changes, goods may not be needed by the original due date. In these cases, to avoid receipt of goods sooner than needed (see Early Deliveries above), the expediter may work with the supplier to delay deliveries to de-expedite. Rescheduled deliveries Any rescheduled delivery requires consultation with the requisitioner or internal customer to ensure that needs of the organization are being met.

F)

4)

EXPEDITING AND FOLLOW-UP PERSONNEL There is considerable debate over the proper organizational positioning of the expediting activity. Some argue that purchasers should expedite their own orders. Others opt for separate expediting personnel. Occasionally, the requisitioning or using organization may expedite orders for its department. The following section will present a discussion of each option. A) By purchasers Most commonly, purchasers are responsible for expediting their own orders. The argument for this process is that the purchaser is most familiar with the order and the supplier, and is, therefore, in the most knowledgeable position to manage the order and any expediting necessary. In addition, it is suggested that purchasers need to know about non-performing suppliers so that corrective actions can be taken. Expediting assures purchasers of this knowledge. An argument against this practice is that less highly trained staff may be capable of most expediting activity, freeing purchasers to concentrate on that for which they are specifically trained. By separate staff Because purchasers are typically more highly paid than other staff, including expediters, it is argued that an organization can maximize its return on staff investment by having purchasers spend their time purchasing and assigning expediting activities to other staff. Special expediting training can be devised for those whose responsibility it is. The argument against this process is that it divorces purchasers from the day-to-day performance of the suppliers they manage.

B)

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Module 1 On rare occasions, senior management becomes involved in expediting in crisis situations. This is usually done between high-ranking personnel from both organizations. Clearly, this tactic is to be employed rarely because if the purchaser receives a lessthan-hoped-for answer, there may be no higher authority to whom to appeal. Almost always it is appropriate to follow a chain of command.

C)

By the user department In some instances, it may be appropriate for a using department to conduct routine follow-up of its orders. The argument for this practice is that it frees purchasing staff for more strategic activities. In situations where a long-term agreement exists between the purchasing organization and the supplier, this practice is common, especially where users place their own orders as with systems contracts.

5)

METHODS USED FOR EXPEDITING AND FOLLOW-UP Technology has significantly changed expediting methods. Traditionally, standard mail, telegrams, telexes, and telephone calls were the modes of communication with suppliers. Today, much of the communication of expediting takes place by fax or email in addition to telephone. Before contacting suppliers, experienced expediters carefully review the order or contract to verify the exact requirements, and then determine the current status. The following methods then apply. A) Verbal/Informal Routine follow-up, as well as non-critical expediting, is usually performed informally. The supplier is contacted by telephone or e-mail, and order status inquiries are made. The supplier responds as soon as the status information is available. This method of expediting is the easiest, the least expensive, and most direct. Frequent, informal communication is also symptomatic of good purchasersupplier relationships. Written/Formal Occasionally, formal written order status inquiries or expressions of order problems are made. These usually follow unsuccessful informal procedures and often signify deterioration in the purchaser-supplier relationship. These situations may well involve significant sums of money or major consequential difficulties or damages. Resolution of problems before they reach this stage is highly desirable. Electronic Today, much expediting can be accomplished electronically. Fax messages, and exchanges of e-mail are often sufficient to relay necessary information and resolve lesser problems. Automated requests for status of long leadtime acquisitions can be established. These tools are efficient and inexpensive, and allow the parties to respond at appropriate times as information becomes available. They typically require less time than phone calls that inevitably involve social and other non-task related conversation. While efficiency may be served, it is worth noting that business relationships are best sustained by personal interaction, either by phone or face-to-face. Personal visits As supply difficulties escalate, the likelihood of a personal visit will as well. For example, if a supplier experiences significant quality problems, it is common for the buying organization to gather a team for a supplier visit. The quality, 126

B)

C)

D)

Part D: Contract Execution, Implementation, and Administration

Task 116

production, purchasing, and other departments are likely to be represented. The purpose is to solve problems, not place blame. At times, a small supplier may not have the resources or expertise to adequately address a problem, so the buying organization often finds it beneficial to assist the supplier. This cements long-term purchaser-supplier relationships and enables both sides to better understand the situation and each other (see Task 111 for more information on conducting supplier visits). 6) CONTINGENCY PLANNING AND PERFORMANCE MEASURES It is critical for purchasing organizations to track and analyze the performance of their suppliers. At the very least, quality and on-time delivery should be tracked for each order. Lack of these fundamental measures is likely to influence the level of expediting effort required to maintain continuity of supply. These measures are the prime determinant of future business. The key to reducing expediting activity and expense is to recognize, through performance measurement, the most reliable suppliers and reward them with increased business, while eliminating underperformers. One of the key ingredients in supplier performance measurement systems is the suppliers contingency planning. Suppliers may experience difficulties ranging from strikes, to their own supply problems, to natural and other disasters. Today, many organizations formally assess the degree to which a supplier has developed and carried out plans to assure the buying organization of supply continuity in the event of one of these supplier difficulties. 7) COST CONSIDERATIONS Expediting and follow-up are non-value added activities. In addition, they may increase costs of a transaction, sometimes significantly. For example, suppliers may be selected for proximity rather than least total cost. Purchasers must disrupt routine tasks to address crisis situations. In many cases premium freight charges may be required. Collectively, orders requiring expediting of any kind are invariably more expensive than routine transactions. For this reason, it is essential that these situations be minimized. 8) LOGISTICAL CONSIDERATIONS It is most common for expediting activities to incur additional logistical costs as noted above. There are other logistical issues of note. By using premium freight to deliver an order, or part of an order, the opportunity is lost to consolidate the expedited order with other orders, potentially increasing the freight rate for the other orders as well. There is a major issue relating to responsibility for additional freight costs for expedited shipments. If premium freight, such as air freight or exclusive use trucking, is required to deliver goods by their need date, who should pay for the difference between routine transportation and the premium service cost? If the failure of timely delivery is because of the suppliers failure, then the supplier is responsible for the difference between routine and premium freight charges. The purchase order or contract should specify that the supplier will be responsible for additional 127

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freight charges, otherwise it may be difficult for the purchaser to be reimbursed. If the change of delivery timing is the result of purchasers changes, the premium freight cost is borne by the buying organization. As noted in section 7 above, every effort should be made to minimize the situations that require expediting and consequent increased logistical costs.

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TASK 117: Resolve contract/purchase order differences with suppliers.

1) TYPICAL PURCHASE ORDER/CONTRACT PROBLEMS A) Description errors Contract or purchase order problems resulting from specification or statement of work (SOW) errors are generally resolved through the good will and common sense of the parties. If the purchase order described incorrect goods, the supplier has no reason to recognize the error, the goods are delivered, and the matter cannot be resolved through simple communication. It will likely fall under the Law of Mistake (see Section G), which, with exceptions, will generally not provide relief for unilateral mistakes. Ensuring that purchase orders or contracts contain correct descriptions is therefore good practice. Pricing errors/omissions The parties do not have to agree on price in order to form a contract. They may agree on price later as long as two requirements are met. First, the parties must demonstrate their intent to contract by their writings or actions. Second, there must be some reasonably certain basis for fixing a price in the event of later conflict. Unless a contract contains specific language to the contrary, the UCC will presume an intent to contract, even though the price is left open. C) Failure or refusal to perform If, after a contract is formed, either party fails or refuses to perform as agreed and it is not excused from performance by law, that party is considered to have breached the contract. In the event of a breach, the basic interests of the parties are: 1.0 Expectation, is defined as that which would have been gained had the other party not breached. Reliance losses, is defined as compensation for losses caused by the damaged partys reliance on the breaching party. Restitution, is defined as the return of value already given. Anticipatory breach Anticipatory breach is when the purchaser has good reason to believe that the supplier will not perform as originally planned, or when the supplier has reason to believe the purchaser will not honor the contract. A plant fire, at either the suppliers or purchasers facility, would serve to create such a belief, as would either party filing bankruptcy. Repudiation If the purchaser advises (in advance of the time when supplier performance is due) that the purchaser will not honor the contract, this is anticipatory repudiation and is a breach. Repudiation also occurs when the supplier advises the purchaser that it will not deliver.

B)

2.0

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Module 1 Breach of contract by supplier A supplier may breach the contract by failing to deliver or perform as agreed, or by delivering incorrect goods (nonconforming tender). In either case, the purchaser must advise the supplier in writing and within reasonable time, that the contract is considered breached. In the case of nonconforming tender, the supplier has a right to cure, that is, to remedy the breach, provided the supplier can do so within a reasonable time. However, a rule of law is that the parties must be allowed to perform within the time they agreed to perform. Therefore, if the supplier delivers incorrect goods earlier than the contracted delivery date, it will still have the remaining time to replace incorrect goods with correct goods, before the purchaser can claim breach. There are two important exceptions to this UCC provision: If, before the time when the suppliers performance is due, the supplier advises the purchaser that it will not perform as agreed, the supplier may be considered in breach at that time although time for performance has not arrived. This is called anticipatory repudiation, meaning that if the supplier says it will not perform, the purchaser has a right to believe it is true. Still, it is good practice to confirm it in writing in case the supplier changes plans again. If the purchaser has reason to believe the supplier may not perform, the purchaser has a right to request the supplier to provide adequate assurances of performance. The UCC provides for this and requires the supplier to respond within 30 days. If there is no response or if there is no adequate assurance, the purchaser may cancel the contract.

4.0

Purchasers recovery from suppliers breach There are several types of damages the purchaser may recover from the supplier. These include: Cover damages The purchaser may purchase the goods from another supplier and claim against the supplier for any cost in excess of the breached contract, but must use reasonable diligence in seeking the best replacement price. Incidental damages These are expenses associated with correcting the breach, or from attempting to rework or utilize nonconforming goods. Consequential damages These are indirect losses resulting as a consequence of the breach and may include lost sales, the closing of a business, or personal injury. As such damages can be very high, suppliers go to great length to disclaim responsibility for them. Liquidated damages Section 2-718 of the UCC provides for prior agreement on an amount whereby damages will be liquidated in the event of breach, which will then become a part of the contract. The amount must be reasonable in view of the anticipated or actual harm caused by the breach, the difficulties of proof of loss, and the inconvenience or non-

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feasibility of otherwise obtaining an adequate remedy. A term fixing unreasonable large damages is void as a penalty. General damages These include any damages resulting from requirements and needs that the supplier reasonably should have had knowledge of at the time of contracting, and that could not have reasonably been cured by the usual remedies.

5.0

Breach by purchaser Ways in which a purchaser can breach are: Wrongful rejection Purchasers must have a valid reason for rejecting goods delivered under a contract. They cannot make a contract and change their minds later. Wrongful revocation of acceptance The UCC makes a distinction between original acceptance of goods and a later revocation of acceptance. Goods may be rejected for cause upon original receipt, but, if they are accepted, the purchaser cannot reject them later. A purchaser can, however, revoke the acceptance if latent defects that substantially impair the value of the goods are discovered later. The supplier must be notified and given an opportunity to correct the defect. Failure to tender payment due before delivery If agreed upon purchaser prepayments are not made, or if a purchaser contracts for goods to be delivered C.O.D. and will not pay for them upon delivery, the purchaser will have breached the contract. Repudiation In this case, the purchaser advises the supplier that the purchaser will not honor the contract.

6.0

Sellers recovery from purchasers breach The suppliers remedies for breach include: Resale damages These include the costs of selling the goods elsewhere. Market damages If between the time of the purchasers breach and the suppliers resale of the goods the market value of the goods falls, the supplier may seek the difference as damages. Lost profits In any suit for damages, the supplier may include profits, up to the full amount, that was lost due to purchaser breach. Contract price recovery If, after reasonable and diligent effort, the goods cannot be sold elsewhere, the supplier may claim against the purchaser for the whole contract price, less any net salvage value.

D)

Liability issues A purchasing manager should act with a view toward insulating his or her organization from liability and protecting its rights to remedy in the event of later conflict. 1.0 Customary limitations to supplier liability The intent of the UCC is not to penalize one who defaults under a contract, but to provide for payment to 131

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Module 1 the aggrieved party of direct damages, together with any incidental or consequential damages, resulting from the breach. That is, the intent is to make the aggrieved party whole again. However, before the purchaser can receive damages, a purchaser must specifically prove them. Further, the supplier is allowed under the UCC to limit its liability for incidental and consequential damages, and will generally do so. 2.0 Consequential damages Consequential damages include: Losses resulting from general or particular requirements of which the supplier had reason to know of at the time of contracting and which could not reasonably be prevented by cover or otherwise. Injury to person or property proximity resulting from any breach of warranty.

In the absence of excuse, the supplier is liable for consequential damages in all cases where it had reason to know of the purchasers general and particular requirements at the time of contracting. The burden of proving extent of loss by way of consequential damages rests with purchaser. Loss may be determined in any manner that is reasonable under the circumstances. 3.0 Hold harmless and indemnification clauses Purchase order and contract terms and conditions should always contain clauses disclaiming or limiting a purchasers responsibility for damages resulting from supplier violation of existing laws. Still, the language typically used on a sales form attempts to limit supplier liability or to place that liability elsewhere, and purchasers must defend against those efforts. Specific concerns include, but are not limited to: The Consumer Product Safety Act This Act is intended to protect consumers against unsafe products. It requires that known or potential hazards in consumer goods be reported to the Consumer Products Safety Commission, and that unsafe goods be recalled. It covers manufactured goods and goods purchased for resale, including components. Purchase contract forms should contain a clause against the manufacturer to indemnify the buying organization from costs associated with recalls or defects. It is also Good practice in purchasing is to require suppliers to notify the purchaser of known or potential product hazards. Product liability Generally, persons injured by or because of products or property owners who experience a loss, have a right to sue, and each party in that products distribution chain is jointly and severally liable. However, any party in the chain that did not contribute to the problem and that is not rightly responsible has a right of indemnification against those parties that are. Furthermore, the parties to a

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contract can make prior agreement as to who will bear responsibility for personal injury or property damage. As the suppliers contract form is likely to contain product liability disclaimers, purchasing contract forms should contain proper indemnification clauses, so as to effectively preserve the purchasers rights. Patent infringement A patent gives its owner the right to make, use, and sell the patented item, and prohibits others from doing so. A purchasers organization may be sued for patent infringement by virtue of its use of a patented item, even though the item was purchased in good faith. If valid, the suit could result in payment of damages and an injunction against continued use of the item. The UCC contains a patent warranty, making sellers responsible for any damages incurred by a purchaser, but does not require such payment until the case is decided. Because patent suits may be very costly, a purchaser should first ensure that the purchasing contract form is asserted and, second, ensure that there is a well-designed indemnification clause that gives the purchaser rights against the supplier, including: - A provision for periodic reimbursement of costs as the suit progresses - The right to require the supplier to defend the suit - The right to have the purchasers lawyers involved in the suit

4.0

If conflicting terms cancel each other out and such a suit falls back under the UCC, only the patent warranty applies. One way to avoid this is to have the supplier sign the purchase order acknowledgment or some other document containing terms favorable to the purchaser. Insurance Sound purchasing practice dictates that suppliers or suppliers who come onto the purchasers property have adequate insurance coverage for damage and personal injury to themselves and others. Recommended coverage includes commercial general liability, automobile insurance, workers compensation, and employers liability insurance with appropriate limits designed to cover potential hazards. Subcontractors should be similarly insured and the purchasing manager should either make the purchase contract conditional upon adequate coverage or ensure that it is in place before issuing a contract. If a contractor is injured on a purchaser organizations property, whether or not the organization will be liable depends on whether a court considers the injured contractor an independent contractor, or an employee of the organization. In the eyes of the court, a contractor will be considered an employee and the buying organization considered the prime contractor, if:

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Module 1 The prime tells the contractors workers how to do the job or has requisite control over their jobs. Even if the prime has the right to control the contractors workers jobs, but does not, an employer-employee relationship can be deemed to exist. The prime furnishes tools needed for the job, including vehicles. The prime has the right to terminate contractor workers services at any time. (If the workers could be terminated only at the end of a job, they would be considered independent contractors, in which case failure to permit the contractor to complete the job would be a breach of contract.) The contractor workers perform work that is part and parcel of the regular business of the prime. The contractor workers are paid by a timeframe (hour, week, month). Contractors are paid by the job. The contractor does not hold itself out to the public as an independent contractor. Evidence of an independent contractor might include contractor letterhead, business registration, previous work as an independent contractor, and so on (see Task 114 for a discussion of insurance issues).

5.0

Risk of loss/liability Risk of loss disputes, as they relate to a transfer of goods between two parties, generally arises in two situations. The first is in direct transactions between two parties. In this situation, the party in possession of the goods has the best opportunity to protect them, and therefore bears the risk. Here, risk of loss passes with delivery, unless the seller is in breach of contract. In such a case, the purchaser has a right to rejection, and the seller retains risk until the nonconformity is cured. The second situation involves a third-party (such as a carrier). Here risk of loss depends on the Free on Board (F.O.B) rules: F.O.B. origin The seller bears risk until it loads the goods onto an appropriate carrier, after which the purchaser assumes risk of loss and must claim against the carrier for damage or loss in-transit. F.O.B. destination The seller bears risk until the goods are transported to the purchasers dock, after which risk will pass to the purchaser. F.A.S. This term is used when goods are transported by ship, and stands for Free Alongside Ship. This requires that a seller place the goods on a loading dock accessible to the carrier, at which time risk of loss transfers to the purchaser. C.I.F. This shipping term stands for Cost, Insurance, and Freight, and is typically used along with a destination point. For example, a shipment C.I.F. purchasers plant would obligate the seller to deliver to and load the goods onto a carrier, obtain a bill of lading, pay freight, insure the goods, prepare necessary documents, and deliver to the purchaser

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all documents necessary to receive the goods. Though the seller buys and pays for insurance, any damaged/lost goods settlement goes to the purchaser. C&F This term stands for Cost and Freight. It is the same as C.I.F. except the purchaser arranges insurance. Liability associated with in-transit goods may extend far beyond the traditional risk of loss as determined under F.O.B. rules. For example, an in-transit spill of hazardous material shipped F.O.B. Origin could be very serious for the purchasers organization, in that liability will generally follow title. Title would have transferred to the purchaser at the origin. Common sense tells us that the purchasers organization is better insulated from liability under F.O.B. Destination contracts on all such goods, and that carriers should be adequately insured for the specific hazards involved. Liability associated with in-transit spills of hazardous materials may extend far beyond traditional risk of in-transit loss. In these cases, the purchaser is advised to: Write F.O.B. destination contracts for all hazardous materials so that the supplier retains title while in-transit. Ensure that carriers are properly licensed and adequately insured against environmental pollution risks. See Task 110 for a discussion on domestic transportation terms.

E)

Financially troubled suppliers Suppliers with financial troubles present two notable problems. The first is that efforts by the supplier to control costs may lead to general reductions in quality and service. The second is the matter of delivery and continued supply from a supplier facing financial failure (see Task 111). 1.0 Milestone payments This is another name for progress payments. Such payments are usually linked to percentage completion or meeting certain benchmarks toward completion of a contract. Early possession of materials This term refers to possession and, therefore, control of materials without a transfer of ownership. This requires an agreement between the parties. Bankruptcy/Financial restructuring While the issue of bankruptcy is probably more important to suppliers, there are two areas of concern to purchasers: Contracts in progress Bankruptcy laws permit a supplier who applies for and obtains protection from the courts to look at all executory contracts and decide which it will perform. Since bankruptcy laws are federal, they supersede state laws governing purchase order/

2.0

3.0

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Module 1 contract terms that reserve the purchasers right to cancel the contract in the event of supplier bankruptcy. Furthermore, bankruptcy laws do not permit a purchaser to cancel a contract based on the purchasers request and subsequent failure to receive adequate assurance of supplier performance (even if the purchase order contains such a clause) except when the supplier is already in default. If the supplier is already in default, then the purchaser can request adequate assurance of performance, and the supplier will have to: - Cure the default. - Compensate purchaser losses resulting from the default. - Provide adequate assurance of performance. When the supplier possesses property of the purchaser Recovery of property in the hands of a bankrupt supplier must be handled through the courts. In such a case, the purchaser has legal right to its property and is essentially in the position of a secured creditor. Sound practice dictates that such goods should be properly marked and that all documentation covering them should specifically identify the owner. If the goods are not returned, the purchaser can sue, but it might not be worth the effort if the supplier is bankrupt. One safeguard, if appropriate, is for the purchaser to file a formal security interest in the property as part of the original agreement. It is good practice for purchase order and other contract forms to contain the usual terms and conditions dealing with insolvent or bankrupt suppliers (even though they may be superseded by federal law) as they may provide some leverage in the lineup for payment. Also, they would be likely to have value if a supplier becomes insolvent and ceases to do business without seeking bankruptcy protection of the courts.

4.0

Bond issues Purchasers use bonds as instruments to insulate their organizations from the consequences of supplier failure to perform or to pay for labor and materials. They are used extensively when dealing with suppliers (see Task 108). Labor and materials bonds If a supplier fails to pay for labor or materials, damaged subcontractors or suppliers can file a mechanics lien against the property, thereby preventing its use by the purchaser or owner. Under this kind of bond, the bonding organization guarantees payment for labor and materials, which insulates the purchaser or owner from such risk.

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Performance bonds Under this kind of bond, the bonding organization guarantees payment of damages to a purchaser or owner in the event of a suppliers failure to perform as agreed. Bid bond A bid bond guarantees that the bidder will accept the contract for the stated bid amount, or that by virtue of the bidders failure to so perform, a purchaser who has to pay more to have the contract performed will be compensated for the difference.

F)

Delivery/Transportation problems Concerns relating to delivery and risk of loss include: Supplier cure for in-transit loss It might be expected that suppliers would readily replace goods lost in-transit where they have the risk of loss. However, in case of such problems as shortages, it may be in the suppliers best interest not to do so. Accordingly, it is good practice to include in the contract how long a supplier has to cure for in-transit loss of goods. Piecemeal deliveries An equally important item to include in a contract is that delivery is not considered complete until the purchaser receives all goods and services, including everything needed to test or use the goods or equipment. Use of purchaser specified carrier Common practice in todays environment is for purchasers and their traffic departments to negotiate freight rates using various measures (for example volume). These can entail considerable discounts. Accordingly, sound practice dictates purchaser specification of the carrier, and a systematic procedure of warning and charge-back when freight charges are higher due to supplier failure to follow instructions. Ambiguity in F.O.B. point Purchasers should remove any ambiguity in F.O.B. points by clearly designating exactly where the risk of loss will transfer. Suppose a contract for delivery at the purchasers plant in New York City was written F.O.B. New York, and that loss occurred just inside the city limits. A case could be made that the destination point was reached and that the purchaser had risk of loss, though the goods never actually reached the purchaser. Similarly, if a supplier has goods shipped from some other point, F.O.B.-origin contracts may involve shipping costs much higher than from the suppliers address to which the contract is made. For example, the purchaser is on the West coast, the suppliers headquarters is in the Midwest, and the goods are shipped from the East coast.

G)

The Law of Mistake The Law of Mistake is not clearly defined, as the UCC has no provisions to cover honest mistakes in contract documents. The purchaser must therefore turn to common law. The courts will not consider relief unless the mistake is material. If it does, then the following general rules apply: The courts will attempt to be fair with both parties. If a mistake is made that does not cause damage to the other party, relief may be granted. However, the court may not grant relief to the mistaken party if the other party is damaged through reliance on an honest mistake. 137

Task 117

Module 1 Relief will usually be granted where one party induced the other to make a mistake or where the mistake, is so obvious that it reasonably should have been recognized as such by the party attempting to take advantage of it.

H)

Acceptance, rejection, and revocation These are UCC provisions: Acceptance Under a contract for the sale of goods, acceptance occurs when, after having had reasonable time to inspect the goods, the purchaser: - Advises the seller the goods are acceptable or that, if they are nonconforming, the purchaser will accept them anyway. - Does not effectively reject the goods. - Acts in a way inconsistent with supplier ownership of the goods such as using, selling, or otherwise altering them. Furthermore, acceptance of a part of any commercial unit constitutes acceptance of the whole unit After acceptance, a purchaser must pay for the goods as agreed and bear the burden of proving any later discovered nonconformity. Rejection The purchaser must notify the supplier of defects and rejection within a reasonable time after defects are discovered (or should have been discovered with normal inspection). The supplier must be given reasonable time and opportunity to cure the nonconformity. Otherwise, the purchaser will be barred from remedy. Furthermore, the purchaser must not have waived his or her right to inspect. Revocation of acceptance If defects are discovered after accepting goods, the purchaser may revoke his or her acceptance under the following rules: - The defects must substantially impair the value of the goods to the purchaser and must be true latent defects (that is, it is not so obvious that they should have been discovered in the normal receiving inspection). - Revocation of acceptance can be based on a suppliers failure to cure non-conforming goods, known upon receiving inspection to be nonconforming, but accepted based on reasonable expectation that the supplier would cure.

I)

Modification, rescission, and waiver Modification A contract may be modified by agreement of the parties provided that the duties or obligations modified have not yet been performed, and that the modification is equitable in view of circumstances not anticipated when the contract was originally formed. Under the UCC, additional consideration is not required to make a modification binding, but it must not have been based on fraud, duress, or any other violation of good faith. 138

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Task 117

Rescission Both parties may agree to rescind a contract before performance takes place. This will have the effect of setting the contract aside, with each party discharging the obligations of the other. Waiver A party may waive its rights under an executory contract. A waiver clause should be specific and written, such that the waiver of one right will not serve as a waiver of others. Care should also be taken to ensure that a waiver is not interpreted as on going and extending to other, similar agreements. Waivers may be retracted by reasonable notification unless the retraction would work an injustice on a party by virtue of its reliance on the waiver.

J)

Breach of Contract/Default/Remedies There are several legal concepts that can apply in these situations. These include cure, cover, incidental damages, liquidated damages, and consequential and actual damages. 1.0 2.0 3.0 Cure Cure is making the situation right. This could be restoring everything back to its original state or fulfilling the contract as originally agreed. Cover Cover is to provide protection against breach or compensation for breach of contract. Incidental damages These are expenses reasonably incurred in the inspection, receipt, transportation, and care of goods rightfully rejected. They also may include any expenses or commissions in connection with purchases required from alternative suppliers as a result of the breach, and other reasonable expenses incidental to the delay or other breach. Liquidated damages A liquidated damages clause is only used to predetermine damages in case of a future breach of contract when both parties agree that damages will be difficult to calculate. The amount specified must be a reasonable estimate. Liquidated damages are applied in place of actual damages and must be agreed to prior to contract signing. A liquidated damages clause can be used for situations such as service response times and downtime on equipment, late deliveries, and failure to deliver certain critical materials. The clause can be used for partial breaches as well as a breach of the entire agreement. Liquidated damages, like other types of damage awards, are for restitution, not penalty. 5.0 General damages General damages are those that flow naturally from the breach. The law presumes these damages are foreseeable. General damages (of which incidentals are a subcategory) are to be contrasted with special damages. Special damages (of which consequential are a subcategory) are those that are unique to a given situation, and their foreseeability must be proven before they can be recovered. In other words, the purchaser must show that the supplier knew the purchaser would suffer such damages in the event of breach. No such proof is required for general damages; the supplier should assume the purchaser will suffer general damages in the event of breach. 139

4.0

Task 117 6.0

Module 1 Consequential and actual damages Consequential damages normally include lost profits and other damages resulting as a consequence of a suppliers inability to perform. They are permitted because they are a foreseeable consequence that a reasonable purchaser and supplier would expect.

K)

Termination of contract Termination occurs when a party exercising a power created by agreement or law ends a contract for reasons other than breach. Upon termination, all executory obligations are discharged, but rights or obligations based on prior performance or breach survive. Cancellation differs from termination in that it implies cause and does not excuse the causing party from damages resulting from its failure to perform. 1.0 2.0 For cause or default This typically results in a cancellation, as the implication is that of breach. For convenience The UCC does not provide a right to cancel for convenience. Therefore, any such right must result from agreement between the parties and is usually contained in a Termination for Convenience clause. Still, the Code requires that all such actions be fair and taken in good faith. For example, terminations for convenience usually involve payment for executed performance, and may include profits for the whole contract. Note that the federal government, in accordance with regulations, can terminate a contract for its convenience at any time, with or without cause. Furthermore, in government contracts, suppliers cannot realize profits on that portion of the contract not performed. 3.0 Frustration of purpose Under the UCC, if two parties enter into a contract and it later becomes commercially impracticable for one party to perform, that party will be excused from performance. However, the Code states that the fact that a supplier may lose money on a deal will not make it commercially impracticable. Accordingly, performance will not be excused due to events such as shifts in markets, changes in costs, or other causes that should reasonably be foreseeable by business people. However, events such as war, natural disaster, shortage of raw materials, or other causes that change the essential nature of the performance would probably be acceptable. To use this defense, a supplier must notify the purchaser of pending nonperformance within a reasonable time and, if the supplier is not completely prevented from performing, must fairly allocate such performance as remains available among involved purchasers. Failure by the supplier to satisfy these requirements would prevent its being excused from performance under the concept of commercial impracticability.

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After notification and a proposal for allocation, the purchaser may accept the allocation or terminate the contract entirely. If the purchaser fails to so modify the contract within a reasonable time (within 30 days) the contract will lapse with respect to any future performance. 4.0 Unexcusable delays Unexcusable delays are delays that cannot be justified as true force majeure events. These are generally a result of managerial actions and can be caused by either party.

L)

Suspension of contract Suspension of the contract occurs when the purchaser unilaterally decides to suspend activity on a contract. The supplier must be given reasonable written notice of the planned suspension. Upon suspension, the purchaser will pay the supplier compensation based on the percentage of contract completion until the effective date of the suspension less any previous payments. If the suspension lasts for an extended period of time (over 30 days), the supplier may be entitled to additional compensation for costs incurred because of the suspension. Inspection/rejection rights 1.0 Right to inspect Purchasers have the right to inspect goods before acceptance. This provision gives purchasers an opportunity to determine whether or not the delivered goods comply with the contract description. When a purchaser accepts merchandise after inspection, the purchaser is ordinarily prevented from raising an issue with regard to quality or quantity. It is important to note, however, that the purchaser must conduct the inspection of goods within a reasonable time period. Right to reject 2.1 Right to withhold payment When a contract calls for payment before inspection, payment must be made unless the delivered materials are so obviously nonconforming that inspection is not needed. But payment required before inspection does not constitute final acceptance of goods. Rejection can still occur if the purchaser inspects after the required payment and finds the goods to be unsatisfactory. When a supplier delivers nonconforming goods, the purchaser can also recover any prepayments made to the supplier. 2.2 Right to return goods Acceptance of goods is interpreted as assent by the purchaser to become the owner of the goods tendered by the supplier. Any words or actions that indicate purchasers acceptance are sufficient. If a purchaser keeps the goods and acts as if the goods are acceptable, then acceptance has taken place, even if the purchaser makes statements to the contrary.

M)

2.0

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Module 1 If the goods fail in any way to conform to the contract, the purchaser has the option to reject the whole shipment, accept the whole shipment, or accept only part of the shipment. If the purchaser rejects the goods, they must be held with reasonable care until the supplier has sufficient time to remove them. 3.0 Disposition of non-conforming goods If, upon inspection, goods are found to be nonconforming, and the time allowed for supplier performance has passed, the goods may be disposed of in one of the following ways: 3.1 3.2 Accept They may be accepted as they are, or with reasonable expectations that the supplier will cure the nonconformity. Reject The goods may be rejected outright, and returned to the supplier (at the suppliers expense) on a shipping order and invoice issued by the purchasing department. The supplier is notified of this action and the reasons thereof..The determination is made whether the original purchase order is still in effect, or whether the order is terminated through the default of the supplier. An alternative procedure is to return the material for replacement, which is frequently done in the case of fabricated parts. Rework Suppliers frequently have representatives come to the purchasers location to make necessary adjustments to faulty equipment purchased from the supplier. Suppliers will also often work with the purchaser to find a satisfactory application for use of the nonconforming materials. Reclassify It may be possible to reclassify the goods received to a lower grade and use them in a different application. For example, fruit received may not be suitable for canning but could be used for juice or jam. Scrap If the goods cannot be reworked or reclassified, or are not worth returning to the supplier, they are classified as scrap. As scrap the goods can be recycled, sold, or sent out for disposal (see Task 307).

3.3

3.4

3.5

4.0

Obligation to give timely written notice A purchaser is obligated by the UCC to notify the supplier of his or her intention to either accept nonconforming goods contingent upon supplier cure, reject non-conforming goods, or rework non-conforming goods. If the supplier is notified of the purchasers rejection of goods or intention to rework goods and does not respond to it within a reasonable amount of time, the purchaser may: Store the goods and claim for storage charges Reship the goods freight collect 142

Part D: Contract Execution, Implementation, and Administration N)

Task 117

Resell the goods and deduct reasonable sales costs from the proceeds Deduct the cost of reworking the goods from the price of the goods

Revocation of acceptance A purchaser may revoke acceptance of goods when they fail to conform to a contract to such an extent that the defects substantially impair their value to the purchaser, provided that the purchaser accepted the goods without knowledge of their nonconformity or with knowledge of nonconformity but had reason to believe that the supplier would cure the default. In other words, a purchaser cannot revoke acceptance merely because the goods do not conform to the contract unless the nonconformity substantially impairs their value to the purchaser. Revocation of acceptance may be made with respect to the entire quantity of goods or to a particular portion. A purchaser who revokes acceptance stands in the same position as though the goods had been rejected when they were originally tendered. A purchaser must give a supplier notice of revocation, and a supplier has a reasonable amount of time to attempt to correct the defects in the goods.

2)

DISPUTE AND CONFLICT RESOLUTION Disputes in purchasing most often occur because of different expectations purchasers and suppliers have, and only rarely because one party attempts to take advantage of the other. Accordingly, business people usually attempt to settle disputes in the simplest, least costly manner, and with a view toward fair resolution rather than toward penalizing the other party. Dispute settlement methods include: A) Alternative dispute resolution 1.0 Arbitration In arbitration, the parties present their cases to one or more arbitrators who, after hearing the evidence, decide how the case should be settled. The decision is binding on the parties and is enforceable through the courts. Unlike litigation, arbitration cases are private. They can also be less costly, can be handled quickly, and do not involve evidentiary rules, discovery, or appeals. Mediation The parties, if unable to agree on a settlement, may enlist the aid of a mediator who will listen to and question each side in an attempt to lead them to settlement. A mediator does not make a binding decision, and the parties do not relinquish their legal rights. Mini-trial This is not really a trial, but rather a formalized settlement process. Usually, there are two parts to this process, frequently involving business entities on both sides. The attorneys make short, opening statements to senior management executives with full settlement authority. After the hearing, the executives discuss the settlement. This process is private and voluntary and is usually presided over by a mutually agreed to neutral advisor. While the minitrial may take only one day, it may take some time for an agreement ultimately to be reached. The mini-trial has been used in cases involving patent infringement, government contracts, product liability, antitrust, and construction cases. 143

2.0

3.0

Task 117

Module 1 The American Arbitration Association has developed a set of guidelines and procedures for mini-trials that can be found on their Web site at www.adr.org. B) C) Renegotiation The parties may place all their differences on the table and renegotiate the contract. Reformation If, through fraud or mutual mistake, a written contract fails to express the true agreement or intentions of the parties, the courts may permit remedy by reformation of that contract. Litigation If unable to resolve the matter through the means listed above, a party may sue for damages suffered as a result of contract breach. The matter will then be decided in the courts according to the law.

D)

3)

OWNERSHIP ISSUES Ownership issues are important to the purchaser as they determine who has the responsibility for filing damage claims and who bears the loss if the goods are destroyed. Under the UCC Section 2-401 title to the goods passes to the purchaser at the F.O.B. (or F.A.S.) point. A) Point of acceptance The title can revert back to the supplier if the purchaser rejects the goods or services appropriately. 1.0 2.0 On delivery The purchaser may reject the goods upon delivery if it is clear they do not conform to the specifications. Title would then revert to the supplier. After inspection Likewise, if the goods require inspection, the purchaser may reject the goods if they do not conform to the specifications. Title would then revert to the supplier. The inspection may take place at the suppliers prior to shipment. This is a useful tool in international procurement when there is some concern about the suppliers capabilities. After functional/performance specifications are met In this case, the product must undergo acceptance testing beyond inspection for defects. Title passes to the purchaser when the goods are tendered at the F.O.B. point. If the purchaser rejects the goods, title reverts back to the supplier. Prior to payment Under UCC Section 2-512, if payment is required before inspection, payment does not constitute acceptance and the purchasers rights to inspection and remedies remain. Payment does not determine ownership.

3.0

4.0

B)

Title liability relationships The supplier represents and warrants that it is the sole owner of any goods to be sold, and that it has the unrestricted right to convey marketable title free and clear of all liens and encumbrances.

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Part D: Contract Execution, Implementation, and Administration 4) WARRANTIES

Task 117

A warranty is a promise made by the supplier that, as long as it is included in the contract, is legally enforceable. A purchaser is free under the law to bargain for broad, strong warranties, or to accept a suppliers total and complete disclaimer of warranties. Warranties fall into two categories: A) Express warranties An express warranty is one that can be expressed either orally or in writing by the supplier and it can include almost any statement or representation a supplier makes about its product. However, to ensure an express warranty will exist because of the parol evidence rule (see Task 114), the purchaser should include the oral or written statements made by the supplier in the contract. In addition to specifications as detailed on the face of a purchase order, express warranties may include advertisements, catalog descriptions, photos, proposals, samples, and even oral claims by the supplier provided they are included in the basis of the contract. A purchase order form nearly always contains a clause establishing that it constitutes the full and complete agreement between the parties. Therefore, to include such expressions in the contract (and thereby make them warranties) they must be referenced in the contract writing. Implied warranties Implied warranties are provided by the UCC. That is, a purchaser does not have to specifically list them in the contract in order to have them apply. Implied warranties include the following types: 1.0 Title and authority to sell Implicit in contracts between merchants is that the supplier has full legal ownership of the goods being sold; that they are not subject to security interests, liens, or any other encumbrance not known to the purchaser at the time of contract formation; and that the supplier has a right to sell or otherwise transfer the goods accordingly. Implied warranty of merchantability Unless the warranty is excluded or modified, it is implicit in a contract for goods that they will be merchantable. This means that the goods must be of fair average quality, must pass without objection within the trade, and must be fit for the general purpose for which such goods are normally used. Fitness for intended purpose If, when a contract is formed, a supplier is aware of the purpose for which goods are being purchased and that the purchaser is relying on its expertise to furnish a suitable product, it is implicit that the supplier warrants the goods to be suitable for that purpose. The UCC allows suppliers to disclaim the implied warranties of merchantability and fitness for a particular purpose by conspicuous use of specific language, and to limit express warranties to repair or replacement. Nearly all sales acknowledgment form contains such language. Therefore it is important that purchasers use forms with well-designed terms and conditions to effectively 145

B)

2.0

3.0

Task 117

Module 1 cancel out supplier disclaimers, after which remaining gaps will be filled by the Code.

C)

Latent conditions Latent conditions are conditions that are not identifiable under normal inspection and when discovered will deprive the purchaser of the products value. The first paragraph of Section 2-719 of the UCC gives suppliers the right to limit warranties to their choice of repair or replacement options. This section is typically the source of supplier arguments to support a repair position. However, the Code maintains that at least minimum remedies must be available and, while a repair or replacement clause may be reasonable in many cases, in others it may not give a purchaser the benefit of his or her bargain. The purpose of a remedy is to give the purchaser goods that conform to the contract within a reasonable time after a defect is discovered and the supplier is notified. Section 2-719 of the UCC goes on to provide that where an otherwise fair and reasonable clause operates to deprive a party of the substantial value of his or her bargain because of circumstances, it is said to fail in its essential purpose. Under these circumstances, such a clause would be thrown out as unconscionable and would give way to general remedy provisions of the code. This would not alter any effective limitations on consequential damages, and so forth.

D)

Effective date Purchasers should be aware of the effective date when a warranty period begins. For example, it is not uncommon for considerable time to elapse between the receipt of capital equipment and its start-up. If the warranty begins upon receipt, the effective result is a shortened warranty period. Whether a warranty period begins upon receipt of goods, upon start-up, after start-up and debugging, or at any other time, is a negotiable matter and the parties are free to agree and contract as they wish.

5)

TYPICAL MANAGEMENT PROCEDURES FOR DEALING WITH CONTRACT PROBLEMS While purchasing professionals are not expected to be lawyers, they should be knowledgeable in routine contract law and the UCC. Further, since most conflicts between contracting parties arise due to differences in expectations, purchasing professionals should ensure that contract language is complete and, to the fullest extent possible, that ambiguity is removed from the writing. In this way, contracts may be structured in ways that eliminate or reduce the potential for conflict. If the purchasing professional is seen by suppliers as coming from a position of strength and knowledge, issues may never rise that, otherwise, may escalate into conflict.

BIBLIOGRAPHY Blitman, B.A. Under the Umbrella of Alternative Dispute Resolution, Purchasing Today , February 1996, pp. 16-17.

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TASK 118: Resolve payment problems with suppliers and user departments.
Prompt payment to suppliers is a key factor in an effective purchaser and supplier relationship. However, the timeliness of payments must be considered in relation to an organizations cash-flow requirements. Most organizations try to balance their receivable and payable days outstanding to ensure sufficient cash flow to operate. 1) PROGRESS/MILESTONE PAYMENTS An effective method for providing suppliers with interim compensation during a long-term contract is to offer progress or milestone payments to be made at specific times based on progress in the completing the work defined or scheduled in the contract. A) How to implement To minimize the risk associated with offering such payments, the purchaser should tie them to tangible events that are easily verifiable, such as completion of the foundation of a building or purchase, receipt, and payment of major equipment. How to protect against loss Mutually acceptable criteria should be established in writing at the onset of the contract, in order to avoid any confusion as to what event triggers payment to the supplier. The contract may stipulate that satisfactory completion of the entire task is required, or else the purchaser may recoup funds already expended. At times, third-party inspectors are used to verify specific progress.

B)

2)

PARTIAL PAYMENTS NOT DIRECTLY LINKED TO PERFORMANCE Partial payment is a method of payment for accepted supplies and services that are only a part of the contract requirements. A) Potential problems Not linking payments to discernible events presents a significant risk to the purchaser. The supplier may be receiving payments, but may not be proceeding in a manner that executes the contract on a timely basis. How to protect against loss To protect against nonperformance by the supplier, the purchaser may schedule regular site visits to monitor progress. The purchaser should also document the organizations expectations at various stages in the production or delivery of the service and communicate those in advance to the supplier. A wellwritten statement of work is the most effective tool for ensuring supplier completion of the work.

B)

3)

COST/PRICE OVERRUNS A) Implications in fixed price/cost-type contracting In a fixed-price contract, the purchaser is not obligated to compensate the supplier for cost overruns. However, supplier performance may degrade as the loss escalates. The purchaser should 147

Task 118

Module 1 consider the following parameters when presented with a request from the supplier for compensation for cost overruns: The financial viability of supplier. The possibility of getting the job completed through another source, and the associated cost of doing so. The investment made by the purchaser in the project, and whether or not it is recoverable from the supplier. The purchasing organizations affect on suppliers costs and overruns.

B)

Purchasers obligations In the fixed-price contract the purchaser has no obligations to reimburse the supplier for cost overruns. If the cost overruns are caused by the purchaser changing the specifications, the purchaser should work with the supplier to evaluate which expenses are a result of the purchasers changes and which expenses are supplier overruns. The contract should then be amended to reflect the agreed upon changes. Suppliers obligations The supplier has a responsibility to minimize the unnecessary expenses and to accurately measure the costs caused by the purchasers specification changes.

C)

4)

ISSUES PERTAINING TO THE FUNDING AND CONTROL OF COST REIMBURSABLE TYPE CONTRACTS Under a cost-reimbursement-type contract, costs must be closely scrutinized because the supplier is increasing the value of the contract by prolonging completion of the task or any other cost increasing activity. The purchaser must have a means of verifying the actual time/cost spent on a contract to avoid abuse. If this capability is not available, purchasers should pursue other contract types. When a funding allocation is part of a cost reimbursable type contract both the purchaser and the internal customer must use care to ensure funding is not exceeded, and that funding for subsequent fiscal periods is approved (see also Task 113).

5)

INVOICE PROBLEMS Normally, the payment cycle commences upon delivery of an acceptable product or successful completion of a service. If the purchaser does not inspect the goods in a timely manner, it is reasonable to start the payment cycle upon receipt of the product. In many cases, errors in receiving, invoicing, or purchase-order processing delay the payment cycle. Both the purchaser and supplier should make a good faith effort to resolve discrepancies in a timely manner. The error, if unattended, can prolong the payment cycle. It is the responsibility of the purchaser to contact the parties so that the details can be worked out, and the supplier and the carrier can be properly compensated. Discrepancies can take the form of any one of the following: 148

Part D: Contract Execution, Implementation, and Administration A) B) Late or early delivery. Incorrect quantity. Unacceptable quality. Goods damaged in transit.

Task 118

Nonperformance If the supplier does not deliver the product or perform the service then the purchaser must ensure that the invoice (if received) is not paid. Rejection If the goods or services are rejected then the purchaser needs to approve payment for any part of the invoice that is relevant to any goods accepted. If the goods are put on hold pending supplier instructions for disposal or repair, the invoice needs to be held waiting disposition of the goods. Errors Invoices that do not coincide with the shipment or the purchase order require the purchaser to determine if it is the fault of the carrier or the supplier. In either event, the responsible party should be notified as soon as possible in order to get the necessary details verified. If there are discrepancies between the receiving report and the invoice, the purchaser needs to work with the supplier to ascertain the cause of the discrepancies and determine what corrections are appropriate. Other errors that can occur include double billing and the use of wrong price information. Debit/credit memos Debit or credit memos are used to deal with adjustments to accounts after payment has been made. Open orders Open orders are orders where the entire order has not been received. The order cannot be closed while there are still items not received or services not completed. The purchaser may authorize partial payment of the invoice to reflect the goods or services received. Over, short, damage If more goods are received than were ordered the purchaser needs to contact the supplier regarding disposition of the extra goods. Likewise, if the quantity received is less than ordered the purchaser needs to contact the supplier. Payment may be held until the shorted goods are received. In the case of damage, the purchasers actions will be based upon ownership. If the purchaser owns the goods it is the purchasers responsibility to file damage claims with the carrier. If the goods were owned by the supplier then the supplier must file the damage claims with the carrier. The FOB point defines transfer of title from supplier to purchaser.

C)

D) E)

F)

6)

ACCOUNTS PAYABLE PROBLEMS It is common for accounts payable to match purchase orders with receiving documents and invoices. If all match, the money is paid. If the documents dont match, then a payment problem results. Examples of the types of problems that can delay payment include the following:

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Task 118 Incorrect invoices. No records of receipt. Incorrect quantities received. Problems with the purchase order, such as missing items or incorrect prices. Incorrect items. No exact match between invoice, receiving reports, and purchase order.

Module 1

Some organizations no longer require invoices. Arrangements are made with suppliers to handle payments through processes agreed to between the purchaser and supplier. A) Discrepancies between original purchase order and invoice When discrepancies occur between the original purchase order and the suppliers invoice, a copy of the invoice is forwarded to the purchaser for reconciliation with the supplier. Common discrepancies include quantity shipped, unit price, product description, and payment terms. Delinquent payments Occasionally payments to a supplier may become delinquent. It is important to correct these problems as quickly as possible to avoid delays in receipt and future materials due to credit holds by the supplier. Delinquency may result from missing paperwork, accounts payable process delays, cash flow concerns, or other administrative delays. They may even be the result of a dispute with the supplier. No receiving report The standard matching process of accounts payable compares the original order with the suppliers invoice and receiving report detailing the specific goods received. If these three documents match, accounts payable issues payment for the suppliers invoice. If the receiving report is not transmitted to accounts payable, this matching process cannot take place and payment is not made. To resolve the problem of missing documentation, accounts payable should contact the receiving department to expedite transmittal of the receiving information. In some organizations, purchasing may also be involved in resolution of this problem. Credit holds Prolonged payment problems may result in a credit hold being put on the purchasers account. Normally, the supplier will not ship a product or provide services while the credit hold is in place. The hold is lifted when the proper compensation is made. Tax considerations In some states, sales tax may or may not be applied depending on whether the goods purchased were for internal consumption (no tax) or for resale (tax). Ordinarily it is the responsibility of purchasing to inform the supplier when and when not to apply sales tax. Finding an incorrectly applied tax from a supplier is not uncommon.. Often the purchaser works with the supplier to correct this problem. Liens and stop notices Occasionally, non-payment of either progress payments or final payments may result in the supplier filing a lien against the purchasing organization. Similarly, following protracted non-payment, the supplier may stop work on

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Task 118

the project. In either case, the cause for non-payment should be resolved as expeditiously as possible. G) Stop payment On rare occasions, it may be necessary for accounts payable to stop a payment that has been issued. If a supplier failed to perform the task for which they had been issued (but not yet cashed) a check, accounts payable might need to stop payment of that check.

7)

IMPLICATIONS OF THE TIME-VALUE OF MONEY The time value of money is based on the concept of compound interest. The concept says that one dollar received today is worth more than one dollar received one year from now. The dollar received today could be put in a savings account and earn interest for one year. At a five per cent interest rate, todays dollar would be worth $1.05. Thus the purchaser must determine if it is to the organizations advantage to pay now or later. The terms of payment will indicate the interest rate charged by the supplier. For example 2-10, net 30 payment terms are equivalent to a 36 percent annual interest rate. Thus if a purchaser decided to increase a commoditys inventory and finance it by delaying supplier payments, the organization is essentially borrowing the funds at 36 percent per year.

8)

PROCEDURES FOR AVOIDING PAYMENT PROBLEMS A) Evaluated receipts To minimize the administrative cost of the accounts payable process, some organizations will pay suppliers without an invoice. If a contract exists with the supplier that details price, payment terms, and all other the financial considerations, payment may be made directly from receiving documents. Whatever is received against the contract is paid for according to the contract terms. Pay on production Payment on production presumes that if a product is completed, it must contain the supplier s component. Therefore if the organization produces 100 finished products, the organization pays the supplier for 100 components. Electronic funds transfer Electronic funds transfer (EFT) is a mechanism that avoids actually having to print a check. EFT can be combined with evaluated receipts or pay on production but will still require approval before the funds are transferred.

B)

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TASK 119: Review and revise purchasing policies to ensure their conformance with established laws, policies, and ethical principles.
Purchasing departments should have written documents to clearly communicate organizational policies and procedures to purchasing professionals and internal customers. While the content of policies and procedures manuals will vary widely, they commonly address the following matters: the scope and level of purchasing authority; organizational structure and responsibility; processes and procedures for dealing with suppliers; forms and document control and retention; ethics policies; matters pertaining to federal, state, local, and international law (that affects purchasing; and the actions of those within the organization); and other topics as appropriate. Developing policies and procedures can be a complex process. However, such documents eliminate confusion, encourage standardization, facilitate training of new personnel, and provide protection for the organization under certain circumstances. 1) LAWS AND REGULATIONS AFFECTING PROCUREMENT A) Health and safety laws Since the 1960s, organizations have been subject to many social changes affecting the well being of workers. In particular, the Occupational Safety and Health Act (OSHA) has dictated safety in the work place. Purchasers are often in a position to protect themselves, their organizations, and internal customers from possible liability by shifting responsibility for compliance with OSHA and similar laws to suppliers. This shifting of responsibility may be accomplished by including a compliance with law clause in their contracts and appropriate indemnification provisions. This shifting, however, does not eliminate OSHA requirements on the purchasing organization in its work. OSHA serves to protect the purchaser in the event supplier action or inaction violates OSHA. Also, effective supplier selection will reduce exposure to risk. Environmental laws The Environmental Protection Agency (EPA) was established to implement and enforce federal laws relating to clean air, clean water, waste disposal, and related matters. Additionally, there are hundreds of state, local, and international laws dealing with environmental issues. This has resulted in suppliers and purchasers having to make many changes in products, services, and methods of doing business. Confidentiality Patent, trademark, and copyright laws provide protection for the owners of intellectual property or identifying information, but offer little protection of trade secrets. The National Conference of Commissioners on Uniform State Laws created a model law, the Uniform Trade Secrets Act (UTSA), that defines trade secrets, offers legal protection to owners of trade secrets, and offers legal remedy to owners in case of theft or misappropriation of trade secrets. This law has been adopted by 40 states and the District of Columbia.

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Task 119

Module 1 The Industrial Espionage Act requires a minimum value of $100,000 of the secret involved, requires a higher burden of proof than the UTSA, must involve interstate commerce, and any fines levied go to the federal government. Organizations should have standard procedures in place for disclosing their own confidential information, including the use of Non-Disclosure Agreements (NDAs). To ensure enforceability, NDAs must be signed before information is disclosed. Thus, a confidentiality provision contained within a contract may be acceptable, but it will not cover information exchanged with the supplier prior to the signing of the contract. Whether governed by non-disclosure agreements or not, purchasers should exercise due care in the dissemination of any information related to their organizations, their purchasing function, or the business of their suppliers (see Section 3-F below).

D)

Business regulation laws There is a host of federal, state, and local laws pertaining to antitrust, taxation, business-to-business transactions and relationships, licensing, permits, and import or export requirements. A working knowledge of these laws and regulations is within the purchasers realm of decisionmaking (see Task 108).

2)

LAWS GOVERNING ISSUES IN ETHICS A) Libel and slander One of the most important individual rights is the right to a good reputation. Accordingly, the law has imposed the general duty on all persons to refrain from making defamatory statements. Defamation may affect a persons reputation, trade, business, or means of making a living. Slander refers to the making of such statements orally. When the statements are made in writing, it is called libel. In either case, the information must be communicated to a third-party who understands what is said. Disparagement Disparagement, when it applies to purchasing, generally refers to the making of statements of fact that are untrue or misleading as to the quality or performance of anothers goods or services in an attempt to influence the public not to buy those goods or services. Bribery Commercial bribery refers to the giving of cash, gifts, or other favors in return for business or favors from the other party. Rulings on commercial bribery rest on the doctrine of agency, whereby any breach of faith on the part of the agent (who is recognized by law as keeping a fiduciary position) is not permitted.

B)

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3)

ISSUES IN ETHICAL PURCHASING PRACTICES Issues of ethical purchasing practice can arise at any time. The professional purchaser will take great care to understand ethical matters, both generally and those specific to the organization within which they work. Seeking guidance from a supervisor or other internal resource is a sound decision should the purchaser have a question or concern related to ethical practice. 154

Part D: Contract Execution, Implementation, and Administration

Task 119

The Preamble to the Institute for Supply Managements Principles and Standards of Ethical Supply Management Conduct states the distinguishing characteristic of a professional is the ability to combine ethical standards with the performance of technical skills. The set of ethical standards to guide individual behavior and the behavior of the profession are divided into twelve areas. A) Perception Essential to the involvement between purchasing professionals and active or potential suppliers is the avoidance of activity that in any way diminishes, or appears to diminish, open and fair treatment of suppliers. Responsibilities to the employer It is the duty of the purchasing professional to ensure that actions taken as an agent for the employer will benefit the best interests of the employer to the exclusion of personal gain. This requires the sound judgment and consideration of both the legal and the ethical implications of a purchasers actions. Conflict of interest Purchasing professionals must not use their positions in any way to induce another person to provide any benefit to themselves, or persons with whom they have family, business, personal, or financial ties. Even though technically a conflict may not exist, purchasing professionals should avoid even the appearance of such a conflict. Gratuities Gratuities include any material goods or services offered with the intent of, or providing the potential for, influencing the buying decision. As such, gratuities may be offered to the purchaser, or to other persons involved in purchasing decisions (or members of their immediate family). Caution must be used in evaluating the acceptance of gratuities, even if of nominal value, and the frequency of such actions, to ensure that the purchaser is abiding by the spirit of ethical practices. Confidential information Purchasing professionals and others in positions that influence buying decisions deal with confidential and proprietary information of both the employer and the supplier. The purchasing professional is responsible for ensuring that such information is treated in a confidential manner. Proprietary information requires protection of the name, composition, process of manufacture, or rights to unique or exclusive information that has a marketable value and is upheld by patent, copyright, or non-disclosure agreement. Information from one supplier should not be shared with another supplier, unless laws and government regulations require the purchasing professional to disclose such information. Purchasers must also realize that certain information about their organizations needs is to be kept strictly within the organization. A purchaser must be careful, however, that his or her restraint in describing the intended use of a product does not result in an unintentional waiver of the benefits that might come from the implied warranty of 155

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Task 119

Module 1 fitness for a particular purpose. The supplier that is not informed as to the intended use is obligated only to conform to the specifications set forth in the order.

F)

Treatment of suppliers The purchasing professional is responsible for promoting mutually agreeable business relationships with all suppliers. In addition to courtesy, the purchasing professional should extend the same fairness and impartiality to all legitimate business concerns within the scope of his or her purchasing responsibility, and the laws and regulations which may affect such practice. Reciprocity Reciprocity is a practice that is prohibited under the provisions of the Sherman Antitrust Act (see Task 108). It refers to arrangements between purchasers and suppliers to deal exclusively with one another (for example a purchaser agreeing with his or her organizations sales department only to purchase from suppliers who purchase from the organization). The affect of reciprocal buying is that it limits the purchasers freedom to select goods and services based on price, quality, and service, and it may foreclose the suppliers competitors from the market. Reciprocity, due to its potential to restrain trade, is both a legal and an ethical issue that may result in legal sanctions against the organization, its management, or purchasing personnel.

G)

H) I)

Federal and state laws Purchasing professionals should pursue and retain an understanding of the essential legal concepts governing conduct as agents for their organization. Small, disadvantaged, and minority-owned businesses While the entire area related to small, disadvantaged, and minority-owned businesses is undergoing changes in the legislative and judicial system of the United States, most government entities and many corporations have developed specific guidelines and procedures to support and stimulate growth and development of small, disadvantaged, and minority-owned businesses. Purchasing professionals must adhere to all applicable laws and regulations, and actively strive to attain organizational and governmental policies and goals. Personal purchases for employees Personal purchases for employees may or may not be a part of an organizations policy subsequently assigned to the purchasing organization. If personal purchase programs exist, the purchaser should make certain the arrangements are fair to suppliers, employees, and employers. Responsibilities to the profession Purchasing professionals have an obligation to support only those activities that uphold the high ethical standards of the profession. International purchasing Purchasing professionals must be cautious when operating in the international arena. International business transactions dictate a need for a knowledgeable, common sense approach, with close scrutiny to the intent of each partys actions.

J)

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Task 119

ISM PRINCIPLES AND STANDARDS OF ETHICAL SUPPLY MANAGEMENT CONDUCT In 1929, the National Association of Purchasing Management adopted the Principles and Standards of Purchasing Practice, a code of conduct for purchasing professionals to ensure that purchasers apply their professional skills in accord with accepted standards of conduct. The current ISM Principles and Standards of Ethical Supply Management Conduct (Domestic and International), approved in 2002 are as follows: LOYALTY TO YOUR ORGANIZATION JUSTICE TO THOSE WITH WHOM YOU DEAL FAITH IN YOUR PROFESSION From these principles are derived the ISM standards of supply management conduct. (Global) Avoid the intent and appearance of unethical or compromising practice in relationships, actions, and communications. Demonstrate loyalty to the employer by diligently following the lawful instructions of the employer, using reasonable care and granted authority. Avoid any personal business or professional activity that would create a conflict between personal interests and the interests of the employer. Avoid soliciting or accepting money, loans, credits, or preferential discounts, and the acceptance of gifts, entertainment, favors, or services from present or potential suppliers which might influence, or appear to influence supply management decisions. Handle confidential or proprietary information with due care and proper consideration of ethical and legal ramifications and governmental regulations. Promote positive supplier relationships through courtesy and impartiality. Avoid improper reciprocal agreements. Know and obey the letter and spirit of laws applicable to supply management. Encourage support for small, disadvantaged, and minority-owned businesses. Acquire and maintain professional competence. Conduct supply management activities in accordance with national and international laws, customs, and practices, your organizations policies, and these ethical principles and standards of conduct. Enhance the stature of the supply management profession.

BIBLIOGRAPHY Jones, M.A. Pssst..Can You Keep a (Trade) Secret From Vendors? Managing to Protect the Theft of Intellectual Property, Proceedings of the 1999 Annual International Conference, NAPM, Tempe, AZ, 1999, pp. 271-275.

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TASK 120: Manage files of agreements, equipment records, and/or specifications.

Senior management has grown increasingly motivated to develop effective record retention programs. As organizations scramble to quickly develop enterprise-wide information management systems, management faces the economic reality of converting old, legacy information. By eliminating unnecessary and wasteful records, implementation costs can be reduced and record retention systems can become operational sooner. At the same time, corporate legal departments face the harsh reality of litigation in the modern era. Plaintiff attorneys, armed with subpoenas and special training in litigation warfare, bombard organizations with demands for information. Corporate counsel is well aware that failure to respond adequately to discovery requests or to explain the destruction of certain records could cost the organization dearly. In both cases new system development and litigation the purchaser can dramatically lower costs if valueless records are destroyed. 1) REQUIREMENTS FOR RECORDS MANAGEMENT Purchasing departments typically establish requirements for the maintenance, retirement, and destruction of official documents and contracts, correspondence, files, and other records. Federal and state laws for the most part determine the period of retention of records. The needs of the organization may also influence record retention policy. In some cases, organizations other than purchasing may have responsibility for the records retention function. For example, capital equipment records may be maintained by plant engineering, and vehicle records may be maintained within the transportation department. Typically purchasing takes responsibility for bills of sale, titles, warranties, contracts, and other documents applicable to the function. Files are maintained to track trends, develop history, project future needs, provide continuity, and to ensure that legal conditions relating to records retention and discovery are met by the organization. Product files contain information on raw materials; maintenance, repair, and operating supplies; services; equipment; and items purchased as components. Each file will typically include purchase history, pricing, specifications, descriptive literature, leadtime information, and the like. Deciding what to keep and what not to keep can be a difficult decision. Though legal and tax issues may govern most decisions, keep internal customers interests in mind when deciding what is important. Remember, records can be used as research information and reference with respect to specifications, pricing, and suppliers. Ask the following questions to help determine a record retention policy for the organization: How often is the record referenced? What are the costs of holding the records? Who, in terms of position, should appropriately have access to the records? Should the record be stored in electronic form, on paper, or microfiche? 159

Task 120

Module 1

Examples of records (paper and electronic) purchasing departments typically keep include: Catalog file This is a library containing listings, catalogs, supplier promotional material, and any other industrial directories that contain the names of suppliers and descriptions of products and services sought by the organization. Open order file This is a file containing all documents on outstanding orders, including associated requisitions, quotes, purchasing orders or contracts, change orders, and all other documents pertinent to each order. Each open order file is closed after receipt and payment of the goods or service. Files are retained according to guidelines established for records retention. Supplier record files These files include background information and experience the purchaser and the organization have had with each supplier, including addresses, key personnel contact information, history of purchases, quality and delivery data, and other pertinent information. This information can be a valuable resource for supplier identification and selection, and as a source of information when preparing for negotiations. Purchase record This is a record of repetitively purchased products or services and includes the description of the item (or service), a listing of suppliers, price history, and quantities purchased. Interview records Interview record files may be maintained to document meetings with suppliers. Other files The purchasing department may retain other files to meet special internal needs, including those of its customers or legal department.

Purchase Orders: Purchase orders should be kept for six years after the contract terminates to conform to the normal statute of limitations (the time you can sue or be sued in court). The statute of limitations begins at the time when either party breaches the contract. This period is long enough to accommodate the six-year retention period for tax records, the fouryear period under the Uniform Commercial Code (UCC) for purchase orders for goods, and the five-year period under federal foreign trade regulations. Electronic Contract Records: Organizations often forget that legally binding contracts, can be created or modified by electronic data interchange and electronic mail. They are admissible as evidence in a court of law just like traditionally signed contracts, and can also be subpoenaed and used by other parties in litigation cases. Related electronic contract records, including change orders, should be retained for the same period as contracts. Tax Records: Although accounting and finance departments are involved in keeping tax records, it is critical for purchasing and supply managers to be aware of the norms. As a general rule, organizations should maintain tax records for a period of six years from the tax return date. The Internal Revenue Service and most states must audit your tax returns within three years after the tax return is filed. But, a few states require a specific retention period of six years. As a general rule, keep depreciation schedules and inventory records for at least three years. In addition, keep employee records through the period of employment, plus an additional three years for reference. 160

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Task 120

Government/Legal This refers to retention constraints and other requirements set by government agencies such as the IRS. When in doubt, the purchaser works with the appropriate internal departments and legal counsel to ensure proper policies and procedures are established for record retention and management. Organizational Organizations commonly establish time and other requirements for record retention not related to legal requirements to meet specific internal needs.

B)

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FORMATS FOR RECORD RETENTION A) Records on paper The retention of records on paper, can range from informal files or loose-leaf notebooks, to organized files of formal purchasing documents. The main problems with this type of storage include space requirements, storage costs, retrieval, and the possibility of damage by fire or flood. Electronic/Computer records/CDs The great advantage of computerized records, besides their ability to store large amounts of data on floppy or hard disks, is the ability to set up a network. In this way, other departments with an interest in purchasings records can gain immediate access to these records with little effort. Disadvantages can include the deterioration of the storage medium, the inability to access data due to hardware and software changes over time, or the need to move the data to a new storage medium as technology changes. Microfilm/microfiche Microfilm or microfiche offer another space-saving alternative to the storage of records and experience the same disadvantages as paper. Other media Many organizations outsource record management with service providers who are in business for that purpose. Payment is usually by volume of storage and by transaction for retrieval of documents.

B)

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BIBLIOGRAPHY Skupsky, D.S. Keeping Records in the Electronic Age, NAPM Insights, May 1994, pp. 6-7. Skupsky, D.S. Know When to Hold Em, Purchasing Today , May 1999, p. 10.

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TASK 201: Prepare for and develop strategies and tactics for negotiations.
Negotiations take place in most aspects of our daily lives. We negotiate with our supervisors about a deadline extension on a report, with our children about an increase in allowance, with significant others about vacation plans, and with fellow employees about who will drive to lunch. While these incidents are not formal bargaining, they are negotiations. This task focuses on negotiations for purchasing and selling as opposed to collective bargaining, negotiations in the political process, and diplomatic negotiations. For purposes of this task, negotiations are defined as conferring, discussing, or bargaining to reach agreement or the process of working out a mutually satisfactory agreement. In this task, negotiations are presented as structured transactions, where purchasers and suppliers attempt to arrive at an agreement about specifications, price, delivery, service, and other issues essential to conducting business in a profitable manner. However, the topics discussed also apply to spontaneous negotiation situations where the amount of preparation time is limited. The ability to negotiate is a skill that purchasers must develop in order to obtain: A fair and reasonable price. Needed quantities and quality. Timely performance. Control over how the contact is performed. Supplier cooperation. Sound and continuing relationships with the supplier.

The negotiation process involves preparation, planning, teamwork, timing, assessment of purchaser and supplier strengths and weaknesses, setting objectives, choice of strategies and tactics, adaptability and even luck. A great deal of time and effort are often involved in successful negotiations. It is a well-established fact that thorough preparation leads to the best results. The best agreement is one that is well balanced, where both parties are comfortable with the final outcome. Negotiations will be influenced by organizational and administrative policies, and by applicable laws and regulations. 1) CONDITIONS FAVORING THE USE OF NEGOTIATIONS A) Lack of competition Competition is limited when any of the following criteria for competitive bidding is missing: Two or more qualified suppliers. Suppliers who want the business. Clear specifications (in the case of materials) or Statements of Work (in the case of services). An absence of collusion among suppliers. A purchase dollar amount large enough to justify the expense of competitive bidding. 165

Task 201

Module 2 When there is a lack of competition, thorough preparation will be critical to obtaining a satisfactory outcome. The purchaser (or purchasing team) can often exploit opportunities that neutralize the lack of competition. For example, the purchaser may explain why it is in the supplier's tactical and/or strategic interest to sell to the purchasers organization.

B)

Price, quality, and service needs These are three important issues for any organization. Price concessions can be gained by offering a supplier 100 percent of the volume (previously split between several suppliers), multi-year contractual agreements, the promise of increased volume (because of new market developments), a willingness to share supplier identified cost savings, and a willingness to mutually grow and develop as a partner. Emphasis should be on working with suppliers to obtain the lowest total cost of ownership, rather than the lowest purchase price. Quality should not be compromised in the interest of better pricing. The quality that an organization expects should be clearly spelled out in the specifications or Statements of Work. Specifications or Statements of Work should also be used in incoming inspections. Suppliers should have no doubt about incoming inspection criteria, so they can inspect and perform at that level. A good understanding of these conditions can save the time and money spent in resolving rejects. Good service is also a point of negotiation. A 24-hour emergency phone number, deliveries on holidays and weekends, emergency shipments, engineering assistance, responses to requests for early shipments, a personal representative to handle the account, and a thorough knowledge of the purchaser's needs are marks of a serviceoriented supplier. All of these should be reviewed in the negotiating process. Creative negotiators (or negotiation teams) recognize that price, quality, and service are not necessarily in conflict. Creative negotiations between purchasers and suppliers can identify ways to simultaneously improve price, quality, and service.

C)

Buying production/service capabilities The purchase of service capabilities is often preceded by some form of negotiation in order to establish the requirements of the purchasing organization. The purchaser may need to present specific requirements in advance to allow the supplier to evaluate and establish a price. Delivery times, frequency, quality, insurance coverage, liability, material costs, and uniforms to be worn, as well as holiday work for the service, are just a few items that should be reviewed for cost. Value analysis and cost-benefit techniques are often useful in identifying tradeoffs that may reduce price without compromising service and quality. High purchaser/seller uncertainty If the purchaser has a high degree of uncertainty about the supplier and the market within which the supplier operates, the purchaser may want to seek a negotiated commitment. A period of tight supply caused by material shortages, or the absence of a major producer, may prompt the purchaser to seek a commitment to strengthen his or her long-term position. Another example is a situation in which a purchaser is not certain that the supplier has made the

D)

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Task 201

commitment necessary to service the purchasers needs. Proposing a binding contract with a negotiated price can draw the required commitment from the supplier. E) Urgency Urgent shipments of products not previously scheduled are requested when purchasers are in a desperate position. A shipment of this nature will be remembered by the supplier, and may require flexibility from the purchaser when the supplier needs extra time because of production problems. Similarly, an urgent shipment requested from a secondary supplier can often result in the secondary supplier seeking additional business. Long supplier leadtimes Long leadtimes may require the purchasers organization to share forecast and scheduling information with suppliers, to carry more inventory, to order further into the future, and to conduct more expediting operations to ensure deliveries. Through negotiation, a purchaser may make commitments to a supplier that allow him or her to better plan raw-material purchases and operations scheduling, thereby reducing leadtime and costs. Necessity for flexible contract type(s) A purchaser may require a unique delivery schedule, have irregular volumes, require services the supplier does not provide, or be unwilling to make the type of commitment to which the supplier is accustomed. In such cases, a purchaser may need a flexible contract or agreement because the purchasers needs will probably not fit within the boilerplate of the supplier's existing contract form. Negotiating such agreements often takes more time, but, when planned carefully, can provide the purchaser with needed flexibility with no loss of contracting advantage. A purchaser may want flexibility in pricing, delivery, volume, or technical features all of which should be detailed in the document showing the responsibilities of both parties. A careful list of all contract issues should be made before the document is drawn up by the purchasing organizations legal counsel. The purchasing organizations legal counsel should be comfortable with the document from a legal standpoint, and the purchaser should be comfortable from a commercial standpoint. Lack of firm specifications The lack of firm product specifications (or Statements of Work, in the case of service purchases) can cause the purchaser a number of problems during negotiations. In areas where the specifications are not clear, the purchaser may have to accept the suppliers specifications or negotiate a middle ground. Some of the greatest problems will often be encountered as the supplier's product moves through incoming quality control. Quality control may interpret an area of the specifications one way, and the supplier may have another understanding. If measuring and testing devices used by the two organizations are not the same, the result can be rejected lots in incoming quality control that will require settlement by purchasing. It would be wise to anticipate problems caused by vague specifications and Statements of Work beforehand, and to resolve problems early in the negotiation process. Single source strategies Single sourcing is the practice of deliberately concentrating purchases of a particular product or service with one source in preference over others in a competitive marketplace. The supplier who has no active competition (in 167

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Module 2 this case due to a decision made by the purchasing organization) may have little motivation to provide customer service or engineering assistance. On the other hand, the purchaser may want the single source because of good pricing (resulting from the consolidation of purchasing volume), transportation advantages, or the suppliers technical expertise. Whatever the incentive, there are several tactics a purchaser can employ when using a single source: Sell the supplier on the mutual benefits of a win-win approach to negotiations. Drop the product line if pricing or other issues cannot be resolved with the supplier during negotiations. Consider producing the product or service in-house. Appeal to the supplier's sense of partnership. Use your assessment of the supplier's strengths and weaknesses to identify points of leverage. For example, supplier inventory or cash flow problems can give the purchaser some leverage.

Single sourcing differs from sole sourcing. Sole sourcing is the use of one source when that source is the only available company possessing the ability to fulfill the purchasing organization's needs. When negotiating with a supplier that is the only source of supply, strategies are limited. However, many of the tactics for single sourcing can be employed when working in a sole-source situation. 2) PREPARATION FOR NEGOTIATIONS A critical step in any negotiation process is planning. Without proper planning, purchasers: are unlikely to know what their negotiation position should be are unlikely to anticipate what the other party is likely to do will be unable to realistically respond to the other party's proposals will not know if the agreement negotiated is reasonable.

Being eloquent in presenting your position is of little help when the planning and preparation underlying your position is weak. An effective purchaser will spend an appropriate, and often significant, amount of time preparing for negotiations. Time should be spent reviewing the purchasing organization's strengths and weaknesses, as well as those of the supplier. By creating a list of areas to be studied, a purchaser systematically evaluates all of the issues that will have a bearing on the outcome of negotiations. The first item in a negotiation plan should be an in-depth analysis of the supplier's proposal. Evaluate price, delivery, specifications (or Statements of Work), terms, and any deviations from your requirements. A thorough knowledge of the supplier's proposal can be an advantage at the bargaining table, especially if the purchaser knows

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Task 201

the suppliers proposal better than the supplier does. Keep in mind that the supplier's proposal is usually the beginning point (optimistic position) for negotiations. The next item in the negotiation plan should be setting objectives. Is the goal a lower price, higher quality, an accelerated delivery schedule, or a combination of these? In any case, a specific plan should be drawn up, and the negotiator (or negotiating team) should work toward the plan. If a negotiating team is involved, the team leader (usually the purchasing manager) should be selected, and all team members should be briefed on what and what not to say. Generally, team members should answer only those questions that lie within their own areas of expertise. A) Negotiation objectives 1.0 Fair and reasonable price Cost control is a major consideration in all purchasing departments and will probably rank high on the list in a negotiating plan. The purchaser should not lose sight of other critical issues, however, such as good quality, on-time delivery, and security of supply. A negotiator should be careful not to drive the price so low that the supplier will lose money. It is important that the supplier be able to its costs and be comfortable with the outcome. The purchaser may have the upper hand in the negotiation at this point in time, but conditions can change and then the purchaser might be at a disadvantage. It is best to seek a price that is fair and reasonable to all parties. Timely performance The negotiated agreement should cover performance issues, including shipment of the specified product according to the production plan (or delivery of the service according to the Statement of Work). Advising the supplier that it will be measured against other suppliers and that a tracking system will be in place should inspire the supplier to perform well. The supplier should be advised that late shipments (and poor performance of services) will not be tolerated because they cause expensive downtime and other problems. Early shipments and poor timing of services are equally undesirable. They may result in unnecessary inventory carrying costs or (in the case of services) disruption of operations. Ideally, a just-in-time approach, with good quality products and services arriving just as they are needed, is the goal. Meeting the minimum essential needs of the organization One objective of negotiations can be to meet the needs of the purchaser's organization with respect to purchased products and services. If the purchasing organization has a shortage of necessary commodities, components, or services, the purchasers job is to secure an adequate supply from an acceptable supplier. In such a case, the purchaser is not negotiating from a position of strength. The only hope is that the volume of the order is attractive for a long-term commitment, and that the purchasing organization is a valued customer. The purchaser can then assure the supplier that, if it provides the needed product or service, the purchasing organization will continue to do business with the supplier in times when supply is plentiful. 169

2.0

3.0

Task 201 4.0

Module 2 Control over contract performance Performance issues should always be clearly defined in the contract. In the planning period, the purchaser should list all issues that can cause performance problems and review the steps that should be taken to resolve each issue before problems occur. Inability to perform as agreed, cancellation clauses, and costs should be spelled out in detail. The responsibilities of all parties should be made clear. Maximum contractor cooperation One important objective in a negotiation session is to strive toward an agreement that does not end in an adversarial atmosphere. A mutually satisfactory agreement between the purchaser and supplier is the best outcome, where both parties are comfortable with each other and look forward to doing business in the future. If either party is beaten down to a point of embarrassment, future negotiations will be approached with caution. Sound relations with contractors All parties must be able to operate profitably under the terms of the agreement. The purchaser and supplier should schedule regular, frequent communication in order to establish and maintain a positive relationship. Each party should strive to appreciate the other's perspective. Problem solving should focus on mutual satisfaction, rather than win-lose.

5.0

6.0

B)

The negotiation site It is sometimes best to conduct negotiations at the purchaser's location, since the purchaser will be most comfortable there; will have all needed data, backup, and support; and can essentially control the negotiations. Stress will be lowest, travel fatigue will be eliminated, and the purchasers confidence will be higher. On the other hand, negotiations at the suppliers site give the purchaser the power to walk away. Regardless of the site selected, wise negotiators pay close attention to negotiation security. Sometimes, unethical conduct by members of the other party's negotiation team occurs. Hidden microphones, snooping and surveillance, and stealing work notes are not unheard of. Knowledgeable negotiators know that they (and their team members) must be careful about what they discuss in public places, must pay close attention to the security of work notes, and must make sure that confidential material is secured. Concerns regarding security apply to both domestic and international negotiations.

C)

Team selection In some situations, negotiations can be performed by a single person. In other cases, it is best done by a team. A team is normally used when a product/ service is complex and one person does not have sufficient knowledge of all issues. The team should consist of purchasing and the other departments involved, such as engineering, quality assurance, operations, accounting, and marketing. Make sure that team members understand their individual roles, can work well with other team members, and can support the team leader, even if it means sacrificing their own opinions. Disagreements among team members should never be expressed in the presence of the supplier.

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Regardless of the size or makeup of the team, meetings should be held to discuss goals, to plan strategies, and to review strengths and weaknesses of both sides. A team leader (usually the purchasing manager) should be selected to guide the team in the right direction and to chair the pre-negotiation meetings. The leader should be the main point of contact between the purchaser and supplier, and should set up times and locations for the negotiating sessions. An important aspect of team negotiations is the caucus. The caucus is a planned or unplanned break in negotiations that gives the negotiation team an opportunity to discuss its strategy, tactics, or progress before proceeding. The caucus should immediately be used when disagreement, confusion, or misunderstanding occurs within a negotiation team. The caucus may also be used to slow down momentum if negotiations are not going well, or to create a pause that causes the supplier's team to caucus. The caucus should be a routine part of negotiation tactics, so that the calling of a caucus does not provide any signals to the other party. D) Relevant information (e.g., proposals, learning curves, backgrounds of players) All relevant information that can have a bearing on the negotiations should be collected and analyzed. Some areas of importance include the following: E) Negotiation objectives Cost data Financial reports on suppliers Records of previous negotiations Market information Financial strength of the supplier Strengths of both parties Weaknesses of both parties Price history Quality history Specification issues Negotiation styles and personalities of those with whom the purchaser will be negotiating Time available

Analysis of supplier's and purchaser's positions A thorough study of the supplier should be made by the negotiator or negotiating team, to ensure that the suppliers position, strengths, and weaknesses are understood. It may take weeks to put together all of the necessary information, but the person or team who does the most homework will usually achieve the best results. 1.0 Supplier's desire for a contract An important factor to evaluate before entering into negotiations is the degree of desire that the supplier has for selling to the purchasers organization. Market conditions may be in the supplier's favor; the supplier may be in an industry with limited competition; or the supplier may 171

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Module 2 have a patented feature, making the organization unwilling to commit to certain requirements. However, the reverse may also be true. An adequate supply and plenty of competition may motivate the supplier to work out a reasonable contract. 2.0 Suppliers certainty of getting a contract Under these pressures, it is important to know the market, the supplier, and the product. Is the market tight, or is supply plentiful? What is the market likely to do in the immediate and distant future? Is the supplier a leader within the industry, or a follower? What about cash flow? Is the organization in sound financial condition? Is the product strong, or is it likely to be replaced by more innovative products? Are new producers entering the industry with newer plants or better costs? The supplier's desire for a contract, and its perceived certainty of getting it, will depend on the relative strengths and weaknesses of the supplier and the purchaser at the time of the negotiation. 3.0 Amount of time for negotiation The amount of time available to negotiate an agreement will have a definite impact on its outcome. Deadlines put pressure on both purchasers and suppliers, but few deadlines exist that cannot be extended. The party most severely affected by time constraints will give up negotiating strength. On the other hand, ample time for an extended negotiating session may result in substantial gain. Both the purchaser's and the suppliers alternatives will change as the amount of time available for negotiations is increased or decreased. Purchasers should allow themselves sufficient time to negotiate from a position of strength. During international negotiations, cultural differences regarding the importance of time may result in substantial disadvantages for those who do not provide sufficient time for negotiations. 4.0 Adequacy of cost/price analysis Price analysis is a means of ensuring that the price to be paid is reasonable in terms of the market, the industry, and the end use. This important step should be taken before entering any negotiations. An analysis of cost components is a good method for isolating and eliminating unnecessary costs. The purchaser should collect information about manufacturing costs, direct labor, overhead, shipping expenses, and administrative expenses. In some cases, suppliers will be unwilling to open their books on cost makeup, but, with persistence, bits and pieces of information can be acquired. Quotations are another accurate and reliable way to determine existing market price. The purchaser can also obtain cost/price analysis information by making it part of the data required in the quotation. Useful estimates may also be developed based on accounting analysis, engineering analysis, and industry data.

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Task 201 A price history file is another valuable source. The frequency and percentage of increases or decreases in past periods may enable the purchaser to project future changes (see Task 104 for a further discussion of cost/price analysis).

5.0

Purchaser's availability of other options The purchasers negotiating strength will be greater if the purchaser has other options available. If it is possible to purchase from other sources, if there are suitable alternative products, or if the products or services can be produced in-house, the purchaser can negotiate from a position of increased strength. Alternative sourcing is the simplest of the three alternatives to pursue, because it may involve only minor differences in the product. The purchaser should make a careful examination to ensure compatibility and acceptability. Alternative products may involve extensive evaluation and engineering studies, while internal production of the component may involve capital investment, additional labor, and the development of additional in-house skills.

6.0

Supplier's competitive position (sole source or otherwise) The supplier's negotiation power can be strengthened in a number of ways. The supplier may be the only source for a commodity or service, or it may operate in a limited competitive market where there are only one or two sources. The supplier may have a patented design or feature, or merely be the closest producer from a transportation standpoint. The supplier may have a higher-quality product, have better engineering support, or have the best productive capacity for the purchasers needs. The supplier may also be the only supplier willing to deal with small volume. Additional sources of bargaining power for the supplier are superior customer service, low reject rates, comfortable payment terms, and a good delivery track record. Skill and authority level of the negotiator/negotiation team What makes a skilled and effective negotiator or negotiating team? Several studies have shown that the following 22 characteristics are helpful: Planning ability Desire to achieve Competitiveness Persistence Personal integrity Insight Analytical ability Self-restraint Intelligence Patience/tolerance Verbal clarity Ability to gain respect Problem solving ability Good knowledge of human nature Ability to objectively consider other's ideas Flexibility Ability to listen Tact Clear, rapid thinking ability Decisiveness High tolerance for ambiguity Recognition of the importance of training and practice 173

7.0

Task 201

Module 2 Professional negotiators agree that planning ability, a high tolerance for ambiguity, and a desire to achieve are the most important characteristics of a negotiator. 8.0 Extent of planning for the negotiation Top executives overwhelmingly rank planning as the most important trait of an effective negotiator. The more the purchaser plans for negotiations, the more effective the purchaser will be. Suppliers financial condition Purchasers should be able to read and interpret financial statements within the context of the organization's industry, and be able to interpret the significance of changes in financial statements over time. In many situations, purchasers may want to consult with their accounting and financial staff to evaluate a supplier's financial condition. Suppliers in strong financial condition may be less likely to agree to conditions that are unfavorable to them. On the other hand, sellers in a strong financial condition bring more credibility to the negotiations regarding their ability to live up to their agreements. Negotiations with suppliers in weak financial condition should be approached with caution. It does little good to negotiate favorable prices, delivery, and service from a supplier that may not have the financial ability to deliver as promised. In some situations a supplier in an unfavorable financial condition may offer potential, if the purchaser closely monitors that organization's financial condition and minimizes the risks of supply interruption (see Task 111 for more information on the analysis of the suppliers financial status). 10.0 Purchaser's financial condition An organization with a strong financial condition is in a better position to negotiate from a position of strength than an organization with a weak financial condition.

9.0

F)

Market and product conditions All things being equal, a seller's market (demand exceeds supply) gives the supplier a negotiating advantage, and a purchaser's market (supply exceeds demand) gives the negotiating advantage to the purchaser. However, many negotiations are conducted within the context of the overall, long-term relationship between the supplier and purchaser. Even though short-term market conditions may give one of them an advantage, both realize that taking excessive advantage of market conditions for short-term gain may lead to long-term problems. For example, one large North American manufacturing organization put tremendous pressure on its suppliers to reduce prices during the 1990s, only to find that several key suppliers later dropped them as customers. Development of strategies and tactics The planning of strategies and tactics for negotiations actually involves a three-dimensional function: Strategic planning This refers to the long-range goals of the organization. Strategic planning requires the negotiator to select sources that will optimize attainment of the overall philosophy and objectives of the purchasers 174

G)

Part A: Negotiations

Task 201 organization. Knowledge of product-market mix; customer and environmental constraints; and the basic goals of the organization concerning technology, price, and policy are essential. Administrative planning This refers to the logistics of getting people and information in place for the negotiations. Tactical planning This involves getting optimal results at the bargaining table. It involves setting goals, and evaluating the strengths and weaknesses of the other party. A careful study should be made of issues, problems, agenda questions, concessions, commitments, promises, pricing, quality, and delivery performance. The team leader should be selected, and negotiating tactics should be reviewed and discussed. Timing, ways to exploit strengths and weaknesses, delays, and deadlock tactics should all be planned. The purchaser should gather as much data as possible.

H)

Organization cultural factors Cross-cultural negotiations are normally thought of as being between parties of different nations. When conducting cross-cultural negotiations, the ability to understand the culture of the other party can reduce the number of misunderstandings that inhibit negotiations. Adequate preparation is crucial to crosscultural understanding. The lessons from cross-culture negotiations can also be applied to negotiating with partners from other organizations. For example, a purchaser for a county government who is purchasing computers from an organization that usually markets to businesses may have to educate the supplier on the process of public-sector purchasing. Once both parties understand each others culture, communications will improve and negotiations will proceed with fewer misunderstandings.

I)

Fall-back alternatives When preparing for negotiations, consider that give-andtake is a normal part of the process. If both parties establish inflexible positions for each negotiating point, there will be little opportunity to confer, discuss, or bargain to reach an agreement. When preparing for negotiations the purchaser (or purchasing team) should identify optimistic, target, and pessimistic positions for each issue. The purchaser (or purchasing team) should also estimate the optimistic, target, and pessimistic positions of the supplier. As negotiations proceed, the purchaser can then assess progress on each issue, and progress on the total package. In some instances a purchaser may agree to less than the pessimistic position on one issue, if the supplier makes concessions that exceed the optimistic position on another issue. This level of planning enables the purchaser (or purchasing team) to anticipate the supplier's position, to anticipate changes in the supplier's position, and to effectively respond to unexpected changes in the supplier's position.

3)

NEGOTIATION PHILOSOPHIES There are many approaches to negotiations, and each depends upon the nature of the market, the relative position of both the purchaser and supplier, and the nature of the outcome each 175

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Module 2

expects from the relationship. These approaches can be described as: 1) win-win/cooperational, 2) win-lose/adversarial/competitive, and 3) lose-lose/confrontational. An explanation of these philosophies is provided by the dual-concern model, where the approach is a function of the negotiator's concern for the negotiator's own outcomes and the other party's outcomes. The choice of negotiation philosophies is also affected by at least four other considerations: A) The history of past relationships (positive or negative). The belief that an issue can be resolved only if someone wins and someone loses. The mixed-motive nature of most negotiations, where negotiators want their own way, but also want a continuing relationship. A situation in which negotiators are accountable to someone else for their performance. Win-Win/Cooperational This philosophy is likely to be used when both parties have a high degree of concern for their own and the other's outcomes. Examples of this include most negotiations between partners, and negotiations where the purchaser and supplier want to do business with each other. Win-Lose/Adversarial/Competitive This philosophy is likely to be used when the negotiator has a high degree of concern for his or her outcomes and a low degree of concern for the others outcomes. This is likely to occur if the purchaser is in a very strong bargaining position relative to the supplier. Conversely, if the negotiator has a low degree of concern for his or her own outcomes but a high degree of concern for the others outcome then the approach is likely to be accommodating, or yielding. This is likely to occur if the purchaser is in a very weak bargaining position relative to the supplier. When both parties have moderate concern for their own and the other's outcomes, the philosophy is likely to be compromising, where both parties split any differences. Lose-Lose/Confrontational This philosophy is likely to be used when both negotiators have a low degree of concern for their own and the other's outcomes. Loselose/confrontational negotiations are likely to occur when both parties prefer not to do business with each other but are forced to because of circumstances beyond their control.

B)

C)

BIBLIOGRAPHY Dobler, D.W. and D.N. Burt. Purchasing and Supply Management: Text and Cases, 6th ed., McGraw-Hill, New York, NY, 1996, Chapter 17. Ferguson, W.C. and J.A. White. Negotiating and Contracting to Prevent Cost Increases, NAPM InfoEdge, (1:11), May 1996. Heinritz, S. and P.V. Farrell, et al. Purchasing Principles and Applications, 8th ed., Prentice-Hall, Englewood Cliffs, NJ, 1991, Chapter 13. Hughes, J.E., and G. Shihata. Preparing for a Successful Negotiation, NAPM InfoEdge, (1:13), July 1996. 176

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Task 201

Leenders, M.R. and H.E. Fearon. Purchasing and Supply Management, 11th ed., Irwin, Chicago, IL, 1997, Chapter 8. Lewicki, R.J. and J.A. Litterer. Negotiation: Readings, Exercises, and Cases, 2nd ed., Irwin, Homewood, IL, 1993. Monczka, R.M., R.J. Trent, and R.B. Handfield. Purchasing and Supply Chain Management, South Western, Cincinnati, OH, 1998, Chapter 14. National Association of Purchasing Management. Focus on Negotiations: A Collection of Previously Published NAPM Articles, NAPM, Tempe, AZ, 1998.

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TASK 202: Conduct negotiations with potential and/or current suppliers to obtain maximum value.
Negotiations occur when two parties confer or discuss to reach agreement or change relationships. Negotiations are increasingly used by both private and public sector purchasers as a tool to obtain maximum value. While use in the private sector is more widespread, most public sector entities now have specific legislation permitting negotiations. 1) NEGOTIATION TACTICS The choice of negotiation strategies and tactics results from the negotiation planning process. This process includes analyzing the supplier's proposal; establishing objectives; formulating optimistic, target, and pessimistic positions on each issue; analyzing and estimating the supplier's optimistic, target, and pessimistic positions on each issue; defining and organizing the issues to identify points of similarity and difference between the purchasing organization and the supplier; developing strategies and tactics; selecting the negotiation team; and developing an agenda. In many instances, this planning process may be lengthy and require substantial research and analysis. Strategy is the planning and direction of the negotiations. The strategy selected will depend on whether the negotiation philosophies are win-win/cooperational, win-lose/adversarial/ competitive, or lose-lose/confrontational (see Task 201). It will depend on the relative power of the purchaser and supplier, and the personalities of the negotiators. Three practical strategies are: reveal no position, reveal the optimistic position, and reveal the optimistic position and then immediately offer the target position. Revealing no position is used when the purchaser does not want to discuss position. This strategy attempts to maneuver the supplier toward the purchasers position by probing the supplier's proposal point by point. This strategy may work when the supplier is eager to reach agreement, when the purchaser lacks information, or when the supplier's proposal is long and complicated. Revealing the optimistic position is the most common approach when the purchaser has the supplier's proposal. This approach establishes the range for negotiation on each issue. The purchaser and the supplier can then discuss and resolve each issue. Revealing the optimistic position, and then immediately offering the target position, can work if the purchaser can sell the supplier on the merits of the approach. This strategy can backfire if the supplier refuses the offer. The purchaser may then have to settle for something closer to the pessimistic position. Tactics are the processes and maneuvers that the purchaser uses to put the plan into action. As with strategies, specific tactics will vary depending on the negotiation philosophy, the relative power position of the negotiators, and the personalities of the negotiators. Effective negotiators are able to adapt their tactics to the situation and can recognize tactics used by the other party. The following summarizes some basic negotiation tactics. Keep in mind that the tactics discussed below are relevant to U.S. negotiators. Those negotiating in other cultures should modify their tactics to fit the cultural situation. Sequence or prioritize the issues for discussion, using one of these approaches: 179

Task 202

Module 2 - Cover the major issues first, assuming that the minor issues will then fall into place. - Cover the most troublesome issues first, assuming that the other issues will then fall into place. - Cover the least troublesome issues first, in order to get a feel for the supplier's position and to evaluate its negotiators. - Arrange the issues so that if one issue is settled the rest will fall into place. Use questions wisely. Questions should draw out information (rather than requiring yes or no answers), and should be phrased so they question the supplier's position without attacking it personally. Listen effectively. Pay attention to what is being said, rather than thinking of what your response will be before the other party has finished talking. Maintain the initiative. Be prepared to probe for justification in areas that are unclear. Use solid data. Be able to back up your position. Positions that cannot be justified hurt your credibility. Use silence. Silence often makes the other party nervous, and may result in additional discussion and concessions. Avoid emotional reactions. Emotional reactions move the negotiations from issues to personalities. Make use of caucuses. Caucuses, or recesses, are an excellent way to rethink your position, interrupt the supplier's momentum, or evaluate a counterproposal. Avoid backtracking when the session resumes. Don't be afraid to say no. Dont agree unless you mean to agree. Beware of deadlines. Before agreeing to a deadline make sure you can live with it. It is often better to let a deadline pass than to settle for less than you can live with. Be aware of body language. When there is a conflict between what people are saying and their body language, the body language is usually telling the truth. Keep an open mind. Preconceived ideas block creativity that is often needed for a positive outcome. Get it in writing. Before adjourning get all agreements in writing and have the appropriate parties sign the agreement. Make appropriate concessions; it can produce significant gains. Concessions need not be made one for one or be of equal value. Your willingness, or unwillingness, to make concessions will set the tone for additional negotiations. Use the missing person tactic. The missing person is the deliberate absence from the negotiations of the person with final authority. This tactic gives the negotiator more time and provides a way out of a tight situation. On the other hand, some negotiators will not meet if someone in authority is not present. In addition, many negotiators will not make a firm offer if someone in authority is not present. Use the take it or leave it tactic. This lets the supplier know that the purchaser is firm on an issue and will not move. Do not use this tactic unless you mean it. Think carefully before using this tactic as a bluff. If you have to back down, your credibility will suffer. Use the bogey tactic. In this tactic the purchaser tells the supplier that he or she likes the product but $X is all that he or she will pay. This tactic often brings a favorable response from the supplier. 180

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Never negotiate beyond your physical and mental endurance. The pressure of extended negotiations is physically and mentally demanding. This is especially true when the negotiator is experiencing jetlag, negotiating in unfamiliar surroundings, negotiating with suppliers from dissimilar industrial or national cultures, or is having to absorb large amounts of information. Fatigue slows thinking and clouds judgment. Scheduling shorter negotiation sessions, scheduling adequate time for rest and exercise , and reducing the intensity of social activities should be an important part of the negotiation planning process.

2)

SPECIAL CONSIDERATIONS IN CONDUCTING NEGOTIATIONS A) Fact-finding sessions These are periods when the negotiator or negotiating team makes every effort to develop data and information about the other party. A complete study of the suppliers business history, length of time in business, growth, and overall success should be conducted. If previous negotiations were held with this supplier, the effectiveness of previous strategies and tactics should be critiqued. Based on previous negotiations and meetings, develop profiles of the supplier's negotiators to assess individual personalities, evaluate strategies and tactics they are likely to use, identify strategies and tactics that are likely to work with them, and provide guidance for others in the organization who may negotiate with them in the future. Financial data can be gained from Dun and Bradstreet reports, libraries, newspapers, government filings, and stock market analysis reports. Valuable information can also be gained by talking to people and organizations who have dealt with and/or know the supplier. Facts and lessons learned should be documented soon after negotiations are concluded. Lessons learned provide insights into what worked, what did not work, what was learned about negotiations, what was learned about preparing for negotiations, and how to prepare next time. Best and final offer Telling the other party that this is the best and final offer (also known as the doorknob price or take it or leave it") is a risky negotiating tactic that the purchaser should use with caution. Because the supplier may decline, the purchaser should have an alternate source before using this tactic. Another risk of the best and final offer is that the purchaser has no room for further negotiations if the supplier agrees. An alternate approach to the best and final offer is to frame the final offer as a close, where the purchaser offers to place an order if the supplier agrees to the offer. For example, the purchaser may say, If you can do this, this, and this, we are prepared to place an order now. This approach often works, while providing the purchaser with the option of continuing discussions if the supplier does not agree. When made, a best and final offer should be clear. Nonverbal signals should be consistent with the verbal or written offer. How the best and final offer is made can convey different meanings. The best and final offer can improve or hinder bargaining power. The manner in which it is stated can convey commitment, and can leave room for further negotiations, if necessary.

B)

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Module 2 If the purchaser is presented with a best and final offer, the purchaser can accept the offer, reject the offer, make a counteroffer, be noncommittal, or remain silent. Being noncommittal or remaining silent may be the best response. This avoids confrontation, provides the supplier with no feedback, and gives the purchaser time to decide how to respond. There is nothing wrong with concluding negotiations if a mutually satisfactory agreement cannot be reached. In most public sector entities, the best and final offer has a distinctly different meaning than above. Often, in the public sector, the rules require best and final offers (BAFOs) as an integral part of the negotiation process. The negotiation process begins with a Request for Proposal, the responses to which are evaluated against established criteria. The purchasing organization negotiates with one or more respondents, then asks for BAFOs. When the BAFOs are received, the purchaser again evaluates the proposals against the established criteria and selects the highest ranked proposal for contract award, with no further negotiation permitted.

C)

Negotiating with sole offeror versus entire competitive range Dealing with a supplier that does not have competition, or that has very limited competition, is a difficult position from which to negotiate. There are, however, several tactics for generating competition within this arena: The purchaser can advise the supplier that the purchasers organization is considering making the item in-house. The purchaser can advise the supplier that if the price is not reasonable, the purchasers organization will no longer consider making the product that requires the component. The purchaser can advise the supplier that he or she is considering substitute items. If the supplier is already supplying products to the purchaser, the purchaser can advise the supplier that his or her long-range interest should be in keeping the purchaser as a customer, rather than achieving a temporary price advantage. The purchaser can seek a win-win situation where costs, risks, and savings are shared. If the supplier has high inventory levels and needs to lower them, the purchaser can use this as leverage. If the supplier has financial problems and can use the additional business, the purchaser can use this to his or her advantage.

D)

Negotiating with small and historically underutilized businesses (HUB) Special consideration may be given to these negotiations in order to help develop the supplier as a new, viable competitor in the marketplace. Providing technical and engineering assistance; sharing cost savings; furnishing raw material and components; helping the supplier identify new sources and customers; training supplier personnel; setting up financial and operations systems; providing long-term orders (that help the supplier obtain financing); and providing assistance in developing business and 182

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Task 202

marketing plans, are some considerations that can help develop a small and historically underutilized supplier (see Task 206 for a discussion on setting up HUB programs). E) Documentation of negotiations Because of problems with personnel turnover and the limitations of human memory, accurate documentation of negotiations is essential. Documentation should include the following: Subject An overview of the negotiations, including supplier's name and location, contract number, and a description of the item to be purchased. Introductory summary A description of the type of contract and the type of negotiation action involved, plus comparative figures of the supplier's proposal, the purchaser's objectives, and the negotiated results. Particulars A description of the product/service to be purchased and who was involved in the procurement. Procurement situation A discussion of the factors in the procurement situation that affected the final decisions. Negotiation summary A description of the supplier's contract pricing proposal, the purchaser's negotiation objective, and the negotiation results, tabulated in parallel form.

F)

Negotiations as a consortium or cooperative The purposes of consortiums and cooperatives (co-ops) are similar; however, they differ in structure. A consortium is a formal organization, usually comprised of private- sector, for-profit, non-competing organizations from varied industries. Members are usually active in the management of the consortium, whether commodity purchases are made by lead members or by a hired third party. Consortiums are actively managed by commodity teams. These teams are usually comprised of purchasing professionals from member organizations. The consortium is usually cash neutral, where members are expected to pay for products purchased on their behalf within the terms of the supplier invoice. A co-op is a profit or not-for-profit business that serves members in a single industry, such as hospitals, universities, or county governments. Co-op members play no role in the management of the co-op's suppliers and administrative activities. Members may recommend suppliers, but co-op management evaluates and selects suppliers. Members may order directly from the supplier, or the co-op may serve as the member's purchaser. Both consortiums and co-ops combine the purchasing power of their members in the market place to achieve lower prices, better quality, reduced administrative costs, standardization, better records, and greater competition. Criticisms of these collaborative purchasing arrangements include inferior products, longer leadtimes, limited item availability, increased paper work, and placing smaller suppliers at a competitive disadvantage. Antitrust problems due to restraint of trade are usually not a problem for consortiums if their activities represent legitimate joint purchasing, that falls within the

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Module 2 federal antitrust safety zone. If the percentage of purchases by the consortium or co-op falls below a certain percentage (usually in the range of 25-35 percent) of total sales in the relevant market, and if the jointly purchased products and services are less than a certain percentage (usually in the range of 10-25 percent) of member revenues), then the co-op or consortium probably will not be challenged for antitrust violations. The Antitrust Division of the federal government has a business review process for evaluating whether a consortium is within the safety zone. Issues for negotiation regarding collaborative purchasing agreements relate to forming or joining a consortium or co-op. Some of these issues are: Protection from antitrust problems. Limitation of liability concerns. Ease of entry and exit. Definition of rights and obligations of members. Protection of confidential information. Costs and membership fees. Requirements to buy from participating suppliers. Special needs, such as storage, delivery, or quality requirements. Rules of behavior.

BIBLIOGRAPHY Anderson, R. and K. E., Macie. Using Cooperative and Consortium Buying for Better Purchasing, NAPM InfoEdge, (2:4), December 1996. Dobler, D.W. and D.N. Burt. Purchasing and Supply Management: Text and Cases, 6th ed., McGraw-Hill, New York, NY, 1996, Chapter 17. Ferguson, W.C. and J.A. White. Negotiating and Contracting to Prevent Cost Increases, NAPM InfoEdge, (1:11), May 1996. Heinritz, S. and P.V. Farrell, et al. Purchasing Principles and Applications, 8th ed., Prentice-Hall, Englewood Cliffs, NJ, 1991, Chapter 13. Hughes, J.E. and G. Shihata. Preparing for a Successful Negotiation, NAPM InfoEdge, (1:13), July 1996. Leenders, M.R. and H.E. Fearon. Purchasing and Supply Management, 11th ed., Irwin, Chicago, IL, 1997, Chapters 2, 8, and 14. Lewicki, J.R. and J.A. Litterer. Negotiation: Readings, Exercises, and Cases, 2nd ed., Irwin, Homewood, IL, 1993. Monczka, R.M., R.J. Trent, and R.B. Handfield. Purchasing and Supply Chain Management. South Western, Cincinnati, OH, 1998, Chapter 14. National Association of Purchasing Management. Focus on Negotiations: A Collection of Previously Published NAPM Articles, NAPM, Tempe, AZ, 1998.

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TASK 203: Develop/utilize a computerized purchasing system (e.g., on-line buying, EDI, web-based electronic commerce). TASK 204: Develop/implement/maintain a database of specifications, suppliers, products, and/or services. TASK 205: Develop/utilize a computerized inventory and/or capital equipment tracking system.
1) INFORMATION TECHNOLOGY BASICS Computers assist purchasing professionals by enabling them to be more efficient and effective. Initially, computers were expensive, large machines employed to manage huge volumes of data in an orderly and systematic manner. Adding to the high cost of securing, using, and maintaining these machines was the costly process of data preparation and input, coupled with the relatively significant labor costs associated with the specialized personnel who made them work. Technological advances, and lower costs of computer hardware and software now permit fast and accurate information processing and decisionmaking by almost any organization, regardless of size. Moreover, the variety of both hardware and software has facilitated the use of computer systems by both large and small purchasing departments for analytical, computational, word processing, and managerial purposes. Today, computer systems offer the purchasing professional a cost-effective and efficient instrument for achieving productivity gains, such as greater output for each unit of labor and/or capital input. The management of information resources can consume over one-third of an organizations indirect costs. Collecting, manipulating, processing, and analyzing data especially data related to decision support uses significant amounts of often scarce labor and capital, and focuses attention on the use of computers in tight budgetary and highly competitive environments. It is important that professionals recognize and understand computer terminology, methodology, and applications of computer systems in the context of purchasing and supply management operations. A) Common computer hardware/software terminology The purchasing professional must be aware of the most common computer terms and related expressions, in order to work with both hardware and software organizations, and with internal departments to acquire, use, and maintain computer equipment and systems. The following terminology applies to current purchasing and supply management environments. Data the basic facts and figures that are input into the computer. Information results derived from the data that have been processed by the computer into a more useful output that can be used within the organization to make better decisions.

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Module 2 Record a series of related data elements. For example, a record could contain information about a single supplier, such as organization name, address, telephone number, fax number, e-mail address, and primary contact. File a set of related records. For example, a supplier file could contain records with information on each supplier. Digital system a computer system that uses the binary digits (0 and 1) to represent data. Bit the smallest amount of data one binary digit. Byte a group of eight bits; also termed a character.

Computer hardware refers to the physical part of an information system. Hardware provides the means by which a user can access the computer system. Its various components include devices for input, processing, storage, and output. Examples of hardware include computer terminals, networks, scanners, and printers. Input Devices Input devices include keyboards, touch screens, scanners, voice recognition instruments, palm pilots, and readers of magnetically coded tape or disk drives. Some of these devices also can operate as output devices. Central processing unit (CPU) This is the centerpiece of the computer system or, strictly speaking, the computer itself. The CPU is composed of the control unit (which decodes program instructions and directs other components of the computer to perform the task specified in the program instructions); the arithmetic-logic unit (which does multiplication, division, subtraction and addition, and compares the relative magnitude of two pieces of data); and the primary storage unit (which stores program instructions currently being executed, and also stores data while it is being processed by the CPU). Storage This refers to media used for both the short- and long-term storage of data and includes mass storage devices, tape, and disks. Hard or fixed disks provide room for storing large amounts of data. The data can be retrieved quickly, but fixed disks lack mobility. Floppy disks provide an easy, portable way to store data; however, space is limited and they can be damaged or lost. Removable disk cartridges combine the storage capacity of a hard disk and portability of a floppy disk. CD-ROMs are a common way to store programs, and some also have writable capabilities. DVD technology provides enhanced quality and faster retrieval of video images than traditional tape. Diskpacs and magnetic tape are reliable and inexpensive , but are slow because data can only be accessed sequentially. Mass storage devices have very large capacities and have automated access and retrieval capabilities. However, the process of retrieving a tape and copying it to magnetic disk is slow. Output Devices These include magnetic tapes and disks, printers, laser imaging devices, computer output microfiche (COM) cards, voice output devices, and terminals. Some of these devices can also operate as input devices. Modems (modulators/demodulators) These devices convert data into formats for transmission over telephone and cable lines, and then convert the data back 186

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again for computer use. Modem capabilities are expressed in baud rates, which means bytes per second (bps) or the speed at which data can be transmitted. Software is a set of instructions for a particular application or for the performance of a specific task that the computer will execute. It is essentially the perceived or actual capability to mimic human decisionmaking, and the processing of data or information. The major types of software are discussed in a later section. Processing deals with how the computer system sequences its operations between users. Real-Time On-line Processing This system handles transactions as they occur and provides output directly to users. It avoids delay and provides users complete and up-to-date information. Batch Processing In this system data is collected and processed in groups. Batch processing is used for large amounts of data that are processed on a set schedule, such as supplier performance ratings. Distributed Data Processing This refers to a system in which data resources are accessible at many locations. The user has access to data, regardless of his or her location. Data can be stored at several locations that are connected by a data communications network of terminals and computers that interface through phone or cable lines. If a centralized mainframe is used for this type of processing the organization usually will have a central data processing center where documents are sent for data entry and then distributed to user sites.

B)

Standard computer network systems terminology Local Area Networks (LAN) This is an interconnection of a group of personal computers and terminals within a defined area or location, such as a department or office. The server permits sharing of software and information between multiple users. This systems architecture is referred to as a client server system. Wide Area Networks (WAN) These are interconnections of personal computers and/or LANs across a business unit, division, or organization on a worldwide basis. The communication interface is accomplished by use of fiber optic cables, phone lines, or satellites. Some people refer to these as Intranets.

2)

HARDWARE TYPES AND CONFIGURATIONS Recent advances in computer technology have changed the categorization of computer hardware. Applications that 20 years ago required the power of a mainframe computer can now easily be performed on a personal computer. The three traditional classes of computers are: microcomputers (PCs), minicomputers (small-scale), and mainframe (large-scale) computers.

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Personal computers The backbone of most individual and systems computing today. They are run by a powerful microprocessor, which holds the arithmetic, logic, and registers, and controls all functions and calculations. Minicomputers A small-scale system that functions as a multi-user system for several hundred users. Today, midrange computers and servers are more popular terms for minicomputers or mid-sized systems. Mainframe computers Powerful machines that run large-scale applications requiring a large amount of memory and storage capacity. Small, medium, and large-scale mainframes handle from a handful to tens of thousands of online terminals. Large-scale mainframes support multiple gigabytes of main memory and terabytes of disk storage. Large mainframes use smaller computers as front-end processors that connect to the communications networks. Computer workstations The term computer workstation can have many different meanings. It can represent a high-performance, single-user microcomputer or minicomputer that is used for graphics, CAD, CAE, simulation, and scientific applications. It is typically an RISC-based computer that runs under some variation of UNIX. High-end Pentium PCs now compete with workstations in performance. A personal computer in a network is also considered a workstation. In the telecommunications industry the term describes a combined telephone and computer. Finally, a terminal or personal computer can be considered a workstation. Client-server configurations This term is most often used in conjunction with networking. A computer network is a group of physically connected computers (or workstations) that are attached to a file server. Networking allows users to share software and some hardware, thus reducing costs while providing the user with more applications. A network administrator is a user who is assigned to manage all aspects of the network, such as adding new users, assigning security levels, and managing print queues.

B)

C)

D)

E)

3)

SOFTWARE TYPES A) System software A set of programs that control the use of the hardware and software resources by allocating computer system resources to application programs based on their needs or priorities. Examples are MS-DOS, OS/2, MAC-OS, Windows 95, Windows 98, Windows 2000, and Windows NT. Application software A program written for, or by, a user that processes data to produce information needed by users. The three major types of applications software are word processing, database management, and spreadsheets. Network software Software that supports networking capabilities for LANs and WANs. Examples are Windows NT and Novell.

B)

C)

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Enterprise software Popularly termed Enterprise Resource Planning (ERP), this is an integrated information system that serves all departments within an enterprise. ERP is a modular-packaged software program. ERP modules may be able to interface with an organization's own software with varying degrees of effort. Depending on the supplier, some ERP software can be altered by programming. An ERP system can include software for manufacturing, order entry, accounts receivable and payable, general ledger, purchasing, warehousing, transportation, and human resources.

4)

COMPUTER HARDWARE/SOFTWARE USES The computer has become a standard tool for decisionmaking and information dissemination in all organizations. Applications for each type of computer continue to grow in number and scope. The following are general computer applications used in organizations. A) Word processing The creation, modification, and editing of text material in various formats exemplifies the use of word processing by computers. The user can create quality documents, reports, summaries, tables, forms, and graphic presentations. Desktop publishing Desktop publishing is a form of word processing that uses an applications software package to make printed matter more attractive and effective. It combines text and graphics for the production of professional publications, without resorting to more traditional printing methods. Spreadsheets A spreadsheet is a program that permits the management, analysis, and organization of numerical data. Numerical data can also be displayed in graphs and charts for presentations and reports. Database management Database management allows the user to manage data, observations, and events. Analysis is accomplished by aggregating or separating this data into a logical format for specific applications and information requirements. Forecasting/modeling In forecasting and modeling, data and information are secured from previously acquired data processing operations and manipulated by application software for output into reports or displays. Such output is used as a decision support tool for management. Modeling may represent the use of Computer Aided Design (CAD) in its interface with numerically controlled machines, and Computer Aided Manufacturing (CAM) in its control of machine centers and industrial robots. In addition, modeling may take the form of what if analysis in both fiscal and manufacturing applications. What if analysis is also referred to as simulation. Graphics/drawing Graphics are used with the various types of computers to produce illustrations of numerical data for decisionmaking and information dissemination purposes.

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Electronic mail (e-mail) Electronic mail is the transmission of messages over a network. Within an organization, users can send mail to single or multiple users. With multi-tasking workstations, mail can be delivered and its arrival announced while the user is working in an application. Otherwise, mail is sent to a simulated mailbox in the network server or host computer, which must be queried by the user. An e-mail system requires a messaging system, which provides the store and forward capability, and a mail program that provides the user interface with send and receive functions. The Internet transformed e-mail from separate and isolated entities into one global system. Firewall/Security Design and operation of computer and database management systems requires a cooperative effort of both developers and users to ensure the integrity of the systems and the confidentiality of data and information. The three levels of security are: Physical access that limits personal contact with the equipment and stored data. Password access that limits ability to perform transactions or to view information to only those authorized to do so. Internal protection programs designed to maintain system integrity, such as virus protection.

H)

A firewall is software that separates two or more networks from each other and controls the flow of data between the networks. A firewall is normally placed between an internal network and an external network, such as the Internet. Encryption is a security measure that involves the coding of sensitive data that can be decoded by software available only to authorized users. The encryption technology uses a public key system that is covered under digital or electronic signatures. Backup procedures ensure the security of data in the event of system problems, crashes, or viruses. Software manufacturers also provide procedures in their programs to recover lost data. 1.0 Digital Signatures Digital signatures are short units of data bearing mathematical relationships to the data in the document's content. They are transmitted using public key cryptography programs. These programs create a pair of keys (one public key and one private key). What the public key encrypts, only the private key can decrypt; alternatively, what the private key encrypts, only the public key can decrypt. This ensures confidentiality of information, and the digital signature allows the receiver to verify the identity of the sender.

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ELECTRONIC APPLICATIONS IN PURCHASING, MATERIALS AND SUPPLY MANAGEMENT The application of a computer system to purchasing and supply management allows the purchasing professional to concentrate on nonclerical duties and responsibilities. Typical applications include the following: A) Database management systems (DBMS) A software system that creates, accesses, and controls a database. This system is the interface between the programs and the users who need to access the data. The four basic DBMS models are: (1) hierarchical, (2) network, (3) relational, and (4) object-oriented. The hierarchical model is organized like a tree, with the root record at the top. The network model arranges records in one-to-many relationships. The relationship between two specific records is termed a set. Relational databases organize data in two-dimensional tables. Each row is an attribute, such as a specific persons name, and each column is a field (or category), such as name. Object-oriented systems focus on the data, not on the process. The data is then accessed in the form users request through an object library. Typical purchasing files that become part of a DBMS include supplier files, purchase order/requisition files, price files, follow-up/expediting files, delivery/return files, acknowledgments, purchase records, commodity files, and files of contracts. Each organization may use any or all of these data sources to accommodate its records and documentation needs. B) Material Requirements Planning (MRP)/Distribution Requirements Planning (DRP)/Enterprise Resource Planning (ERP) These powerful software programs provide for the management of operations and inventory through purchasing and marketing and operation input (MRP). They also control inventory at distribution centers (DRP). Lastly, they are a tool to provide necessary data required for all functions enterprise wide (ERP) (see Task 304). Electronic data interchange (EDI)/Electronic commerce An area for the application of computers in purchasing is the process known as electronic data interchange (EDI). It has been evolving rapidly in the area of purchasing as well as in the traffic and transportation areas. EDI is the computer-to-computer transfer of documentation and information between organizations. EDI allows data and documentation to be directly processed and acted upon by the receivers. EDI is the inter-corporate electronic transfer of common business forms, such as releases, purchase orders, invoices, and shipping notices. Three major types of EDI systems are: One-to-many In this arrangement the focal point is a single organization that buys from numerous suppliers directly connected to that organization.

C)

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Module 2 Value-added network (VAN) In this system the VAN becomes an electronic warehouse or depository, where transmissions are stored and then transferred to the appropriate party electronically. VANs permit easy purchaser and supplier interactions. Third-party networks Third-party networks permit a purchasers computer to interface with a number of suppliers computers in any format, greatly expanding the choice of suppliers and commodities. Such a network operates as a central communications switch. It receives an organizations purchase orders in a batch, separates them by supplier, holds those for each supplier in an electronic mail box, and then transmits the orders to the suppliers at predetermined times. The suppliers then process the data and ship the purchasers requirements.

The most immediate benefit of EDI is the reduction of paperwork needed to complete transactions. Implementation of EDI results in improved accuracy, reduced clerical work, reduced order-cycle time, and increased productivity. Long-term benefits include reduction of paperwork and freeing up of time, which purchasers can use to conduct other analytical and value-added activities. EDI enhances productivity, making it unnecessary to hire additional personnel. EDI also fosters the development of integrated and improved procurement and supply-chain systems, by encouraging the use of complementary technologies, such as bar coding and Electronic Funds Transfer. Purchasers act as commodity managers and focus on managing a smaller number of suppliers to reduce the total cost of doing business. Standards are fundamental to EDI. Several organizations, notably the American National Standards Institute (ANSI), have produced standards suitable for a wide range of purchasing transactions. The ANSI X12 standards apply to almost any form of purchase order, and to other documents, such as invoices, shipping notices, freight bills, and acknowledgments. See http://www.harbinger.com/resource/X12/ for a listing of the various document standards. The use of ANSI X12 standards has resulted in the rapid growth of EDI. The Institute for Supply Management supports the adoption of the ANSI X12 standards to facilitate organization-to-organization electronic communications. Using this format, documents pass through a chain of intermediaries, with each adding to the information and documentation. For example, such a system could include financial institutions and freight forwarders, who would electronically transfer funds and add documentation at each stage of the transaction. The steps in EDI implementation for most organizations may include the following: Establish a need for EDI. Establish a planning committee. Perform an EDI audit to assess current status, availability of information systems resources, and level of interest of personnel. Consider availability of standards and current practices of trading partners and competitors, and availability of support from third-party networks. 192

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Present a plan of action to top management. Decide on the type of system. Include a decision on types of standards, system configuration, and third-party networks. Suppliers should also be selected at this point. Educate potential internal customers and suppliers. Present final plan and pilot-test schedule to top management for approval. Establish contact with trading partners. Conduct pilot-test of system. Evaluate the system. Expand system on an incremental basis.

Because EDI precludes the use of signed contracts, a separate contract governing the terms and conditions associated with doing business using EDI must be established. In general, such contracts should state that purchase orders will be transmitted electronically, and that the purchasers and suppliers authorize third-party networks to interchange data. The contract should also state the designated locations for scheduled deliveries, and require that functional acknowledgments of transmitted documents be sent. Electronic commerce is similar to EDI in that it involves the computer-to-computer transfer of information. Electronic commerce can be broadly defined as managing and conducting business within a digital information environment. It involves doing business online, typically via the World Wide Web. It has also been termed e-business, e-tailing, and e-commerce. As previously mentioned, it can refer to electronic data interchange (EDI). One of the major advantages that e-commerce has over EDI is its relatively low cost. There are currently two major types of e-commerce systems. They are the sell-side systems and buy-side systems. Each system has its own advantages and disadvantages, which are discussed below. Sell-side systems contain the products or services of one or more suppliers. Registration on sell-side sites is usually free and the supplier guarantees that the site is secure. One advantage to using sell-side sites is easy access to an ever-increasing number of suppliers websites. Another advantage is that they require no investment on the part of the buying organization. Sell-side sites are ideal for purchasers wishing to start ecommerce with little risk. A disadvantage is the difficulty in tracking and controlling spending at these sites. Examples of such sites are www.grainger.com, operated by W.W. Grainger, a large industrial supply distributor. Several versions of buy-side systems exist. They include electronic marketplaces, and third-party and purchaser-designed sites. Electronic marketplaces are designed by third-party organizations that compile the products from many supplier catalogues in one place. These marketplaces allow the purchaser to compare several sources at one site and similar to individual sell-sites require no investment and are secure. 193

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Similar to the sell-side sites, the disadvantage of electronic marketplaces is the tracking and controlling of spending. Examples of these marketplaces include www.echemicals. com and www.metalsite.com. Buy-side systems that are developed specifically for the buying organization require investments in software. These systems are secure (within the organizations firewall) and allow users to source with approved suppliers at negotiated prices. The advantages of such systems include: Ability to leverage buying volume with key suppliers. Quick response to user needs. Reduction in clerical effort. Reduction in administrative expenses associated with placing traditional purchase orders. Allowing purchasers to focus on professional activities. Providing control over purchase expenditures.

The major drawback is the expense of implementing and maintaining the system. Third-party providers develop secure trading sites that allow the buying organization to interface with many suppliers. They license their technology to many buying organizations and have access to several suppliers. Third-party providers reduce the investment needed in private buy-side systems, allow access to multiple suppliers, and allow the purchaser to focus on professional activities. Finally, control is tracked and maintained over purchase expenditures. Internet auction sites allow purchasers to search and bid for components online from the inventory of various manufacturers and distributors. These sites provide generous savings on inventoried items that manufacturers are moving. They require no investment, and offer a marketplace for those manufacturers looking to move inventory. Purchasers realize great savings at these sites, usually on an as-needed basis. D) Electronic funds transfer (EFT) EFT is the transfer of funds electronically from one computer to another. This process saves organizations the processing costs associated with the payment cycle such as invoicing, check generation, mailing, and depositing. Internet/Intranet/Extranet The Internet is the sum total of devices interconnected using the Internet Protocol (IP). The Internet Protocol is an open communication network that allows computers to connect with each other through networks commonly known as the World Wide Web (Web). The pages on the World Wide Web are delivered in hypertext transfer protocol (htp). The creator of the Web was Tim BernersLee, who created the uniform resource locator (URL), which is the way an address is specified on the Web. Berners-Lee also invented the hypertext markup language (HTML), which is used to create Web pages. HTML continues to be supplemented by other languages, including extensible markup language such as XML and Javascript. The first standardized Web browser (Mosaic) simplified the way in which the Internet 194

E)

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is accessed and allowed for the tremendous growth that continues today. A popular Web site for purchasers is www.ism.ws. This site provides a wealth of information about educational opportunities, activities, and resources for purchasing and supply management professionals. An Intranet is an in-house Web that serves the employees of the enterprise. Although Intranet pages may link to the Internet, an Intranet is not a site accessed by the general public. Intranets use the same communication protocols and hypertext links as the Web. They provide a standard way of disseminating information internally and can extend the application worldwide, if the organization elects to do so. A Web for existing customers and suppliers is called an Extranet. It can provide access to supplier design information, current inventories, and internal databases information that is private and not published for everyone. An Extranet uses the public Internet as its transmission system, but requires a password or other mechanism to gain access. F) Decision support systems (DSS)/Negotiation support systems (NSS) DSS systems help users make better business decisions through the analysis of external and internal data. Such systems allow the user to create a model of the critical factors affecting the decision and to pose what if questions by changing the variables. NSS systems are similar, in that they permit the user to simulate potential outcomes based on each partys wants and needs. They also may suggest certain strategies that the purchaser could use in negotiations. Users must remember these support systems are only tools and not a replacement for good judgment and analysis. Electronic file transfer File Transfer Protocol (FTP) is used to transfer files over a network such as the Internet. It includes functions to log onto the network, list directories, and copy files. It can also convert between the ASCII and EBCDIC character codes. FTP operations can be performed by typing commands at a command prompt. FTP transfers can also be initiated from within a Web browser, by entering the URL, preceded by ftp://. Unlike e-mail programs, in which graphics and program files have to be attached, FTP is designed to handle binary files directly, and does not add the overhead of encoding and decoding the data. Performance measurement (e.g., purchasing, supplier) Software programs provide for the compilation and recording of key data to permit the evaluation of supplier performance on quality, delivery, and price. These reports, with improvement suggestions, can be electronically forwarded on a periodic basis to suppliers for their review and response. The system provides for the timely collection of data. Much data about supplier performance that was either too time consuming to capture or too detailed to analyze is now available. Project management These are software programs that provide the ability to plan, estimate, execute and monitor individual projects, such as construction of new facilities or development of new products.

G)

H)

I)

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Analytical applications Purchasing and supply management requires analysis of several important decisions. These include bid analysis; make, buy, or outsource decisions; leasing alternatives; and optimum-order quantities. Transactional uses Computer systems and software programs allow for increased efficiency in processing such items as requests for quotations, material releases, purchase orders and change notices. Cost data management Internal costs and personnel as well as supplier cost data can be collected and compared to indices, such as the Producer Price Index (PPI). Asset management The original book cost of assets (buildings and equipment) can be accounted for, as well as the accumulated depreciation, location, and condition of physical assets. In the event of an emergency, such costs provide invaluable assistance in settling insurance claims. Maintenance management Preventive maintenance schedules can be established, because the computer programs can provide a chronological listing of the machinery history of repair and scheduled maintenance.

K)

L)

M)

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6)

SOFTWARE FOR PURCHASING AND SUPPLY MANAGEMENT A) Off-the-shelf Off-the-shelf software refers to standard versions that are commercially available and require no modification. They are ready to run and install right out of the box. Most personal computer software is off-the-shelf. Most standard applications lend themselves to off-the-shelf software. In-house In-house software is developed by the organizations information systems (IS) department personnel in situations where internal customers require software applications that are unique and no suitable off-the-shelf software exists. Outsourced This involves contracting with a software supplier or third party to develop a software package. If the organization lacks the in-house capabilities, expertise, or time, outsourcing provides an attractive alternative. Correctly outsourcing software development requires consideration of a range of alternatives from having the supplier modify an existing package, to having a third party completely develop a new system.

B)

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7)

HARDWARE/SOFTWARE TRAINING Ultimately, the success of any computer system depends on the skills of the people who operate and use it. Purchasing personnel should be familiar with the various applications of computer technology, its terminology, and its theory. Training should be focused on the use of both hardware and software in specific execution of the purchasing and supply management function. Because the computer is a tool for decisionmaking and information dissemination, purchasing professionals must recognize the need to integrate this tool into their daily routines to assist in 196

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meeting their individual responsibilities. Training may be available from both internal and external sources, and management can decide the appropriate use of these sources based on fiscal, time, and policy/procedural constraints (see Task 412 for a discussion of training purchasing and supply management personnel). A) In-house The development and conducting of in-house training for a software package or new hardware is usually a joint project involving purchasing and the IS department. Such joint development for training is particularly common when the software is developed specifically for a purchasing application. Outsourced It is common to outsource training in cases where the software is purchased or modified, because the software provider is an expert on the system and has knowledgeable staff available to perform the training. During the negotiation phase of the software acquisition process it is common to request training as part of the package. In some cases suppliers will offer a set amount of free training. In other cases the extent and cost of training is negotiable.

B)

8)

IMPACT OF COMPUTER SYSTEMS A) Within the department Computers have a multitude of uses in purchasing operations. They can be used to create and maintain a supplier database, including supplier categorization, sourcing evaluation, and the storage of supplier performance history. They can be used for the maintenance of product specifications, including design and performance criteria evaluation and measurement, and to generate and maintain orderrelated information, such as the status of open orders. They can be used for requisition, purchase order, and contract processing; for follow-up and expediting; for controlling acknowledgments; and for prioritizing and scheduling. Computers can also be used in the administration of a standardization program; for monitoring costs and benefits; and for analyzing price and cost data, life-cycle costing, and lease-or-buy decisions. They can also provide a sophisticated decision support system for management, and can be used for bid, make or buy, and what if analysis. They can be used to generate management reports, and to establish management-related databases for supplier and departmental performance evaluation. When purchasing and supply management has responsibility or is within a logistics or materials management organization, computer systems provide other benefits. The logistics function uses information technology to help control the inventory of finished products at its various warehouses and distribution centers on a global basis. This system, called Distribution Requirements Planning (DRP), has been discussed earlier. Order processing, transportation planning and scheduling, document processing, and freight bill payment are other uses of information technology in logistics. Computers can be used for many aspects of inventory management. Among them are ABC categorization, inventory classification, JIT applications, and the maintenance 197

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of a surplus or reclamation program. Other uses include the computation of balanceon-hand, order quantities, and when to order. They can automatically generate stock requisitions, and can maintain master files of items and bills-of-material. They are required in order to use MRP, MRP II, and ERP systems (see Task 304 for a discussion of inventory management). B) Within the organization Computers are used by all other departments within the organization. Two of the departments that work extensively with the purchasing function are receiving and accounts payable. Computers can be used in the maintenance of receiving and traffic information, such as material receipts, material disposition and routing, and material returns. Accounts payable was one of the first functions to be automated. Today there is a close link between accounts payables and purchasing systems, with several organizations extending this to electronic transfer of funds to suppliers. External ( e.g., suppliers) Advances in technology permit the linkages of the supply chain, and permit a greater coordination of the physical and process flow from the original supplier to the final customer. A number of software companies provide supply chain management software that permits the coordination of these activities to permit more efficient, effective operations. As previously discussed, electronic commerce and EDI provide a platform from which to place orders and pay suppliers. Drawings, specifications, and information can flow freely and efficiently between the buying and selling organizations requiring a significant level of trust in the purchaser-supplier relationship.

C)

BIBLIOGRAPHY Caffrey, B., D.A. Steggell, and R.G. Weissman. Electronic Commerce: Your Tool to Value-Added Purchasing and Supply Management, NAPM InfoEdge, (3:6), February 1998. Hofacker, C.F. Internet Marketing, Digital Springs Publishing, Digital Springs, TX, 1999, p. 164. Parker, J.T. Understanding Electronic Commerce, NAPM InfoEdge, (2:6), February 1997. Raedels, A. and L. Buddress. How to Use the Internet and Other Online Services, NAPM InfoEdge, (1:5), November 1995. Shelley, G., T. Cashman, and H. Rosenblatt. Systems Analysis and Design, Course Technology, Cambridge, MA, 1998.

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TASK 206: Resolve quality problems with suppliers and user departments.
1) DOCUMENTATION OF CORRECTIVE ACTION PROCESS The corrective-action process needs to be documented for both the purchaser's and the supplier's benefit. The process notifies suppliers of nonconformance, documents corrective action, and ensures a permanent solution. A typical process may include the following steps: Phase 1: Resolve the problem at hand. The first phase of the corrective-action process is to deal with disposition of the nonconforming goods and services - Step 1: Clarify nonconformance Clearly identify the problem and the relevant specifications or Statements of Work to which the goods or services do not conform. Prepare a written report, including photographs and diagrams. Digital cameras are an excellent tool for documenting problems, as the pictures can be e-mailed to the supplier. - Step 2: Contact supplier Contact the supplier verbally, if necessary, and follow up with a written report that carefully and completely describes the problem(s). The supplier has the right under the UCC to inspect the nonconforming goods and make arrangements to repair or replace the offending items (see Task 117). Because services are not covered by the UCC, the purchaser will need to ensure the Statement of Work has terms to cover the situations covered by the UCC. If the supplier chooses to have the purchasing organization resolve the problem, written supplier approval should be obtained. It may be desirable for the suppliers representative to inspect the defect and approve the cost of problem resolution. - Step 3: Obtain supplier completion date If the supplier elects to correct the problem, obtain a written estimate of the completion date. Phase 2: Establish a date for a report from the supplier documenting the cause of the nonconformance and what corrective actions are being undertaken to prevent the problem from happening again. Phase 3: Document that the corrective actions have been completed and the results obtained.

The goal of a corrective-action process is to implement appropriate and effective changes thereby eliminating the cause of the problem (see also Task 405). 2) ROOT CAUSE ANALYSIS The root cause is the fundamental, underlying reason for a problem. Correcting symptoms is simply putting a bandage on the problem. By attacking the root cause, the purchaser prevents the problem from recurring. Root-cause analysis is like peeling an onion one layer at a time to reach the core. As with the onion, the process is often accompanied with much shedding of tears. Often, identifying root causes will lead to management policies or systems design improvements. Solving a root cause will often correct other problems, as well.

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Root-cause analysis provides a logical method for validating cause-and-effect relationships. In root-cause analysis, the purchaser: Gathers relevant data. Identifies the internal causes that have allowed the problem. Analyzes the comparative benefits and cost effectiveness of all available prevention options.

Several quality tools can help identify root causes. Tools include box plots, check sheets, control charts, histograms, cause-and-effect diagrams, the five whys, and Pareto charts. The key to identifying root causes is to collect data about the exact operation of the process under examination. Data is then used to identify possible problem causes for further analysis. Once the root cause has been identified, solutions are developed and implemented (see Task 207 for a discussion of quality tools). 3) CORRECTIVE ACTION ALTERNATIVES AND OPTIONS Several options are available to the purchaser for handling nonconforming goods or services. A) Return to supplier The nonconforming goods may be designated for return to the supplier. The purchaser is required to provide adequate protection for the goods until the supplier can make arrangements for the return of the nonconforming items. The supplier may repair the goods or supply new material. Typically, the transportation costs will be paid by the supplier. In the case of services, the purchaser cannot return the service. The options are to negotiate a discount on the performed service, or to have the supplier perform the service again. Rework of documentation If the nonconformance is simply a documentation discrepancy, it may be possible for the supplier to issue correct documentation without having to replace the goods. Rework of parts and materials The supplier may elect to have the purchaser rework the nonconforming goods and either bill the supplier for the cost of repairs or credit the purchasers account for the cost of the rework. This may provide a quicker solution than having the goods or service reworked by the supplier, but this solution must be approved by the supplier in advance. Renegotiation The purchaser may choose to renegotiate the terms of the agreement, including payment terms, delivery quantities, or nonconformance procedures. For example, the nonconforming goods may be accepted at a lower price. When a service is determined to be nonconforming, it is common to identify specific actions that must be undertaken so that the final service outcome is acceptable to the purchasing organization. Disposal If the nonconforming goods are not salvageable, arrangements must be made for their disposal. The supplier is responsible for making such arrangements, 200

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Tasks 206

but the purchaser must provide appropriate precautions for the care of the material (see also Task 117). F) Retraining Sometimes nonconforming goods or services result from improper or inadequate training of supplier personnel or others in the supply chain. Retraining to ensure that proper processes or procedures are implemented can reduce or eliminate future problems.

Some corrective action options have been delineated above. The purchaser may return the goods to the supplier in which case the supplier may rework the goods and return them, replace the goods, or credit the purchasers account. The supplier may rework the goods onsite or at the suppliers own facility, or may have a third party rework the goods. Disposal of the rejected material is the suppliers responsibility. It may also be necessary to review internal policy and process procedures. For example, has some change within the organization been overlooked change in personnel, engineering specifications, or design change processes)? It may also be prudent to consider more far-reaching corrective action options. Is it time to find a new supplier? Should the purchasing organization implement a supplier training program? Should management create a program to influence quality at the third-tier supplier level? BIBLIOGRAPHY Fabian, L. When the Goods Aren't Good Enough, NAPM Insights, August 1995, pp. 12-13. Tague, N.R. The Quality Toolbox, ASQC Quality Press, Milwaukee, WI, 1995.

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TASK 207: Develop measurements for quality improvement and target setting (e.g., best in class benchmarks).
Although others in the organization directly determine the quality of the goods or services purchased, those in purchasing need a conversant understanding of what quality is, and how it can be achieved, in order to work with suppliers to make sure it is achieved. 1) QUALITY ASSURANCE A) Definition of quality The definition of quality has two components: What the item or service must look like or do (i.e., specifications). A frequency measure of how often it must conform to the specifications (for example, parts-per-million).

Specifications and Statements of Work are usually determined by the internal customers or by the technical staff of the organization (such as engineering). Often specifications or Statements of Work are created by a team of people, including internal customers, purchasing, engineering, and marketing. B) Acceptance testing This includes all tests for compliance to specifications or Statements of Work that create the basis for acceptance of the goods and services. Acceptance tests are especially critical for capital equipment to ensure that equipment is not accepted until it is performing to a predetermined level of quality for a specified period of time. Certification requirements Organizations may create quality standards which, when achieved, become the basis for the supplier to be certified, thereby qualifying for reduction or elimination of incoming inspections. These standards usually include definitions of how the measurements are made and the minimum level of quality that will no longer require inspection. To become certified, suppliers review their measurement system with the buying organization to ensure that the measurements are correlated and to provide documentation that the minimum certifiable quality levels have been achieved. Under the UCC, after a reasonable opportunity to inspect the goods, purchasers become responsible for all defects that incoming inspections should have uncovered, even if no inspection took place. Documenting the certification arrangements with suppliers (and defining the liability for quality problems discovered later) can avert potential problems. Make sure both parties sign the documented agreement. D) Levels of inspection Inspections may occur at many places and may have many levels of thoroughness. Location of inspections may be at:

C)

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Module 2 The suppliers plant, in-process, as the goods are made or as a service is produced. The suppliers plant, at inspection stations. The suppliers plant, at final inspection before shipment or at end of service. The purchasers plant, at incoming inspection. The purchasers plant, in-process, as suppliers materials are used. The purchasers plant, at final inspection before shipment.

The earlier inspections occur, the more likely the problems will be corrected. Suppliers who use process controls and inspect as materials are made (and who correct problems immediately) are the least likely to ship a defective product. The levels of thoroughness of inspections include: No inspection at all. Occasional audits or random inspections (for example, for certified suppliers). Routine sample inspection. One-hundred percent inspections ( such as automated testing).

Thoroughness early in the process can eliminate or drastically reduce the need for inspection later in the process (see Task 117 for a discussion of inspection rights). E) Quality documentation The results of inspections (anywhere in the process) should be documented in a format that is easily understandable by both the purchaser and the seller. If inspections take place at the purchasers facility, then the data will become the basis of the suppliers quality measurement and should be fed back to the supplier on a regular basis. If inspections take place at the suppliers facility, then the supplier can provide that data to the purchaser as proof of quality. Quality system modules Systems for ensuring quality include: 1.0 ISO-9000 ISO-9000 is a series of standards promulgated by the International Organization for Standardization (ISO). These standards are focused on measuring quality assurance. Quality registration aspects ISO-900X certification means that the organization has been examined by a qualified ISO registrar and the organization meets the standards. Focus The focus of ISO-9000 includes two main thrusts: To document the procedures of the organization involved in processes that affect quality. To perform actual operations in compliance with the documented procedures. 204

F)

1.1

1.2

Part C: Quality Issues 1.3

Task 207

Levels of approval (9001, 9002, 9003) There are levels at which an organization can be certified: ISO-9000 is not a certification. It is a description document for the standards series. ISO-9001 is the most extensive certification. It includes all the following processes: research, design, production, shipping, installation, and service. ISO-9002 includes only the processes of production and installation. ISO-9003 includes only the processes of warehousing and distribution. ISO-9004 is not a certification. It is a guidance and definitions document.

2.0

Other systems There are many systems for obtaining quality. One of the more valuable systems is Statistical Process Control (SPC), discussed later in this task. Inspectionbased systems include statistical sampling, certificates of compliance, and certificates of analysis. Ship-to-stock is a waiver of inspection.

2)

TOTAL QUALITY MANAGEMENT A) Definition Total Quality Management (TQM) is a management approach to long-term success through customer satisfaction. TQM is based on the participation of all members of an organization in improving processes, goods, services, and the culture in which they work. TQM is composed of a philosophy and its supporting techniques. The philosophy of TQM includes focus on the customer; continuous striving for improvement; a willingness to suspend judgment and really look at what is happening; and a willingness to work from data rather, than opinion. Meeting customer needs TQM places emphasis not only on meeting the customers needs, but going beyond those expectations to provide more than the customer expects. Quality tools 1.0 Team training Many of the tools of TQM are designed to be used by a group of people involved in a process. A core competency is the ability of all members to work as a team. Implementation of TQM almost always includes training in teamwork skills (see Task 209 for a discussion of team concepts). Benchmarking A benchmark is a standard, or point of reference, used in measuring or judging such things as quality, performance, value, and price. In purchasing and supply management, benchmarking usually takes the form of a comparison of a product or a portion of the operations to the best that is available. The results show how the purchasers product or process compares to the best. The differences can become targets for improvement.

B) C)

2.0

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Task 207 3.0

Module 2 Kaizen Kaizen is the Japanese term for continuous improvement the understanding that process (therefore product) quality can get better as the result of numerous small improvements made continuously over time. When continuous improvement has been practiced in an organization for a period of time it also changes the culture and becomes a self-sustaining habit. Statistical tools 1.0 Pareto charts A Pareto chart is a graph showing the frequency with which events occur, arranged in order of descending frequency. It is used to rank the issues so that resources can be applied first to those with the largest potential return. Cpk Process capability (Cpk) is the comparison of the output of a process (with all its variation) to the specifications. If the output of the process falls within the specifications exactly, then Cpk = 1. If the output of the process contains more variation than the specifications allow, then Cpk < 1; if the output of the process is more tightly controlled than the specifications demand, then Cpk > 1. Knowing the process capability of suppliers is one of the most critical issues in determining their product quality in the future. Cause-and-effect diagrams Cause-and-effect diagrams (also called Ishikawa or Fishbone diagrams) capture all the possible causes of a problem in a format designed to show their relationships to the problem (the effect) and to each other. Tolerance stack-up/Upper and lower control limits When many individual items fit together to make a final product, the variations from each of the individual items are added together. By random chance, some individual variations may cancel each other while others may amplify, increasing the probability that the final product will not work as expected. An alternate term is variation stack-up. Upper and lower control limits define the normal range of variation of the item being produced. They are defined as three standard deviations above or below the process mean. If a process is in control, items produced should fall somewhere between the upper and lower control limits. 5.0 Six-Sigma Six-sigma is a high-level quality target. It is also the name given to a quality approach that seeks minimum possible variation. Sigma is the Greek letter used to signify the standard deviation, a statistical measure of variation. Three-sigma has long been used to calculate the upper and lower limits of a process. It encompasses 99.97 percent of all occurrences. Six-sigma compares to three-sigma as follows:

D)

2.0

3.0

4.0

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Part C: Quality Issues 3-sigma: 6-sigma: 6.0 Cpk = 1 Cpk = 1.5

Task 207 or 2,700 defects per million opportunities or 3.4 defects per million opportunities

Statistical Process Control (SPC) Statistical process control is a technique that uses statistical control charts in measuring and analyzing the variation in processes. The methodology monitors the process to determine whether outside influences are causing the process to go out of control. The objective is to identify and correct such influences before defective products are produced, and thus keep the process in control. SPC is a quality management system that focuses on understanding and control of processes. If the process is tightly controlled, then its output (products) will be within allowable tolerance. SPCs primary activities are directed toward: Defining the process (using tools such as data collection, histograms, run charts, and process capability). Reduction of variation (using tools such as cause-and-effect diagrams, Pareto charts, brainstorming, and team-based problem-solving).

3)

QUALITY FUNCTION DEPLOYMENT A) Definition Quality Function Deployment (QFD) is a system designed to ensure that the product or service delivered to the customer meets or exceeds all of a customers major requirements. QFD works to eliminate the gap between what the customer wants from the product and what the product is capable of delivering. It does this with a set of communication and translation tools designed to: Obtain a thorough understanding of what the customer wants. Compare existing product features to the customers wants. Features the customer does not care about can become candidates for elimination. Features that the customer wants can be added.

BIBLIOGRAPHY Buddress, L. and A.R. Raedels. Benchmarking and Purchasing, Proceedings of the 1994 NAPM International Purchasing Conference, NAPM, Tempe, AZ, 1994, pp. 33-35. Trent, R.J. and R.M. Monczka. Achieving Competitive Advantage Through Supplier Quality Management, Proceedings of the 1999 NAPM International Purchasing Conference, NAPM. Tempe, AZ, 1999, pp. 1-6.

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TASK 208: Develop/manage/evaluate relationships with other internal departments.

Purchasing department effectiveness and efficiency is critical to successful long-term relationships with internal customers. Proactive development, management, and evaluation of relationships with internal departments are key responsibilities of purchasing and supply management professionals. Due to the complexity and number of internal linkages affecting the interaction between the purchasing department and other parts of the organization there are many opportunities to miscommunicate, misperceive, or misconstrue information and communications. In addition, barriers may exist that negatively affect the interaction of purchasing with internal customers. Roadblocks tend to be structural, functional, organizational, or individual in nature and scope. Developing processes and guidelines, establishing subsequent objectives, and implementing ways to measure the good and bad in each primary relationship will ensure that purchasing professionals focus on this important task. It is equally important to give internal customers the clear message that purchasing values each relationship. Relationship building requires two-way communication, and the development of mutual respect and trust. It implies participation by all parties, and has a permanent place as a part of each professionals job responsibilities. 1) BASIC FUNCTIONS PERFORMED BY OTHER KEY DEPARTMENTS IN AN ORGANIZATION AND THEIR RELATION TO PURCHASING The purchasing and supply management function is a subset of an integrative, cohesive whole with considerable interdependencies. Supply management effectiveness is, in part, a function of the quality of its exchanges and relationships with internal partners. Because internal partners share similar opportunities and risks, purchasing and supply management should maximize its involvement with relevant subgroups within the organization. The nature, character, and tone of these interactions vary, based on the situation, resources required, and impending internal and external mandates. Regardless of the particular circumstances, purchasing is quite often integrally woven into the fabric of the organization. Some of these internal interfaces are highlighted below. A) Top management Increasingly, purchasing is being spotlighted by key executives because of the latent value-adding potential of this critical function. More and more often, senior management acknowledges that purchasing savings contribute directly to profitability in the for-profit world, and to a reduction in spending in the non-profit and public sectors. Thus, purchasers must relate to top management in a way that maximizes opportunities to heighten purchasings visibility and to sustain its influence. Engineering/Design Purchasing plays a pivotal role in facilitating the conception, design, and development of new products and services. Given the frequency and criticality of interactions with engineering, it is essential to maintain good relations.

B)

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Module 2 In purchasings efforts to achieve greater efficiency through improved product design and value analysis, involvement with engineering is essential for success. Relationships with the design function are particularly critical in organizations that practice the Early Purchasing Involvement (EPI) and Early Supplier Involvement (ESI) concepts (see Task 314). In these organizations, new product design involves purchasing and selected suppliers early in the process. The objective is to coordinate design requirements with supplier manufacturing and supply capabilities to improve both efficiency and quality in the purchased product or component.

C)

Quality control/Quality assurance Given the organizational commitment to continuous improvement, purchasing is expected to work collaboratively with quality assurance to develop, implement, and assess the necessary systems and processes required to add the greatest value to the enterprise. Increasingly, purchasing must work with quality assurance in managing the large numbers of outsourced areas. Quality has both internal and external dimensions, and the role of purchasing is critical to both. Operations/Manufacturing/Production Purchasing and operations are partners in balancing the conflicting materials challenges posed by various functions. On one hand, sufficient material quantities are required to satisfy production requirements; on the other hand, management wants to commit as little money as possible to inventory. This balancing act proves treacherous during periods of dynamic demand. In a manufacturing environment, the absence of material presents major challenges and tremendous opportunity costs, including layoffs and downtime. One of purchasings primary responsibilities is to prevent such occurrences. Proper coordination between operations and purchasing is a prerequisite to enterprise effectiveness.

D)

E)

Accounting/Finance Supply managers depend on accounting and finance to pay the bills and to provide the cost data required to assess the supply system's performance. Accurate and timely responses from the financial areas allow for enhanced purchasing effectiveness. Evidence of the necessity for close working relationships can be found in different areas. These include negotiation of long-term contracts, purchase of capital equipment, various leasing and pricing arrangements, and development of t total-cost-of-ownership models. Finance welcomes reports from purchasing on outstanding commitments, cash-discount policies, and the setting of standard costs for production.

F)

Marketing/Sales Timely information exchange between these functions is important. Marketers reflect the voice of the marketplace. Thus, forecast data is provided to purchasing in order to adjust materials purchases and to plan for special contingencies. As purchasers buy more effectively, marketing can sell more competitively.

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Part D: Internal Relationships G)

Task 208

Facilities Effective use of finite space is an ever-growing concern. Effective communication between stores and purchasing can determine adequate stocking levels for every item used on a regular basis, and can ensure that there is space to store incoming orders. Logistics/Supply chain In some organizations purchasing and transportation must coordinate the logistics of moving materials through the supply chain from suppliers, and to a lesser extent finished goods to supply chain intermediaries and final consumers. Purchasing communicates to the transportation department specific plans that affect such things as transportation mode, timing, and special requirements. Additionally, purchasing functions in a similar capacity by providing information useful in buying transportation services for finished goods. Product/Business managers Many organizations use the product manager concept to manage a family of products. Purchasing needs to have strong relationships with these individuals to ensure the availability of materials to support product promotions and the market in general. Management information systems Because information is the heartbeat of the organization, purchasing is highly dependent on this function (management information systems or information technology) for support in designing and implementing systems that facilitate every aspect of the procurement process, from beginning to end. The system should integrate all relevant information from internal and external (other supply chain members) partners, and take into account external influences on purchasing decisions (economic, competitive, legal, global variables). Information systems must provide support, maintenance, and upgrading of technology to meet the needs of purchasing. In turn, purchasing should be exact in specifying its information needs. Legal In an increasingly litigious corporate environment, concerns about legal aspects of supply management have escalated. Purchasers need basic knowledge of key legal areas, including contracts, liability, antitrust, and the legal system in general. Purchasers should know enough to avoid the legal pitfalls that may beset the purchasing process. An honest and open line of communication should exist between purchasing and the legal area. Public relations/Public affairs Purchasing can be useful to public relations in the areas of supplier evaluation and selection to provide and support public relations services and activities. Also, because of purchasings constant contact with the marketplace, purchasing can provide information on attitudes and issues that may be of value to public relations. Merchandising In a retail- or distribution-oriented organization, purchasing interfaces with merchandising to reflect the demands of the marketplace. This may include adjusting to the seasonal and cyclical requirements of end users.

H)

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Module 2 Production/Service planning This is a critical relationship for purchasing because the production-planning function determines the future production plans, thereby determining what needs to be purchased and when it needs to be delivered. Research and Development Purchasing can support the research and development agenda by early involvement in the process. Purchasings expertise in supplier evaluation, competition, market trends, and important external factors makes it an indispensable partner. Product development Involvement in the product development and design process through Early Purchasing Involvement (EPI) and Early Supplier Involvement (ESI) can ensure the availability of materials and components, as well as determine the costs of materials. Field service Communication between purchasing and the field can serve to identify what components are failing and can help provide feedback to suppliers. Other information and observations from field sources can provide a reality check on processes and procedures, and on other matters affecting the ability to meet customer needs. Maintenance Knowledge of planned shutdowns and overhauls enables purchasing to have the necessary parts and materials available.

O)

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R)

2)

INTERDEPARTMENTAL COMMUNICATION Communication is the underlying key to successful interfunctional relationships. By its very nature supply management has to be an interdependent function, achieving its goals through others in the organization. More than ever before, purchasing professionals are required to interface with a wider array of organizational members. Effective communication across groups is a major prerequisite for effective interactions. In fact, some have suggested a marketing approach to viewing internal partners. Each function should be viewed as a market segment with distinct needs and preferences. By designing a specific interaction mode for key categories of partners, supply management can more adroitly address the concerns of each segment. This approach forces supply management to target the appropriate resources and approaches to respective partners. The quality and nature of the interaction that purchasing has with other areas is, in part, shaped by the following: A) Mechanisms To the extent that supply management forges strong and substantive relationships with various functions, more positive outcomes are likely to ensue. Each function is dependent on the others, to varying degrees, to accomplish end results. Approaching each partner in a non-adversarial, non-accusatory manner is a fundamental prerequisite for maintaining mutually beneficial relationships over a sustained period. The critical question becomes, How can supply management achieve its goals and those of other partners within the context of enterprise goals? Each interaction should be viewed from the perspective of the macro view (the big picture) rather than the micro view (the immediate issue). Additional mechanisms for facilitating 212

Part D: Internal Relationships

Task 208

interdepartmental communication include use of newsletters, regular meetings with internal customers to discuss sourcing strategies, early purchasing involvement, and customer surveys. B) Role/Perception of purchasing within the organization The overall perception of the supply management function in the organization is critical in crafting solutions to a myriad of problems. If the purchasing group is viewed as weak, tradition-bound, rules-enforcing, procedurally-driven, and hopelessly mired in minutia, it will diminish purchasings overall effectiveness and stature within the organization. Conversely, if purchasing is viewed as progressive, innovative, entrepreneurial, and carefully focused on broader, organizational goals, then others will perceive the purchasing function differently and will be more likely to work with purchasing from a posture of respect and appreciation. The purchasing function has as much authority as the organization allows. Other organizational partners must recognize and understand the overall supply management strategy and how it connects with their respective business strategies before they can accept the proper exercise of purchasings functional authority. C) Establishment of trust and credibility It is important for purchasing to Purchasing must establish rapport and productive dialogue with internal customers. Once internal customers believe that purchasing can contribute to their success and profitability, support and cooperation should be more forthcoming. There must be a sharing of common values, motivations, and goals. User areas must be won over by purchasing in an evolutionary fashion. Both trust and credibility are earned over time and must be reinforced regularly. Every aspect of the purchasing function should exude trust, genuineness, and a spirit of teamwork and helpfulness. This includes personnel, processes, policies, and procedures. True purchasing professionalism is embodied in the concepts of trust and credibility. Early Purchasing Involvement (EPI) To ensure maximum effectiveness of purchasing acumen, the function has to be involved in most key decision areas early enough to make a difference. This is especially true in engineering, design, and new product development. If given the appropriate skills and resources, purchasing can better understand the needs, plans, and behaviors of clients. These talents can be used to identify problems, alternative solutions, and various plans of implementation. Others can benefit from what supply managers know only if the timing of the involvement is mutually advantageous. Internal customer surveys The quality of internal relationships is directly commensurate with the caliber of information exchanged among functions. Information about each internal partner facilitates a stronger marketing orientation because the needs are understood better. Information may be collected by internal surveys, personal interviews, focus groups, e-mail interviews, video-conferencing, and telephone conversations. Secondary data may be gleaned from internal records and various databases. Regardless of the type of information exchange, purchasers realize that 213

D)

E)

Task 208

Module 2 without consistent, reliable data, decisions may be haphazard and may not truly reflect the dynamic circumstances affecting relationships at all levels in the organization. The solicitation and use of feedback by purchasing can be an effective tool in value creation on behalf of the organization.

BIBLIOGRAPHY Fernandez, R.R. Relationeering The Key to Successful Organizations, Proceedings of the 1998 NAPM International Purchasing Conference, NAPM, Tempe, AZ, 1998, pp. 227-282. Kaye, S. The Human Side of Communication, Proceedings of the 1999 NAPM International Purchasing Conference, NAPM, Tempe, AZ, 1999, pp. 161-165. Pfau, G.S. Enhancing Your Leadership and Career, NAPM Insights, September 1993, pp. 12-13. Williams, A.J. and K. Dukes. Barriers to Customer-Friendly Behavior in Purchasing Organizations, Proceedings of the 1998 NAPM International Purchasing Conference, NAPM, Tempe, AZ, 1998, pp. 28-31.

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TASK 209: Participate in cross-functional and/or multifunctional teams (e.g., project management, process improvement).
Cross-functional teams are groups of people from various organizational functions brought together to achieve clear, worthwhile, and compelling goals that cannot be reached without a team. Teaming leverages organizational resources, while using the expertise of team members. Purchasers typically participate on teams dealing with sourcing, commodities, quality, and/or product/service development. 1) PURPOSE OF CROSS-FUNCTIONAL TEAMS Cross-functional teams are dynamic mechanisms to achieve clear, worthwhile, and compelling goals that demand joint and diverse input for success. Teaming leverages an organization's resources and takes advantage of internal expertise. 2) TYPES OF TEAMS RELATED TO PURCHASING A) Cost reduction The focus of cost reduction teams is to find ways to lower product or service cost through interaction with product design, suppliers, marketing, and production (see also Task 310). Value analysis The purpose of a value-analysis team is to maintain the function of an item while lowering its cost, or to increase the functionality of the item while maintaining its cost. Purchasing often plays the lead role in this activity, along with engineering, quality, production, suppliers, and marketing (see also Task 310). Capital equipment Capital equipment Capital-equipment teams usually consist of representatives from purchasing, engineering, and operations. Their objective is to identify equipment that meets the requirements, and possibly to negotiate price and delivery terms with the supplier. Sourcing Sourcing teams may be used to evaluate potential suppliers. They are usually led by purchasing and include representatives from engineering, finance, quality, and operations. Product development Purchasing normally plays a key support role in product development, assisting engineering and marketing. Budgeting Purchasing may provide input into the budgeting process, especially as it relates to near future material and service price changes. Supply development As technology forces changes in products and services, purchasing must be involved in developing new suppliers to provide necessary technology and services. Other participants in supply development may include engineering, quality, and operations.

B)

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E) F) G)

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Module 2 Information systems Purchasing should be involved in information systems selection and development, both as a user and as a purchaser of the systems. Finance Purchasing's unique skills in supplier evaluation, and in understanding the marketplace, may be very useful to the organization's finance area, in evaluation of potential mergers or acquisitions. Cycle-time reduction The supply process is a major component of cycle-time, both in terms of production and new product introduction. Purchasing should be looking for ways to reduce its internal cycle-times as well as supplier leadtimes. An area of application is reducing time-to-market for new product introduction. Quality improvement Given the large percentage of sales dollars spent by purchasing for materials and services, it is vitally important that purchasing be involved with quality, engineering, and operations to ensure and improve the organization's product and service quality. Inventory control Purchasing needs to be involved with marketing, production planning, and operations in ensuring that the right materials are available at the right times. A team can be used to find ways to reduce inventory. Other As the importance of purchasing and supply management becomes recognized within the organization, purchasing professionals will find the demand for their skills and expertise growing within the organization.

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3)

ROLE OF PURCHASING IN TEAMS Given the wide array of skills possessed by purchasing professionals, the range of their team participation can include sourcing, commodity, quality, and new product development teams. The exact nature of purchasings input will vary depending upon the teams charter. For example, purchasing usually plays a leadership role on sourcing teams, while its role may be that of team member in other situations. Regardless of role, purchasing is responsible for sharing its market and financial expertise to complement the talents of other team participants. Specific roles of purchasing might include the following: A) Support/service/information In teams involved with areas such as cost reduction, value analysis, capital equipment, product development, budgeting, and inventory control, purchasings primary responsibility will be to provide information about sources of supply, product availability, and supply market conditions. Project management Purchasing may have responsibility for managing the entire project in areas such as supplier development, sourcing, and cost reduction/value analysis. Leadership As purchasing is recognized as being strategic, it will be expected to take more of a leadership role in finding ways to make the organization more 216

B)

C)

Part D: Internal Relationships

Task 209

competitive through cycle time reduction, supply chain management, and quality improvement. D) Facilitation At all times purchasing professionals should work to facilitate and improve the performance of any teams with which they are involved.

4)

ADVANTAGES/DISADVANTAGES OF TEAMS Teamwork has the advantage of bringing together the major functions of an organization that have a vested interest in the team's goals. Talents and expertise are combined resulting in increased quality, reduced costs, and optimized organizational objectives. The team mechanism ensures some degree of input equity regarding the challenge confronting the group. Byproducts of input equity are reduced interfunctional friction, shared ownership, and a stronger sense of unity of purpose. Organizational cultures must adjust to allow for the energy and dynamics of high-performance, self-managing, progressive teams. A stodgy and traditional culture is not likely to allow teams the independence and autonomy required to really grapple with key issues. Some teams have a more or less permanent place in the organization and others are more ad hoc. Successful teams require a defined purpose and time frame, complementary team members (in such areas as personalities and skills), a leader, and specific outcome measures. If these ingredients are missing, expect lackluster performance from teams. Other issues affecting team management and performance are discussed below. A) Consensus building Diversity of thoughts, motivations, and expectations represent some of the usual inputs in any team endeavor. However, clear thinking must be directed toward achieving consensus, and methods of determining consensus must be addressed and agreed upon by participants. It is important to make these decisions early in the group deliberation process. Time considerations Time factors influence the fervor with which some team efforts are embraced. If there is a strong sense of immediacy, the team may approach its work in a very different manner than if governed by other time considerations. Understanding time matters influences the team management process. Ownership issues Even within the context of a group, people want recognition for their contributions. The group should determine how it will function and should decide if identification of ideas or approaches will be presented as individual team member contributions or as group contributions. It is important to consider the risks and benefits associated with alternative approaches to ownership. For example, will team member participation be greater if they know individual contributions will be carefully noted? Or, are team members likely to sit back if the contribution is only from the group? Because there are no clear-cut answers about ownership, the nature and context of the team's charge may provide some indication concerning the appropriate action.

B)

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Module 2 Managing or introducing change Teams can be an effective instrument in introducing and managing change. Decisions that involve cross-functional relationships and activities can benefit from the use of teams. Because the team has representation from all the key areas, there is a built-in advocate for change in each of the affected functions. This helps spread ownership throughout the organization, helping to reduce resistance to change. Cross-functional teams can provide communication and education throughout the organization about the need for change, the process of change, and the effects of change. Team spirit, along with a common vision, can serve to remind others who want to pursue change that they are not alone. Groupthink Teams functioning over an extended time period begin to think in similar ways and have a tendency to make the same assumptions about problems and situations. It is especially important for members to maintain some degree of conceptual autonomy, but still function in a way that will deliver the real benefits of a team focus. Team members must simultaneously balance individual and group concerns. If each team member surrenders all individuality, the purpose of forming the team would be negated. Synergy Achieving synergy within the team is important. There is a much higher probability of synergy when participants share the same vision, goals, and process expectations. Thus, it is important to train individuals for teamwork. It does not come naturally and without effort. Preparation is a significant input into the team success equation.

E)

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5)

PHASES OF TEAM BUILDING Teams go through phases or cycles, just as in other forms of relationships. Teams have introductory, growth, maturity, and decline phases. In the introductory phase, teams work to understand their charter, set governance policies, timelines, assess skills and personalities of participants, and generally work to ensure a smooth-flowing work environment. During the growth phase, efforts are devoted to channeling group resources toward the main goals and to increasing the momentum of the team. At this point there is general agreement on what should be done and how it should be approached. Maturity suggests a work group that is clearly focused and moving toward the completion of the project. There is concern about crafting the final project and targeting alternative means of presenting the groups work. The decline phase represents somewhat of a wrap-up period, in which team members come to some tough conclusions about the essence of their work and about whether or not they have done what they were chartered to do. This phase also allows for planning specific means of follow-up and possibly allows for implementation of the recommendations. While there is no set period of time a team spends in each phase, an awareness of the various stages allows groups to conceptually divide their work into integrated sections that encourage them to see the big picture at the end.

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Part D: Internal Relationships 6) PROBLEMSOLVING MODELS

Task 209

Team members must address how problems will be solved within the context of the group. Some models may be more familiar to certain organizational cultures than others. Present alternative models and get buy-in from the beginning. All problem-solving models are variations of the scientific method. Exhibit 3 compares four different problem-solving models. Although the details vary, the approaches are all fundamentally the same. EXHIBIT 3 Scientific Method Definition of problem Deming Scholtes Tague What do we want to accomplish? Who cares and what do they care about? What are we doing now and how well are we doing it? What can we do better? What are the underlying problems? What changes can we make to do better? Do it. How did we do? If it worked, how can we do it every time? What did we learn?

Analysis of problem Plan

Collect meaningful data

Identification of causes Planning countermeasures Implementation Confirmation of result Standardization

Identify root causes of problems Develop appropriate solutions Do Check Act Plan and make changes

7)

PERSONALITY PROFILES Generally, the more divergent the personalities on a team, the richer the contributions. However, extreme divergence can be counter-productive. Personality inventories or profiles should be conducted on each member. This is valuable input in managing the team. This information provides some hints concerning communicating with group members, solving problems and conflicts, sharing information, and evaluating performance. These profiles should be considered before forming the team.

8)

EFFECTIVENESS MEASURES Research involving cross-functional teams indicates that members who receive evaluations put forth a greater effort than those who do not. Both team performance and individual performance should be evaluated. Two critical issues are: (1) how to evaluate performance and (2) who has responsibility for determining performance. 219

Task 209 A)

Module 2 Individual A member's formal evaluation should include a component for team participation. Performance measures focus on the individual's contribution, such as carrying out assigned responsibilities. Evaluations can be performed by the member's immediate manager, but are frequently more effective if performed by the other team members. Team The team's performance should be evaluated against the team's goals. Leaders should quantify goals whenever possible. Performance measurement allows the sponsor to determine a team's progress toward its stated objectives. The sponsor should give the team accurate, specific, prompt, direct, reliable, and appropriate feedback to ensure its success.

B)

9)

PROCESS IMPROVEMENT MODELS Purchasing should continually be looking for ways to improve its processes (see also Task 309).

10)

PROJECT MANAGEMENT Essentially, project management oversees an activity (project) from concept to operational use, with emphasis on the functions, roles, and responsibilities of the project manager and project team members. A project requires a special form of management because of its complexity, cross-functional skill requirements, and temporary nature. It is the project manager's responsibility to accomplish the work within budget, schedule, and performance requirements by integrating the work efforts of participating functional support areas to achieve the project goals. To this end, knowledge, skills, tools, and techniques are used to meet or exceed stakeholder needs and expectations in a variety of areas, such as scope, time, cost, quality, human resources, communication, risk, and procurement management. A key component of project management is the use of cross-functional teams. These teams, if not managed appropriately, can lead to project failure through internal conflict, lack of focus on the key issues, and poor decisionmaking. Purchasing has a responsibility, both as a team member or as a team leader, to ensure that the team accomplishes its goals on budget and on schedule. Project management can work well in the purchasing and supply environment resulting in better communication, positive department interaction, supply chain support, improved cycle time, and improved upper management support. However, there can be a downside to project management. For example, problems may occur if management does not empower those responsible by providing the level of authority and responsibility needed to get the job done, if the organizations culture is not attuned to a project management approach, or if a project is not well understood. Skills needed for successful project management include leadership, understanding risk management in a project environment, project scheduling, cost control, and budgeting. Purchasers must have the ability to apply each skill in a project management environment. Creativity and the ability to find new ways to accomplish things can be important too. 220

Part D: Internal Relationships BIBLIOGRAPHY

Task 209

Crowder, M.A. Project Management, NAPM InfoEdge, (4:2), October 1998. Lester, M. Purchasing and Supply, Meet Project Management, Purchasing Today , December 1998, p. 30. Nicholas, J.M. Managing Business & Engineering Projects, Prentice-Hall, Englewood Cliffs, NJ, 1990. Scholtes, P.A. The Team Handbook, Joiner Associates, Inc., Madison, WI, 1988. Tague, N.R. The Quality Toolbox, ASQC Quality Press, Milwaukee, WI, 1995.

221

TASK 210: Recommend/implement changes to the organizations purchasing, supply management, and material usage policies as needed.
Purchasing and supply management professionals are in a position to have significant impact on policy matters within the department and throughout the organization. For example, purchasers may influence the buying processes of the organization by recommending the introduction of procurement cards or the implementation of a requisitioning system that reduces cycle time between order placement and delivery of a product or service to the customer. Purchasers influence product design decisions by searching the marketplace for substitute materials or component parts, and by making information known to engineers and others responsible for developing specifications. The frequent review of policies and the modification or elimination of policies that have ceased to add value help the department to remain customerfocused, while providing the services needed to make the organization successful. 1) THE SCOPE OF THE PROCUREMENT PROCESS A) Purchasing/Procurement In most purchasing departments, personnel will have responsibility for the major buying tasks, which include: Providing and managing purchasing processes. Checking requisitions. Selecting suppliers. Placing orders. Scheduling purchases and deliveries. Analyzing bids and conducting negotiations. Following up and expediting orders. Interviewing sales personnel. Handling claims with suppliers. Providing information for capital acquisitions. Seeking engineering and product improvement assistance. Developing and training other purchasers. Maintaining product and supplier source files. Maintaining files on supplier performance. Developing new sources of supply and establishing standardization programs. Conducting make-or-buy decisions. Conducting materials and components analysis. Conducting market trend analysis and forecasts for management. Training users on the purchasing/requisition processes, as appropriate. Providing input to product design and product improvement. Handling contract administration and supplier management. Developing partnerships and strategic alliances with suppliers. Developing cost reduction programs. Identifying ways to use technology more effectively. 223

Task 210

Module 2 The use of technology continues to free purchasing from tactical and operational tasks. Purchasers are spending more time and effort developing and managing relationships with suppliers and internal customers.

B)

Contracting One of the prime functions of purchasing is the creation of contracts with suppliers. The purpose of contracting is to reduce the time and cost involved in ordering, receiving, and paying for goods or services that are used repetitively by the purchasing organization. Materials management Materials management is a managerial and organizational approach used to integrate the supply management functions in an organization. It involves planning, acquisition, flow, and distribution of production materials from the raw-material state to the finished-product state. Typical activities included are procurement, inventory management, receiving, stores and warehousing, in-plant materials handling, production planning and control, traffic, and surplus and salvage. Many purchasing departments manage part or all of the materials function as part of their responsibilities. Examples include determining the amounts or quantities of materials needed; establishing specifications with internal customers; determining the timing of purchases; arranging inbound transportation; handling inspections; managing the carrier claims process; managing inventory; overseeing stores; and disposing of scrap, surplus, and hazardous waste. While purchasing is a key contributor in creating specifications, the actual preparation and issuance of specifications is normally carried out by the internal customer. However, it is not uncommon to find these activities controlled by engineering, or even quality assurance.

C)

D)

Supply management Supply management is a systems management concept employed by some organizations to optimize the factors of material costs, quality, and service. This is accomplished by consolidating the following operating activities: purchasing, transportation, warehousing, quality assurance for incoming materials, inventory management, and internal distribution of materials. These activities normally are combined in a single department, similar to the arrangement under a materials management form of organization. Service management Purchasing increasingly finds itself acquiring a broader range of services. Contrasted with materials, the purchase of services requires perhaps even more diligent, day-to-day effort in developing specifications, in sourcing and qualifying, in contracting, and in monitoring performance. Logistics/Supply chain Logistics is the process of planning, implementing, and controlling the efficient, cost-effective flow and storage of raw materials, in-process inventory, finished goods, and related information from point-of-origin to point-ofconsumption, for the purpose of conforming to customer requirements. Said another way, logistics represents a combination of materials management and distribution. 224

E)

F)

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Task 210

Logistics is the control and planning of all activities involved with the inbound movement of needed goods, and with the outbound flow of finished products. Its purpose is to attain a certain service level for the organization, and to work as efficiently as possible while meeting that service goal. The ultimate goal is to balance the entire organization so that it attains its goals in a low total-cost manner. Purchasing is a vital part of the logistics concept, and more and more organizations are including these functions as part of the duties of purchasing. Supply chain has come to mean a group of supplying organizations that may include a series of companies that extract materials from the earth, perform a variety of valueadded activities on the subsequent product, and eventually create goods or services that are purchased by the ultimate consumer. To a purchasing organization, the concept includes the identification and management of specific supply chains that are critical to the organization's operations. G) Licensing Purchasing will often have the responsibility for negotiating and administering license agreements with suppliers. Examples of licenses include software, patents, technology, and copyrights. Merchandising/Inventory planning Purchasing may have the responsibility for determining the amount of inventory the organization should maintain. Areas of application may include MRO inventories, the wholesale/distributor, and retailing. Quality systems Although purchasing normally does not have responsibility for quality systems, it is a major user, especially for evaluating suppliers. As such, purchasing is concerned with the techniques used to evaluate incoming materials and services, particularly acceptance-testing procedures and criteria (see also Tasks 206 and 207). Document control Purchasing departments typically establish requirements for the maintenance, retirement, and destruction of official documents and contracts, correspondence, files, and other records. Purchasing takes responsibility for bills-of-sale, titles, warranties, contracts, and other documents applicable to the function. Files are maintained to track trends, develop history, project future needs, provide continuity, and to ensure that legal requirements relating to records retention and discovery are met by the organization (see Task 120 for a discussion on records management and records retention). Risk Risk management involves managing the potential for a higher return with the potential for failure. Proactive purchasing management includes activities that go beyond the traditional administrative purchasing cycle. For example, reducing the supplier base, developing long-term alliances, achieving early supplier involvement, and outsourcing are activities that are beyond the traditional administrative purchasing activities. These trends have the potential to increase risk for the purchasing group and the organization. For example, developing a long-term alliance may expose the organization to risks of noncompetitive pricing, may cause a shortage if the supplier's 225

H)

I)

J)

K)

Task 210

Module 2 facilities are destroyed, or may cause a lag in new technology development. If purchasing manages these risks effectively, the return to the entire organization will be greater. If purchasing does not manage proactively (and minimizes its risks by engaging only in traditional administrative activities), the overall return for the organization is likely to be diminished. Highly competent purchasing professionals can manage the risk of proactive purchasing. Skilled purchasers manage proactively by pursuing such activities as supplier certification programs, development of target-costing with partners, outsourcing, and implementation of quality management programs. In addition, they work to reduce routine administrative activities with such tactics as procurement cards and decentralization of routine tasks through systems contracts.

L)

Investment recovery Many organizations implement a systematic, centralized organizational effort to manage the surplus equipment/material and scrap recovery/marketing/disposition activities in a manner that recovers as much of the original capital investment as possible (see also Task 307).

2)

THE ROLE OF PURCHASING IN ORGANIZATIONAL STRATEGIES A) Public sector Governments buy services and goods to fulfill the requirements of the various authorized programs; to maintain, repair, and operate facilities; and to accomplish necessary research and development. Pressed by shortages of funds and rising costs, governments try to operate at maximum efficiency and at minimum cost. Good purchasing is a critical element in such efforts. Typical areas for purchasing by governmental entities include support for various services such as police and fire protection; the maintenance of streets, parks, and public buildings; garbage collection and disposal; and other services. The annual budget or the unexpended portion thereof usually strictly limits purchasing in the government sector. Laws and regulations affecting policies and procedures pertaining to obtaining goods and services may also limit government entities. Private sector Manufacturing and service organizations buy raw materials, component parts, and subassemblies to convert or assemble into finished products or to provide some service. They also buy goods and services to maintain, repair, and operate facilities, and to perform research and development for new product lines. Purchasing has the responsibility in most organizations to ensure the availability of these materials. It converts cash and other liquid assets into physical goods and services, and must be sure that such purchases are sound. An effective purchasing department plays an important role in determining an organizations material costs and, hence, its profit. Many organizations spend between 40 and 65 percent of their sales dollar for materials and services used in their operations. This highlights the profit-making possibilities of the purchasing function. In most cases, a dollar saved in the cost of materials is equivalent to a new dollar of profit. The exact percentage of profit improvement that will be produced by a one percent 226

B)

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Task 210

saving in material costs depends on two factors: (1) the organizations profit margin and (2) the percent of sales represented by materials costs. The lower the profit margin, the greater the material cost-saving impact; the greater the material cost as a percent of sale, the greater the material cost-saving impact will be. The two most common ways an organization can increase its profit are: (1) reduce costs and (2) increase sales. To see the impacts of these two possibilities more precisely, consider an organization that has a 10 percent profit margin before taxes, and at the same time spends 50 percent of its sales dollar on materials. In this case, a 1 percent reduction in material costs will produce exactly the same profit increase that would be produced by an increase of 5 percent in sales. Both will produce an absolute profit increase of 5 percent. After analyzing these figures, it is clear why management should rely heavily on purchasing to control costs and contribute to profitability. C) Not-for-profit There is no legal difference between a not-for-profit and a Non-profit; however, the Internal Revenue Service makes a distinction by defining not-for-profit as an activity and non-profit as an organization. Therefore, purchasing in a not-forprofit would be similar to purchasing in a non-profit, which is discussed below. Non-profit/Institutional sector As in the private and government sectors, non-profit organizations buy goods and services to accomplish objectives, to maintain, repair and operate facilities, and to perform research and development. An example of non-profit purchasing includes buying for a hospital or a university. In such situations the profit motive and competitive factors are absent, and the primary goal is to get the maximum value for the expenditure of a fixed budget appropriation for materials or services.

D)

3)

MANAGEMENT OF THE CHANGE PROCESS ("CHANGE MANAGEMENT") Managing change involves making changes in a planned and systematic fashion. The objective is to effectively implement new methods and systems in an ongoing organization. Managing the change process involves dealing with three questions: how, what, and why. The first question deals with the process of getting people to adopt change. The second question addresses what the organization is going to change. The third question addresses the rationale for change. The purchasing profession is constantly undergoing change. Purchasing professionals of the future will see changes as they become heavily involved in areas such as economic forecasting, countertrade, outsourcing, international sourcing, transportation and logistics, supplier quality, and e-commerce. The steps for managing change include: Collecting data Data collection involves searching for opportunities for improvement. Information is gathered from customers, suppliers, and employees.

227

Task 210

Module 2 Evaluating the opportunities for change Using the information collected in the first stage, compare the advantages and disadvantages of proposed changes, including implications such changes might have on cash flow, working practices, supply and distribution networks, and customer loyalty. Design strategy Develop a detailed plan that covers rationale for change, objectives of change, implementation process, individual involvement, resource requirements, time frame, and evaluation measures. Implement change strategy Implementation begins with education of all those involved and affected. Present the plan, encourage clarification, monitor the changes, and modify the plan as necessary. Review Using the evaluation measures defined in the plan, periodically review progress.

Reasons for failure include: 4) Inconsistencies between management's words and their actions. No system to evaluate the change and what it is to accomplish. No change in compensation, performance appraisal, information, or organizational systems. Unrealistic timelines for change. The assumption that training is all that is needed for change to take place.

LEGAL RAMIFICATIONS As purchasing recommends changes in policies and procedures, the proposed changes should be reviewed by legal counsel, human resources, and top management for conformance to statutes and organizational policies (see Task 114 for a discussion on the role of legal counsel).

BIBLIOGRAPHY Limperis, J. Beyond Buying: Purchasing's Changing Role, Proceedings of the 1996 International Purchasing Conference, NAPM, Tempe, AZ, 1996, pp. 52-55. McGinnis, M.A. Change Management: Basic Skills for Purchasing Professionals, Proceedings of the 1997 International Purchasing Conference, NAPM, Tempe, AZ, 1997, pp. 58-63. Murphree, J. Defining Change Management, NAPM Insights, March 1995, pp. 55-56. Smeltzer L.R. and S.P. Siferd. Proactive Supply Management: The Management of Risk, International Journal of Purchasing and Materials Management, Winter 1998, pp. 38-45.

228

TASK 211: Disseminate information and provide training related to purchasing and supply management policies and procedures.
Dissemination of information and training related to purchasing and supply management policies and procedures has taken on added significance in recent years. While it is standard to provide training within the purchasing and supply department, the reduction or elimination of departmental boundaries and the use of cross-functional teams have resulted in the need to more effectively and conscientiously educate others within the organization about purchasing and supply policies and processes. In some organizations, training even extends into the supplier community. The greater the understanding of how effective purchasing techniques and processes support the mission and goals of the organization, the more likely that purchasing will be successful and that internal customers will be satisfied. 1) THE DEVELOPMENT OF TRAINING MANUALS A) B) Responsibility The development of a comprehensive training manual is the responsibility of every purchasing department. Relationship to general training manuals Purchasing training manuals and policies and procedures manuals are developed and used to train personnel inside and outside of the department. Within the department, new or untrained personnel may be overwhelmed with purchasing job requirements. They can refer to these manuals when they have questions on policy or procedure during and after orientation and initial training. Procedure manuals are especially useful when extensive details in routine operations are needed. Often purchasing has the responsibility to disseminate information or to provide training related to purchasing and supply management policies to others in the organization. When carefully constructed, the same training manuals and policies and procedures manuals (or portions of them) can be incorporated into training materials for use by other departments, divisions, or agencies within the organization. This will help ensure that a consistent message about purchasing policies and procedures is given to the entire organization. C) Use as an on-going reference Policy and procedure manuals encourage standard practices, improve procedures, aid in training internal customers, and clearly delineate authority and responsibilities. For example, Texas maintains a procurement manual on its Web site (www.gsc.state.tx.us). It is available to state employees, suppliers, and the general public. The manual includes information about procurement authority, the procurement cycle, the procurement method selected, solicitation, receipt of bids, evaluation and awards, inspection and acceptance, contract administration, payment, disposal of property, audit matters, and general information.

229

Task 211 2)

Module 2

TRAINING COST, EFFECTIVENESS, AND OUTCOMES MEASUREMENT When training has been extensive and formal it is important to measure training outcomes in behavioral and operational terms, to determine the effectiveness of the training effort (including how trainees actually behave on their jobs) and to determine the relevance of the trainees behavior to the organization's objectives. In this way, purchasing can assess the utility or value of the training, and make changes as necessary. Questions usually addressed when evaluating training programs are: Was there a change in knowledge, skills, and/or abilities related to purchasing effectiveness in the various participants? Were these changes due to the training? Are the new skills positively related to the organizations goals? Will similar changes occur for new participants in the training program? Was the training cost effective? Was it worth the expense to the organization? Could the same effect have been achieved with a less expensive training mode?

Large organizations may be able to use trained researchers to determine the answers to these questions using educational research techniques, such as tests, questionnaires, interviews, and experimental design. Smaller organizations will need to rely on less sophisticated approaches such as interviews and surveys. The objective of the evaluation is to provide data for making decisions on whether to continue, discontinue, or modify a training program. 3) THE LEARNING ORGANIZATION CONCEPT True learning organizations do not simply adapt to changes in their environments. They teach from the changes they make, challenging their mental models, their core beliefs about how the world works, and their processes of thinking and solving problems. Learning-oriented purchasing organizations focus on combining adaptability, continuous improvement, and a strong sense of purpose. They adapt to the nuances of both the internal and external environments that shape the essence of purchasing and its related functions. In these types of organizations, organizational resources are permanently mobilized to respond to almost any challenge or opportunity. This kind of readiness to respond is a hallmark of a learning-dominant organization. Learning-dominated supply management organizations share some of the following traits: Shared vision Learning-dominated teams in procurement have a collective vision that is like a beam of light guiding a ship. Where, how, and why does supply management contribute to organizational effectiveness in the broadest possible sense? Responses to these questions require enlightened thinking on the part of primary and secondary participants in the procurement process. Using conflict constructively All dynamic organizations experience dissension and conflict. However, learning-dominated groups consider certain types of friction constructive 230

Part D: Internal Relationships

Task 211

and valuable. In fact, it is encouraged and promoted because it forces constant reassessment of both the internal and external landscapes. Thus, continuous learning is a natural outgrowth. Spirit of creativity and innovation Few things are as critical to leading supply managers forward as the development and institutionalization of creativity. This mindset allows for the generation of more and better options, increased flexibility, and the general capacity to understand and appreciate configurations and states of nature that may influence procurement performance. Learning organizations accept and use the multitude of creative problem-solving methods available to improve the ability of people to do their jobs. In these environments, an alternative approach is not viewed with suspicion and disdain. It is seen as a serious prospect for accomplishing the procurement mission. Commitment to education A commitment to education in its very broadest sense is the hallmark of moving individuals and organizations to the highest levels of performance. Supply managers must have a passion and total commitment to increasing the knowledge of every single person in procurement. This is consistent with the 13th Principle of Deming's Management Method: Institute a vigorous program of education and retraining. The other phase of this is continuity in the education process. Education should not be instituted as a knee-jerk reaction to problems; it should be an ingrained part of the organizational psyche. Providing training to other members of the supply process creates a learning environment. Perceptive risk-taking Learning-dominant supply organizations are more comfortable with risk-taking. They pursue calculated and intuitive risks. Given the array of uncertainty that abounds, those groups and individuals that have learned risk assessment strategies will outperform those without such knowledge. The learning environment of supply management must reinforce the importance of risk-taking behavior, and supply management must be willing to absorb some of the consequences of mistakes. Because learning can partially be defined as a change in behavior over time, resulting from some cause, positive results are likely to ensue as managers learn to evaluate risk. The capacity to measure risk can be enhanced through continuous learning and development. Development of entrepreneurial talents internally Learning organizations harness entrepreneurial skills internally. Intrapreneurs do what entrepreneurs do just inside the organization. They take new ideas, concepts, and practices, and convert them into profitable realities. While most supply managers are not directly converting tangible materials into something, the principle is the same for various aspects of their work areas. The most critical point is that in learning-dominant organizations, individuals have a sense of ownership in what they do. They are willing to lead their areas as though the resources were their own.

4)

TRAINING DELIVERY METHODS There are a number of ways to provide training, such as on-the-job, classroom, seminars, audio/videotapes, online courses, and books and other publications. Purchasing should identify training products and delivery methods that will meet the needs of internal customers.

231

Task 211 5) SELECTION OF TRAINING PERSONNEL

Module 2

The type of individual needed to provide training varies with the particular mode of training selected. In the case of on-the-job training, the desirable trainer will have a solid understanding of policies and processes, will know how each will affect internal users, and will know how each fits in the big picture. It can be useful to have every member of the department conduct some aspect of training (including the manager). Teaching forces the trainer to understand the material before teaching someone else. It is also important to select training personnel who will help create a positive image with internal customers. A side benefit for the trainer and for purchasing is that the trainer will have a chance to meet and get to know internal customers from other departments. BIBLIOGRAPHY Buck, J. Thriving in the Learning Organization, NAPM Insights, December 1994, pp. 25-27. Williams, A.J. Supply Managers for the Twenty-First Century: The Learning Imperative, International Journal of Purchasing and Materials Management, Summer 1995, pp. 38-42. Williams, A.J. Learning, Entrepreneurship, and Creativity: A Winning Triad for Purchasing's Future, Proceedings of the 1997 International Purchasing Conference, NAPM, Tempe, AZ, 1997, pp. 232-236.

232

TASK 212: Develop/manage effective relationships with suppliers, utilizing such techniques as supplier partnerships, strategic alliances, supply chain management, and supplier training programs.
The continuum of purchaser-supplier relationships provides the purchaser and supplier communities with a variety of relationship management alternatives and opportunities. Due to the movement toward outsourcing more complex product development, and manufacturing and service delivery, the focus on core-competency strategies and, in some sectors, the reduction in the supply base, supplier-relationship management has taken on added, long-term importance. 1) BENEFITS OF GOOD SUPPLIER RELATIONS Developing good will between purchasers and suppliers has long been considered sound business policy. The benefits of maintaining good supplier relations are numerous. For example, there are many occasions when a purchaser may need prompt supplier attention to deal with a sudden surge in orders, a purchaser may have a sudden need to move up a product delivery, or a purchaser may need to ensure an immediate shipment of spare parts. Such situations are better handled if the purchaser has a sound and friendly business relationship with the supplier. Suppliers who are treated fairly will be more likely to be cooperative when dealing with rejected materials and with other situations that may involve negotiated settlements. They are also more likely to provide technical support, inventory backup, and other services. Also, negotiations may be shorter, terms may be simpler, disputes may be minimized, and communication will be enhanced when relations with suppliers are good. 2) WAYS OF PROMOTING GOOD RELATIONS Establishing good supplier relations relies on the purchasing manager's ability and willingness to foster the creation and improvement of a mutually satisfying arrangement. Methods used to promote good relations include: Completely and clearly communicating the need, application, and use of the purchased material or service; the scope and limitations of the product or service; the outlook for continued use and the probable quantities required; and any special requirements of either a technical or commercial nature. Ensuring a mutual understanding of the conditions and problems resulting from any communications. Developing a mutual confidence and trust in the statements and intents of both parties. Showing mutual consideration by not making unreasonable demands; by giving as much notice as possible about changes in schedules or instructions; by keeping an open mind in the discussion of differences; and by being willing to waive or modify non-essential details of the agreement, if the modification does not impair quality and is to the advantage of either party.

233

Task 212

Module 2 Taking a genuine interest in the mutual give-and-take of procurement and supply, rather than focusing on strict contract fulfillment (this includes suggestions for cost reduction in the product itself and in methods of packing, shipping, usage, and accounting). Exhibiting an active desire to fulfill contract obligations, minimizing inquiries and expediting action, and ensuring prompt processing and payment of invoices. Continually improving ordering methods and other processes as opportunities arise. Cultivating personal contacts in the buying and supplier organizations, establishing yourself as a liaison and creating goodwill. Top management meetings For key suppliers, top management of each organization should meet periodically with key suppliers to discuss long-term strategies and objectives. Relations between suppliers and customer functions All those in the supply chain should understand that everyone serves the same final customer. This creates a common focus. Timely payment of invoices Suppliers rely on payment from purchasers to support their operations. Late payment may create ill will and may cause financial problems affecting the suppliers ability to pay its suppliers or to perform its contract, thereby unfavorably affecting the purchaser's customer service. Equitable treatment of suppliers Equal application of policies, changes, and access to opportunities is key to building trust and loyalty with suppliers. Periodic supplier surveys Periodically solicit supplier feedback through surveys, asking such questions as: How knowledgeable are our purchasers? How accurate are our specifications? How timely are our payments? What can we do to make your job easier? What can we do to reduce your costs? Surveys allow suppliers to provide anonymous feedback on how good a customer the purchasing organization is. Purchasing should respond to the feedback and modify its behavior accordingly. Purchasings goal should be to be a preferred customer. The purchaser must be a world-class customer in order to obtain world-class suppliers.

A)

B)

C)

D) E)

F)

Enhanced two-way communication Excellent computer linkages (electronic data interchange, Internet) and face-to-face communication, are critical to maintain clear expectations and good performance. Supplier training Some purchasing organizations provide their suppliers with training to help them improve quality and other processes. This is an investment in the suppliers performance, as well an investment in the relationship. Encouraging confidentiality All cost, technology, and performance information related to a purchasing organizations suppliers should remain strictly confidential. Many organizations sign mutual confidentiality agreements with suppliers. Public-sector information 234

G)

H)

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Task 212

may not be confidential except within narrow guidelines (see Task 119 for a discussion on handling confidential information). 3) ISSUES IN SUPPLIER PRODUCT EDUCATION AND INVOLVEMENT A number of organizations provide training for their suppliers in the areas of Statistical Process Control (SPC), Just In Time (JIT), and Total Quality Commitment (TQC). These training programs are conducted because supplier competence in these and related areas is of paramount importance to the buying organization. For example, some organizations operate what are known as supplier clinics, where a representative group of suppliers (usually high ranking officers) is invited to come to the purchaser's location for one or two days, during which materials requirements, problems, and policies are explained to the group as a whole and in private conferences. In this way, the suppliers obtain a comprehensive view of the organization's products and service needs, and can see how their products and services will be used. A) Advantages B) Suppliers performance may improve, which will benefit the purchasing organization. Suppliers will become familiar with the purchasing organization's processes and procedures. Suppliers may network with each other, and form relationships that benefit the purchaser's organization.

Possible problems The purchaser must walk the talk and have a supportive culture, or the approach will fail. The purchaser must ensure confidentiality of key information. The purchaser must use care when potentially competing suppliers are involved.

C)

Site visits Visiting a suppliers site and having it visit the purchasers location can help ensure better understanding of each other's operations resulting in opportunities for mutual improvement.

4)

ISSUES IN RECIPROCITY Reciprocity is the practice of purchasers giving preference to suppliers that are also customers. A) Legality Reciprocity can be illegal. The key factor used to determine illegality is the degree to which any reciprocal activity tends to restrict competition. It is legal to buy from customers without economic threat and without the intent of restricting competition. In a questionable situation, however, the burden of proof rests with the purchaser. 235

Task 212 B)

Module 2 Impact on suppliers and purchasers Many purchasers shun reciprocity, even when legal, because it restricts competition among potential suppliers. Reciprocity does not follow the principle of buying and selling that is based on the fundamental criteria of quality, price, and service. A supplier that also serves as a customer may start to relax competitive efforts in technical and production areas as a result of reduced competition. Also, a buying organization's reputation may be impaired because of bad publicity resulting from reciprocity. Suppliers of new, advanced products and processes may feel they are wasting time with organizations tied up with reciprocal arrangements. Consequently, new suppliers may be hard to find for purchasers engaged in reciprocal relationships. Some organizations may have a reciprocity policy that says: When important factors such as quality, service, and price are equal, we prefer to buy from our customers. In practice, abuse of such a policy may occur.

C)

Domestic versus international In the international marketplace, reciprocity is practiced more widely. International companies, for instance, may receive government contracts on the condition that they meet local content requirements, forcing the foreign supplier to develop new sources.

5)

CONCEPTS OF CONTINUOUS IMPROVEMENT A) Quality Many organizations establish certified supplier programs that their suppliers must meet. Such programs typically involve an internal quality investigation by the buying organization, including an examination of the supplier's facilities. Once the supplier is certified, shipments from the supplier receive no incoming inspection. Cost It has become increasingly popular to enlist the aid of suppliers in the design phase of a product. This involves inviting highly qualified suppliers into early discussions with design engineers. Management, quality, technology, delivery, and competence, as well as costs, are evaluated before the approval of the prospective source. Maintaining close, long-term relationships with suppliers will often yield acceptable quality and competitive prices. Design This is where about 80% Eighty percent of product and service costs are determined in design. Quality should be designed into products and services. Because the design phase is of such importance it is important to monitor design processes over time, to ensure continuous improvement techniques are applied and used. For example, an electronics company, after a $500,000 product recall, discovered the problem could have been corrected in the design phase for $37. Service Service to customers and from suppliers is key in distinguishing routine relationships from value-added relationships. It is critical to know what type of services the customer really values, and to focus attention on those. The purchaser must

B)

C)

D)

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clearly define service needs to suppliers and continually work to enhance the flow of two-way communication. E) Cycle time reduction Time is money. Longer cycle times tie up time, and financial and human resources, resulting in more inventory and creating waste. Cycle times can be reduced by concurrent processing, by improving quality, and by improving communication/information systems.

6)

SUPPLIER PARTNERSHIPS/STRATEGIC ALLIANCES Strategic partnering is the systematic leveraging of purchasing's resources and capabilities through mutually beneficial relationships with other internal and external players, to strengthen the organization's competitive advantage. A supplier partnership between a purchasing and a supplying organization involves a mutual, long-term commitment to work together for the mutual benefit of both parties, sharing relevant information and the risks and rewards of the relationship. These relationships require a clear understanding of expectations, open communication and information exchange, mutual trust, and a common direction for the future. Such arrangements are collaborative business activities that do not involve the formation of a legal partnership. The term strategic alliance is used by many organizations to mean the same thing as a supplier partnership. In some organizations, however, the term strategic alliance is used to describe a more inclusive relationship involving the planned and mutually advantageous joint use of additional operating resources of both organizations. Selecting suppliers as partners involves more than the usual up-front analysis, therefore it is best to use a team-oriented approach to selecting partners. Such a team will usually involve purchasing, engineering, operations, quality control, and senior management. To ensure survival of the partnership, both the purchaser and the supplier need to keep abreast of changing technology through periodic meetings, and through other forms of communication. The buying organization must be open about its needs, and must agree to protect the supplier from sudden changes that might leave the supplier with excess goods or materials. It may be necessary for the buying organization to perform cost and value analysis of the supplier's operations, to ensure the supplier earns a fair profit and to provide a fair price for the purchaser. A) Rationale It is possible that a supplier may add more value as an alliance partner than in a routine relationship. An alliance is defined as any union, coalition, or formal agreement between parties in their common interest. A strategic alliance includes that, plus all the elements of a partnership and a sharing of long-term strategies, including some or all of the following: the mutual recognition and acknowledgement of a long-term, ongoing relationship between both organizations ongoing joint teams, as appropriate senior management involvement and support mutual idea generation and creative problemsolving 237

Task 212 B)

Module 2 ongoing contact and visibility confidential information sharing early supplier involvement in new products/services/processes concurrent engineering and project development contributions by the supplier to the purchasers competitive success/strategy (not readily available from other suppliers) cooperative continuous improvement efforts the sharing of risks and rewards

Methods for identifying potential alliances Organizations tend to form alliances with suppliers with whom they have significant relationships. Alliances should be formed to achieve specific benefits, such as: - reducing leadtimes - gaining increased flexibility and good market responsiveness - reducing administration and all other costs - gaining a competitive edge - obtaining early involvement in product design or process development, with full access to a suppliers resources - reducing inventory - improving services, delivery performance, and overall product/service quality - emphasizing right first time and zero defect programs (rather than simply quality assurance) - gaining technical or informational advantages - reducing the supply base

An alliance is a two-way relationship, so the purchaser must ask, Whats in it for the supplier? In many cases, competition drives the supplier as well the purchaser. An alliance can enable the supplier to gain more market share, to develop joint processes to work more effectively and to understand the current and future needs of the purchaser. C) Forms of alliances Basic Alliance This type of relationship can be formed with any supplier. It involves treating the supplier with a basic level of trust and honest communication. It tends to be tactical and short-term. Operational Alliance An operational alliance is one where the supplier performs a service or supplies a product as a matter of routine, or as part of the transaction flow of business, not as an additional commitment. While there may be some joint problem solving, there are no ongoing, cross-organizational teams. However, it is crucial that the purchaser receive accurate information from the supplier about potential shortages, changes, and prices, because the item is important to the buying organization. 238

Part E: External Relationships

Task 212

Business Alliance A business alliance is one where the buying organization wants the supplier to provide some unique or specialized product or service. There is increased recognition of mutual dependence. The supplier may invest in additional assets, specialized personnel, or technology, or make other similar investments. The purchaser will have reduced the supply base and committed volume for an extended period of time. The benefit to the buying organization is not strategic or core to the organizations success. Limited concurrent engineering or joint technology development may occur. Ad hoc, cross-organizational teams may be formed for joint development or to solve problems. Strategic Alliance A strategic alliance involves a good or service that is of strategic importance to the success of the buying organization. This type of alliance requires sharing long-term strategies. This includes early supplier involvement in new product/service/process idea conception; concurrent engineering; and the mutual recognition of a long-term, ongoing relationship between buying and selling organization. There must be agreement as to the risks and rewards of a strategic alliance, and an understanding of how these will be shared. Ongoing, joint cross-organizational teams, and top management support, contact, and visibility are required for strategic alliances.

D)

Developing alliances Alliances develop through a multi-stage process, as follows: Conduct initial analysis - select supplier - develop strategy - obtain approval of team leaders/stakeholders - prioritize opportunities with the alliance - conduct kick-off meetings with executives and joint team - develop timeline for relationship development Conduct opportunity analysis - conduct detailed analysis of supply chain and processes - dentify/quantify/validate potential benefits - determine timing - finalize opportunity list - update executives Develop recommendations and implementation plans - develop recommendations - evelop implementation plan - develop joint business case - identify metrics - validate business case with budget owners/teams - gain executive approval Implement recommendations and measure benefits - obtain implementation resources 239

Task 212 E) implement solutions monitor/accrue benefits review joint scorecard recognize individual/team accomplishments

Module 2

Maintaining/sustaining alliances To maintain an alliance, there must be on-going benefits for both the purchaser and the supplier. Use joint-planning and continuous-improvement teams to keep the alliance going. Keep a high level of management visibility. Continue to measure and report the benefits. Provide incentives to the supplier for good performance. Celebrate successes together.

F)

Concluding alliances If the alliance is no longer mutually beneficial (and all opportunities to revitalize the alliance have been exhausted) or the business opportunity has changed, the relationship should be modified to suit the organization's needs. It is good to prepare terms for the end of the alliance while the alliance is being developed. Supplier certification issues In general, alliance suppliers are certified. This means that their quality systems are audited, so that the suppliers products/services can be received and used without further quality inspection or supervision. However, certification does not mean a supplier is an alliance partner, nor is an alliance supplier necessarily certified. These can be mutually exclusive processes.

G)

7)

REVERSE MARKETING Reverse marketing is defined as an aggressive approach to developing a relationship with a supplier, in which the purchaser takes the initiative in making the proposal for the relationship and the specific business transaction a reversal of the usual purchaser/supplier marketing practice. The purchasers degree of aggressiveness and initiative will determine whether or not reverse marketing is effective. In such a situation, the purchaser must recommend prices, terms, and conditions, rather than evaluate them. In most purchasing arrangements, it is assumed that at least one suitable and willing supplier exists, and that the purchaser's problem is merely choosing among those suppliers. There are times, however, when no suitable source exists for a needed product or service. In such a case, the purchaser will have to employ an even more aggressive form of reverse marketing to create a source. Reverse marketing implies the use of more aggressive techniques than those employed in normal procurement, and involves a considerable amount of persuasion on the part of the purchaser to convince a supplier to make and/or sell a product or service to the purchasing organization.

240

Part E: External Relationships 8) SUPPLIER MENTORSHIP

Task 212

Mentoring is the providing of assistance to a supplier in a wide variety of ways. It may be limited, such as in establishing training for statistical process control or loaning engineers to give technical assistance with a manufacturing problem. Some organizations have gone so far as to provide systems software, to facilitate total quality management (TQM) implementations, and to provide support with sales and marketing efforts. At its extreme it might even mean loaning capital so that appropriate investments can be made in equipment and raw materials inventories. 9) EARLY SUPPLIER INVOLVEMENT (ESI) A) New product development Because 70 to 80 percent of the cost of the product or service is determined during the design phase, ESI is critical. Suppliers are experts in their area. Their ideas and capabilities should be incorporated to speed cycle time, to improve outcomes, to improve quality, to reduce costs, and to ensure availability. Supply chain involvement Sometimes it is important to get multiple tiers of suppliers involved with a new product or service. Some organizations do this directly; others expect their first-tier suppliers to manage sub-supplier relationships. Development cycle reduction time Cycle-time reduction can be a tremendous benefit of ESI. By incorporating the suppliers ideas and technology rather than re-inventing the wheel, the purchaser can get new products and services to market much more quickly. Co-located engineering By locating the suppliers engineers with the purchasing organization's engineers, they can work together to resolve problems and issues as they occur, and can pool their skills to develop better solutions.

B)

C)

D)

10)

SUPPLY CHAIN MANAGEMENT A) Definition Supply chain management is the identification and management of specific supply chains that are critical to a purchasing organization's operations. It deals with the planning and control of materials and service flows, from earliest suppliers to end users, including disposal and end-of-life issues. Supply chain management attempts to cooperatively manage interorganizational relationships for the benefit of all parties involved, to maximize the efficient use of resources in achieving the supply chain's customer-service goals. Potential benefits Optimization of resources including inventories, capacities, transportation, and transaction mechanisms across many organizations substantially reduces expenses resulting from normal business uncertainties. The sharing of accurate demand information across the chain is cited by many as critical to achieving the maximum benefits of supply chain management. Procurement cycle reduction (process mapping) Supply process mapping is performed to identify the current competitive state of the supply chain. This is done by 241

B)

C)

Task 212

Module 2 drawing a map of leadtimes and inventory levels. The map's relationships are then analyzed to determine where cycle time and inventory improvements are possible, relative to the best industry practices.

D)

Risk management A major advantage of supply chain management is risk reduction. Risk reduction refers to the ability of the organization to lower the overall risk and cost of conducting business by sharing assets and information, and by joint planning between various members of the supply chain. For example, the sharing of logistics assets within the supply chain can increase an organization's flexibility. Information sharing can reduce costs and uncertainty, by allowing chain members to anticipate and plan for the actions of other members. Supplier process layout The suppliers processes can be analyzed to improve flow, thus reducing inventory and waste. Role of purchasing As more information is shared with all members of the supply chain, and opportunities for increasing both effectiveness and efficiency are sought, purchasing becomes a logical focal point because of its understanding of transactions, inventories, and inbound transportation, as well as its knowledge of the operations of its principal suppliers. Second-tier purchasing agreements When a buying organization has many suppliers that use the same raw material and its collective supplier volume for those raw materials is greater than that of its individual suppliers, the buying organization might contract with the second-tier supplier of raw materials on behalf of its first-tier suppliers. The buying organization can leverage the volume to gain better service, visibility, and pricing.

E) F)

G)

11)

DEVELOPMENT OF TRUST Studies show that competitive advantage and a more trust-based orientation are linked and are critical in any supplier relationship. The keys to alliances are trust, open communication, data sharing, early supplier involvement (ESI), concurrent engineering, and most other proactive purchaser-supplier behaviors. Open and honest communication is the foundation of trust building. Purchasers should learn to model the behaviors they expect from suppliers. A purchaser must proactively work to develop trust, learn the importance of disclosing information, and be prepared to exhibit trust-building behaviors, not only during times when all is going well, but when problems arise.

BIBLIOGRAPHY Bechtel, C. Developing Trust in Strategic Alliances: Concepts and Best Practices, Proceedings of the 1997 International Purchasing Conference, NAPM, Tempe, AZ, 1997, pp. 115-117. Zaheer, A., B. McEvily, and V. Perone. The Strategic Value of Buyer-Supplier Relationships, International Journal of Purchasing and Materials Management, (34:3), Summer 1998, pp. 20-26. 242

TASK 213: Review product availability and/or pricing information with suppliers.
1) FACTORS WHICH MAY AFFECT AVAILABILITY AND PRICING A) Market drivers The structure of the market for a good or service plays a major part in determining both availability and pricing. The greater the supply relative to demand, the lower the prices will be. As supply shrinks relative to demand, prices will tend to rise. Supply may be limited by natural scarcity (natural resources), by lack of production capacity, by supplier action such as cartels, or due to patent or copyright protection. Economic conditions The current and projected economic conditions will affect both availability and price to different degrees depending on the product or service in question. As economic activity declines, orders usually decline, causing production to decline. As production declines, organizations usually lower prices to stimulate demand. Lower production levels also may lead to shorter leadtimes. As demand increases, prices are raised as production levels rise. Also, as production levels increase, leadtimes will increase, reducing availability. Industry capacity Industry capacity is measured by factory utilization. As factory utilization reaches 80 to 90 percent, the industry is generally considered to be at full capacity. To produce at a higher level, organizations will need to use overtime and add shifts. As factory utilization rises, prices will rise, reflecting the longer leadtimes and lack of product to meet the increasing demand. As utilization decreases, suppliers will lower prices to stimulate demand. Supplier capacity As available supplier capacity diminishes, the supplier may begin to raise prices to slow demand growth and/or begin to place customers on allocation. Purchaser's share of supplier's business Some suppliers have policies that limit the level of sales to one customer. If the purchaser is approaching that limit, the purchaser will either need to develop an additional supplier or try to negotiate for more capacity. Likewise, some purchasers have policies limiting the maximum percentage they want to be of a supplier's business. The percentage needs to be set high enough to give the purchaser leverage with the supplier, yet not so high as to jeopardize the supplier's financial health should the purchasers business be withdrawn. Quotas Quotas limit the production or import of an item. If a quota is reached before the end of the limitation period, the purchaser will be unable to acquire additional product. Any product that does become available will be premium priced. Labor status The stability of a suppliers labor may affect price and availability. As contract negotiations near, prices may rise in anticipation of a shortage. When the

B)

C)

D) E)

F)

G)

243

Task 213

Module 2 contract is settled, prices may fall if customers have excess inventories from stockpiling in anticipation of a shortage.

2)

PRICE MODEL ANALYSIS There are different perspectives on how to set the price of a product or service. The seller defines a fair price either as a price that covers the full cost to produce the product or service (including overhead costs plus a reasonable profit) or as a price that compensates the seller based on the value of the product or service to the purchaser (and that covers all the relevant costs). A reasonable profit is defined as a profit that rewards the seller for the risk involved in providing the product or service. The purchaser usually defines a fair price as the lowest price required obtaining the desired product or service. The purchaser's perspective is normally focused on the cost of the product or service. Three dimensions come together to determine price from the seller's point of view: market structure effects on price, cost-based pricing models, and value-based pricing. Each is discussed below. A) Market Structure One factor that clearly affects price is the level of competition. The various types or degrees of competition range from one seller with many purchasers (a monopoly) to many sellers with one purchaser (a monopsony), as explained below: Monopoly one seller with many purchasers. In the United States most monopolies, such as public utilities, are regulated to keep prices reasonable. With no competition, the seller could set any price it desired. Monopolistic competition few sellers and many purchasers. The few sellers create the illusion of many sellers through product differentiation. An example is the breakfast cereal industry, in which a few companies control the market but offer a wide variety of products that compete for market share not only with other companies but also with the organization's own brands. Oligopolistic few sellers and many purchasers. Price is controlled by either an industry leader or a cartel. The steel industry was traditionally an oligopoly, that is, one organization would propose a price and the rest of the industry would often quickly adopt that price. An example of a cartel is the petroleum industry, where OPEC establishes the price for all its members. Perfect competition many purchasers and sellers. In a perfect market, all purchasers and sellers have equal importance. Most markets are not perfect but function effectively like a perfectly competitive market. Price is established based on supply and demand. Oligopsonistic many sellers with few purchasers. In this market, purchasers have a major effect on pricing because all the sellers compete for their business. Monopsony several sellers and one purchaser. This is the reverse situation of a monopoly. In a monopsony, the purchaser controls the pricing. An example is the market for military fighter aircraft, where the U.S. government controls sales by domestic producers. 244

Part E: External Relationships B)

Task 213

Cost-Based Pricing Cost-based pricing models start with an estimate of the unit-cost of goods sold, which includes direct labor, materials, and overhead. Three common approaches to pricing are straight markup, rate of return, and variable. 1.0 Straight Markup In the straight markup model, price is calculated by multiplying the unit-cost times a markup fraction to cover the contribution to overhead and profit, and then adding the unit cost. Mathematically, the formula is as follows: Price = Unit Cost + (Unit Cost)(Mark-up Fraction) For example, if the unit cost is $80 per unit and the markup rate is 20 percent, the price would be $96. Price = $80 per unit + ($80 per unit)(.2) = $96 per unit The questions the purchaser should ask include the following: What costs are included in the unit cost? The purchaser will want to make sure that costs not related to the product are not included, such as product development costs for another product or fully depreciated tooling. The purchaser should also be concerned about direct costs, and should ask if the process can be improved and if different materials can be used. Is the supplier marking up both direct costs and overhead? Overhead may already include a contribution to profit; thus, the supplier is making a profit on profit. Is the markup appropriate given the supplier's cost structure? A supplier may be proposing a higher markup than normal without a commensurate increase in risk.

2.0

Rate of Return The rate of return model is based on recovering all costs plus a return on the required investment. This model can be used when a supplier must invest substantial funds in tooling or equipment. Application of the model involves five steps: Determine the desired rate of return (ROR) on the investment: The desired ROR is a number that is equal to or greater than the organization's required investment return rate. For example, a 15 percent rate of return would be expressed as 1.15 , that is, the investment should return the original investment plus 15 percent. Estimate required investment: This could include tooling, equipment, and additional materials. Estimate sales quantity: This is the estimated volume of units to be produced because of the investment. Estimate unit cost: The unit cost should be a fully absorbed cost including a contribution to overhead and profit. 245

Task 213

Module 2 Calculate the price: The price is calculated using the following formula: Price = [(ROR)(Investment)/(sales quantity)] + unit cost

For example, a supplier is quoting a price on a new part it would like to produce. If the supplier's desired rate of return is 15 percent, the required investment is $150,000, the estimated sales quantity 5,000 units, and the unit cost $80, the price would be: Price = [(1.15)($150,000)/(5000 units)] + $80 per unit = [$34.50 per unit] + $80 per unit = $114.50 per unit This is an all-inclusive price from the supplier, which includes product costs, product markup, tooling investment, and a return on the tooling investment. In this case, the purchaser would want to verify that the desired rate of return is reasonable, that the investment costs are appropriate, and that the estimated sales quantity is realistic. Also, the make-up of the unit cost is subject to investigation. The purchaser can clarify costs by asking for separate quotes for the product and tooling. 3.0 Variable Pricing In some cases, suppliers will temporarily price products based only on their variable costs (see Task 104). Their reasons for doing so may include the following: The supplier is trying to keep its workforce employed during lean times to retain skilled labor. The product is a byproduct of a process and the overhead is already covered. The item is a loss leader, that is, its purpose is to get customers to buy other items. Suppliers are trying to buy the purchasers business today with a plan to raise prices in the future.

A purchaser needs to understand a supplier's rationale for such pricing. Clearly, suppliers cannot absorb the losses caused by variable pricing in the long run. Many factors affect a purchaser's perception of value as it relates to price (value-based pricing). Value can refer to the total benefits or satisfaction ( its utility) that a customer receives from the product or service. Another concept of value is the exchange value or economic value to the customer. This value is based on what the customer's perceived alternatives are. Among the factors that affect a purchaser's perception of value are: perceived substitutes; unique value switching cost; difficulty of comparison price-quality; expenditure size; end benefit; shared cost; fairness; inventory; location or time; and supplier reputation, service, and relationship.

246

Part E: External Relationships C)

Task 213

Price Analysis Techniques Several methods can be used for analyzing price quotations from suppliers, including competitive proposals from other suppliers, comparison with published prices, historical comparisons, and internal cost estimates. These methods are relatively fast and inexpensive. They work best when acquiring industry-standard materials and components. Each method is explained in detail below. 1.0 Competitive Proposals Competitive proposals are used in a competitive market to ensure that prices quoted by suppliers fairly reflect cost, value, and risk. This is often the situation for industry standard products where many companies offer interchangeable products. For the price analysis to work, the conditions for a competitive bid must be met (see Task 108). Competitive proposals may cause problems, however, when the following situations exist: 2.0 The existing contract holder has a competitive advantage due to access to costs and volumes. The specifications are slanted in favor of one supplier. There is a lack of competition ( when demand exceeds supply, the prices may become unreasonable). The use of performance specifications may result in solution proposals that differ significantly, making cost comparisons difficult, if not impossible.

Comparison with Published Prices Publicly available price quotes may exist for some items. One source is regulated prices, such as utility and transportation prices. A second source of information may be the market price established by the transactions between a number of purchasers and suppliers. A third source of information may be advertisements. A fourth source is published catalogs (paper and electronic) that give the suppliers initial asking price. Historical Comparisons Another way to evaluate prices is by comparison with past prices. There are several caveats a purchaser must consider when using historical prices. The past does not determine the future. Market conditions change, sources of supply change, and economic conditions change. Purchase quantities may change over time, which can lead to different prices ( for example, smaller orders generally lead to a higher unit price). The pricing in the past may have been based on one order or on total purchases over a specified period of time. If the item was purchased using competitive bidding, the prices might differ from the prices charged if the item was sole-sourced. Single or multiple sourcing differences may also cause price variation. Start-up costs that have been recovered may be associated with the previous pricing ( such as tooling or equipment investments). 247

3.0

Task 213 4.0

Module 2 Historical comparisons of prices also require the availability of price indexes. Internal Cost Estimates Often cost estimates are needed for new items. Purchasers have three methods for obtaining an internal cost estimate: roundtables, comparisons with similar products, and detailed estimation. Roundtables In a roundtable, representatives from engineering, manufacturing, purchasing, and finance (accounting) are brought together to develop an estimate based on their experience, product knowledge, and market knowledge. Although roundtables are quick and relatively inexpensive, the results are extremely subjective. This technique works best when a quick estimate is needed and the organization has experience with similar products. Comparison with similar products If an organization has experience with similar products, components, or services, the purchaser may be able to use that information in pricing a new product or service. The technique can be done at the cost-element level or at the total price level. Cost-estimating relationships are developed from observations of historical costs and parameters such as weight, speed, area, volume, and density. Purchasers can develop mathematical models (such as multiple regression) to estimate the new cost. The advantages of this approach are that it establishes a baseline for future estimating, it is relatively time efficient, and it is economical. On the negative side, a purchaser must be concerned about comparability of the data used in developing the cost relationships. The technique projects past inefficiencies, requires complex mathematical models, and assumes no major changes in quality or technology. Detailed analysis If adequate time exists, a cost estimate can be derived through a thorough review of all components, processes, and assemblies. This bottom-up approach takes advantage of the fact that small items can be estimated more accurately than large ones, and that errors in estimating individual elements tend to cancel each other out. Data requirements include specifications; delivery quantities and rates; bill-of-materials; purchased component and material prices; drawings; and an understanding of the manufacturing process, quality requirements, time standards, overhead, and profit estimates. Detailed analysis is potentially the most accurate method for estimating the costs for an item. It can also provide a historical base for future estimates. However, detailed analysis is time-consuming and expensive. It requires the efforts of many people and requires detailed specifications.

248

Part E: External Relationships

Task 213

Nonetheless, it yields the best, most complete information for use in negotiating important purchases. 5.0 Discounts Discounts also affect pricing. Common discounts are quantity, trade, cash, and seasonal discounts. Each is described below. Quantity discounts Quantity discounts are price reductions offered in recognition of the lower unit costs associated with larger orders. These reductions may result from manufacturing economies of scale (for example, distributing set-up costs over a longer production run). Other cost reductions may be administrative. For example, an invoice costs the same to process whether it is for $10 or $10,000. Quantity discounts are often reflected as price breaks on the suppliers' price sheets, depending on the quantity ordered. Quantity discounts can be applied in several ways. One approach is to apply the discount only to a specific quantity purchased at one time. The purchaser may want to investigate the feasibility of purchasing the next larger amount to obtain a price break and achieve a lower total cost. This concept is often useful in purchasing transportation, where a lower cost can be obtained by shipping goods in the next higher weight category but at a lower rate per pound. For example, an order to be shipped from Portland to Seattle weighs 3,800 pounds. The published rate is $2.75 per hundred pounds (cwt.) between 3,500 and 3,900 pounds. If shipped as 3,800 pounds at $2.75 per cwt., the total cost would be $104.50. The published rate for 4,000 pounds, however, is $2.50 per cwt. If the 3,800 pound order is shipped as 4,000 pounds, the cost would be 4,000 pounds times $2.50 per cwt., which equals $100. Quantity discounts can also be based on the total dollar value of an order, regardless of the number and quantity of items purchased. Thus, the discount is taken as a percentage of the total value of the order. A third approach to quantity discounting is to base the discount on the total dollars spent with a supplier over a specified time period. This type of discounting can be used with blanket orders or systems contracts. A caution is that the discounts should be immediately payable when earned. Occasionally a supplier will propose payment of discounts months after they are earned. This can cause a loss of discounts if the purchaser changes suppliers. Trade discounts Trade discounts are reductions from a list price that are given to various classes of purchasers and distributors to compensate them for performing certain marketing functions. Trade 249

Task 213

Module 2 discounts are stated in the form 25-10-5, which translates to the retailer receiving a 25 percent discount off the list price, the wholesaler receiving a 10 percent discount off the retailer's purchase price, and the manufacturer's price is five percent below the wholesaler's purchase price. For example, a series discount of 25-10-5, based on a $100 retail price, would yield: Retailer: Wholesaler: Manufacturer: Discount is ($100.00x.25)=$25.00, so the purchase price is $75.00. Discount is ($75.00x.10)= $7.50, so the purchase price is $67.50. Discount is ($67.50x.05)= $3.38, so the manufacturer's selling price is $64.12.

Cash discounts Cash discounts are offered by suppliers to encourage payment within a specified time period. For example, terms of 2-10/ net 30 means that a two percent discount is allowed if an invoice is paid within 10 days; otherwise the full invoice amount is due within 30 days. Cash discounts can provide substantial savings. For example, a 2-10/net 30 discount is equivalent to a 36.5 percent annual interest rate [((365 days per yr)/(20 days))(.02)=.365]. The term 2/10 EOM means the purchaser receives a two percent discount if the invoice is paid within 10 days after the end of the month in which the order is shipped. The purchaser may also be able to get a price discount for prepayment. Seasonal discounts Seasonal discounts are offered to induce purchasers to purchase items during the off-season, for which there is a seasonal demand pattern. The purchaser must determine whether the discount received offsets the increased inventory carrying costs. One way to avoid higher inventory carrying costs is to order the goods in the off-season but not take delivery until later. A variation of this discount occurs when the buying organization takes delivery of the goods during the off-season but does not pay for them until much later. Although price is not discounted, the delayed payment terms are equivalent to discounts. In either case, these seasonal incentives are effective mechanisms for sharing inventory carrying costs.

BIBLIOGRAPHY Wright, B.J. Decoding Payment Terms, Purchasing Today , November 1996, pp. 12-13.

250

TASK 214: Conduct interviews with current and prospective supplier sales personnel.
The act of selling is a complicated one. It dominates the everyday life of most purchasers and must be managed carefully for maximum value. The purchasing and selling interaction and resulting relationships are important to the purchaser and seller. The salesperson is in the position to make a strong business case, identify opportunities, and help the purchaser understand how the purchase of a product or service offered by the selling organization will meet the needs of the purchaser and the purchasers organization. 1) TYPICAL SALES METHODS Salespeople receive considerable training, and organizations spend huge amounts of money on the training and development of sales personnel. When a sales representative is sitting across the desk from a purchaser, he or she is there as part of the selling process. The selling process consists of five phases: prospecting and development, presentation, responding to objections, gaining commitment, and follow through. Prospecting involves evaluating the chances of doing business with an organization. Prospecting can focus on creating leads, on qualifying the business, or on any other activities that help to determine if the organization has need of a product or service. The sales representative will probe for what the purchaser considers important by asking questions and seeking information. The sales presentation must be adaptable to the needs and decisionmaking structure of the buying organization. If a team is involved in the decisionmaking, the salesperson becomes a conflict manager and/or mediator in order to manage the conflict in the team to work toward a decision. The salesperson needs to be able to identify the power source in the decisionmaking process. The presence of a team makes it more difficult to aim the presentation at a particular functional area, making communication more difficult. The objective is to develop trust in the relationship. The techniques salespeople may use in their presentations include: Giving an economic justification of why their product or service is better. Making a point-by-point comparison between their product or service and the competition. Showing how they can meet the purchasers needs identified in the prospecting phase. The purchasers needs may be psychological, as well as for the actual product or service. Focusing on the benefits. Letting the purchaser talk 90 percent of the time (purchasers will tell what it will take to sell to them.) Using testimonials from other customers. Letting the user handle, try on, or use the product.

251

Task 214

Module 2

In order to overcome purchaser objections and concerns, the salesperson must be able to provide facts and qualitative arguments, show value added, and demonstrate the benefits versus the costs. The salespersons job is to enable the decisionmakers to understand how or why the salespersons organization and its products or services should be purchased. Sometimes the sales representative will try to avoid purchasing by going directly to the user. If the user will either design or specify the sales representative's product, the only contact the sales representative wants to have with purchasing is to pick up the purchase order, Techniques that salespeople use for overcoming objections include: Use the yes, but technique. Agree with the purchaser and then offer new information. Question purchasers when they make statements about why they will not purchase or what they do not like about the supplier's product. The objective is to discover why the purchaser feels as he or she does. Restate the objection so the purchaser can hear it. This helps to reduce the magnitude of the objection or allows the purchaser to modify the objection. Tactfully respond directly to the purchaser's statement. It may be necessary to contradict the customer.

To close the sale usually involves pushing the decision maker ahead. The purchaser must be convinced that the supplier's product or service truly will add value to the buying organization. Common closing techniques used by salespeople are: 2) Quit talking and give the purchaser an opportunity to say yes." Offer an added service. Offer a choice. Create a sense of urgency. Lead the purchaser through a series of small decisions that are easier to make rather than one large decision. Ask for the order.

APPROACHES TO HANDLING SALES METHODS The purchaser can take a number of actions to leverage off the salespersons approaches. Responses include the following: Include suppliers on cross-functional teams, as appropriate, to encourage their interest in process improvement in the supply chain. Encourage them to find ways to improve their processes as well as the purchasing organizations. Look for opportunities to transfer liability to a third party, or offer incentives for supplier flexibility and creativity in helping the purchaser reach cost goals. Facilitate the interaction of cross-functional teams between the purchaser's and suppliers organizations. Work with suppliers to ensure they understand your needs and plans for the future, enabling them to serve the purchasing organization better. 252

Part E: External Relationships

Task 214

Provide feedback to the supplier on a regular basis, including all facets of the relationship, not just price, delivery, and quality. Encourage salespeople to be the purchasers eyes and ears in the market place and to regularly contact the purchaser with information and ideas.

3)

TYPICAL ORGANIZATION POLICIES FOR MEETING WITH SALES PERSONNEL Some typical policies regarding interaction with sales personnel are presented below. Individuals performing a purchasing function shall not request or negotiate a special pricing structure from a supplier that the supplier is not willing to offer to other purchasers of goods of like quality and quantity. Giving pricing, technological, or strategic information by an employee of the organization to an employee of the competitor is not only unethical, but is likely to be in violation of one or more of the various antitrust laws and should be scrupulously avoided. In personal contacts with suppliers, each employee represents the organization, and should reflect and present the interest and needs of all departments. Purchasing should be informed of all meetings between supplier representatives and the purchasing organization's personnel. The objective is not to limit interaction between user and supplier but to ensure consistency in the information shared. Any employee who does not have agency authority is not allowed to sign an agreement or letter of intent.

4)

PROFESSIONAL COURTESIES Some examples of professional courtesies that should be extended to suppliers include: Provide a prompt and courteous reception, as well as fair and equal treatment, to all suppliers and their representatives. Provide equal opportunity for all suppliers to make price and specification quotations. Guarantee the confidentiality of all specifications and price quotations. Decline to take advantage of supplier's errors and show consideration for supplier's difficulties by cooperating whenever possible. Avoid putting the supplier to unnecessary expense or inconvenience on return goods. Explain as clearly and fully as possible to suppliers the reason for rejection of their bids/proposals. Keep suppliers informed about organization products and methods.

BIBLIOGRAPHY Baker, J.R., L. Buddress, and R. S. Kuehne. Policy and Procedures Manual for Purchasing and Materials Control, 2nd ed., Prentice-Hall, Englewood Cliffs, NJ, 1992. 253

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Baker, T., G.L. Hopper, and T.V. Freese. Don't Look Now, But Knock, Knock, Purchasing Today, June 1999, pp. 14-15. Drozdeck, S., J. Yeager, and L. Sommer. What They Don't Teach in Sales 101, Boardroom Reports, April 15, 1992, pp. 5-6. "The Sales Process, Online Women's Business Center, www.onlinewbc.org/docs/market/mk_sales_ process.html. Williams, A.J. Interfunctional Coupling: Implications for the Selling Process, Proceedings of the 1994 International Purchasing Conference, NAPM, Tempe, AZ, 1994.

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TASK 215: Coordinate/review/respond to supplier inquiries, protests, and appeals.

In the course of daily business, purchasing is called upon to coordinate, review, and respond to supplier inquiries, protests, and appeals. A supplier inquiry is an effort by the supplier to obtain information from the purchasers organization. A protest is the objection by a supplier to an action taken or decision made by purchasing. An appeal is an effort on the part of the supplier to overturn or modify purchasings response to a protest. 1) PROCEDURES FOR DEALING WITH INQUIRIES AND PROTESTS Purchasing receives both written and oral inquiries from suppliers on a continual basis. Most of these inquiries are an effort by the supplier to obtain information and have no further implications. For example, a supplier may be seeking information about future plans for acquisitions, or may need clarification on a bid or proposal for a pending purchase. On the other hand, the supplier may be seeking information about a purchasing action or decision so the supplier can determine whether or not it agrees with the action or decision taken by the purchasing organization. Regardless of the reason for an inquiry, purchasing should review and respond to each in a timely manner. The purchasing organization should have clearly defined policies regarding the types of information it can make available to suppliers and what information must be kept confidential. Often , purchasing must coordinate with other departments ( for example, with the customer for technical information or with the legal department for legal advice) before responding to an inquiry. If the inquiry concerns a pending purchase, the purchaser must ensure that all prospective suppliers receive the same information to keep an even playing field. Therefore, this type of inquiry may result in an addendum to a pending bid document. Many organizations have a protest process in place by which a supplier can object to a purchasing action or decision. In the private sector, this process is established by company policy. In the public sector, it is established by statute or administrative rule. It is a process more commonly found in the public, rather than the private, sector. Typically, when an organization has a protest process, it requires the supplier to object in writing to a purchasing action or decision within a specified timeframe and to include with the written objection any substantiating evidence. For example, a supplier may disagree with purchasings decision to award a contract to its competitor and may file a protest in an effort to get purchasing to change its decision. Usually, any such objection is directed to the head of purchasing, who reviews and responds in writing to the objection within a designated timeframe. Some organizations, mostly in the public sector, have an appeals process by which a supplier can appeal the decision from the protest process. In such a process, the supplier is allowed to 255

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appeal the decision in writing and to provide evidence to a higher authority, or an established appeals board, within a specified timeframe. The higher authority or appeals board reviews all the evidence from both the supplier and purchaser and issues a written decision within a designated time. The decision is binding and final. The private sector typically uses a dispute resolution process if things get to this stage (see Tasks 115 and 117). Sometimes the protest/appeals processes cause a delay in the procurement process. If the acquisition or project is time-sensitive, this delay may have a detrimental affect on completion and costs. Therefore, it is essential that steps in the processes are executed as expeditiously as possible. 2) LEGAL REQUIREMENTS A) Freedom of Information Act Federal, state, and local governments have statutes regarding freedom of information. In essence, these acts say that in the conduct of public business all information is public except in very narrowly-defined circumstances. This allows any member of the public (both private citizens and businesses) to obtain complete information (including bid prices) about all government activities and decisions. Often, a request for information by a member of the public must be in writing, but the government is required to respond with complete information. It may, in some instances, charge for copy and administrative costs, but these are usually nominal charges. Freedom of Information Acts makes public all information in the purchasing process (unless classified for security reasons). As a result, the public purchaser may be required to provide complete information on the process and decision activities on the winning bid to losing bidders. Therefore, it is critical that the purchaser adheres to written procedures and documents at each step of the process and when making each decision. BIBLIOGRAPHY Casper, W. A. The Public Procurement Code: What It Can Do, NAPM Insights, January 1994, pp. 38-40.

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TASK 216: Develop/implement a small business/disadvantaged supplier development program.

Minority purchasing initiatives, sometimes called socially and economically disadvantaged supplier programs, and women-owned business programs continue to grow in the United States. Organizations have undertaken minority- and women-purchasing initiatives for a number of reasons, including government legislation, social responsiveness, the development of alternate sources of supply, the need to increase market share, and the need to meet the demands of their customers. Organizations that have made a commitment to purchasing from minority and women suppliers typically have specific policies for dealing with them. In general, a minority-owned business is defined as one that is at least 51 percent owned, controlled, and operated by an ethnic or racial minority group member. A woman-owned business is defined as one that is at least 51 percent owned, controlled, and operated by one or more women. Government definitions of minority- and women-owned business classifications vary, as do program guidelines. Also laws, regulations, and definitions continue to undergo change and updating. Consequently, purchasers should use care when implementing programs and when communicating information about guidelines to others. It should be noted that the National Minority Supplier Development Council approved a change creating a new category of company that can keep its minority status while accepting equity funding from other sources. The percent minority-owned can now fall to as little as 30 percent under a set of strict guidelines. 1) SOURCES OF INFORMATION ON SOCIALLY OR ECONOMICALLY DISADVANTAGED SUPPLIERS/HISTORICALLY UNDERUTILIZED BUSINESSES A) Small Business Administration (SBA) PRO-NET The SBA has a computerized directory of small (SB) and small disadvantaged business sources (SDB). This directory is officially known as PRO-NET. It contains information on more than 75,000 small, minority, and women-owned businesses. PRO-NET is an electronic gateway to procurement information for and about small businesses. It is a search engine for contracting officers, a marketing tool for small organizations, and a link to procurement opportunities and important information. To access the PRO-NET database, log on to www.pro-net.sba.gov.

B)

Minority Business Directories TRY US To many purchasing professionals, TRY US is the best known, as well as the most widely used, minority business directory. The 2000 edition of the TRY US National Minority Business Directory contains more than 8,000 certified minority sources, listed by both commodity and by state. It is published by TRY US Resources, Inc., and is available in book or disk version. Visit the TRY US web site at www.tryusdir.com. 257

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Module 2 Minority Business Information Resources Directory (MBIRD) This directory is also published by TRY US. This directory supplies a list of all 38 Minority Purchasing Councils, all five Minority Business Development Center Regional Offices, all 71 Minority Business Development Centers, all 10 SBA Regional Offices, the 87 SBA District Offices, and a list of 56 Small Business Development Centers. It also contains a comprehensive list of all minority business directories in the country. TRY US National Womens Business Directory This directory lists more than 2,000 certified women owned businesses. Visit the TRY US web site at www.tyrusdir.com. National Association of Women Business Owners (NAWBO) - This organization publishes a directory that is currently available only to its members. This group states that there are more than 8,000,000 women-owned businesses in the United States. Visit their Web site at www.nawbo.org. National Directory of Minority-Owned Business Organizations This directory lists more than 37,000 minority-owned organizations. It is published by Business Research Services, Inc. in Washington, DC. Visit their Web site at www.sba8a.com. National Directory of Women-Owned Business Organizations Lists more than 19,000 women-owned organizations and is published by Business Research Services, Inc. Womens Business Enterprise National Council (WBENC) This organization provides information on certified businesses through an Internet database WBENCLink. The council states there are more than 9.1 million womenowned businesses generating $3.8 trillion in sales. The WBENC list currently has more than 1,600 certified women-owned businesses. Visit their web site at www.womenconnect.com/wbenc.

C)

Minority Business Development Councils The National Minority Supplier Development Council (NMSDC) has 38 Minority Purchasing Councils in the country. These councils are funded by more than 3,500 majority-owned concerns, including more than 150 of the top Fortune 500 companies. They commit more than $36.1 billion annually to minority-owned concerns. Council membership includes more than 15,000 certified minority-owned concerns. The primary tasks of these councils are the certification of minority business suppliers; the referral of corporate purchasers to minority supplier; support in developing, expanding, or promoting corporate minority purchasing programs; dissemination of information; training and technical assistance; and maintenance of corporate and supplier directories and other publications. Visit NMSDCs web site at www.nmsdcus.org for more information. Local minority chambers of commerce Local minority chambers of commerce include the Asian Business Association, the Black Business Association of Los Angeles, the Miami-Dade Chamber of Commerce, CHAMACO, the Latin Business Association, the U.S. Hispanic Chamber of Commerce, and the National Black

D)

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Chamber of Commerce. For contact information for these and other associations, look in the Encyclopedia of Associations available at a local library. E) Business fairs (trade fairs) Many entities, including cities, counties, states, individual companies, womens organizations, and local minority purchasing councils conduct business fairs.

2)

SMALL BUSINESS/SMALL DISADVANTAGED BUSINESS (SB/SDB) REQUIREMENTS The legislative history of minority business development in the United States can be traced back to 1968, when the Small Business Administration established a program to channel federal purchases to socially or economically disadvantaged owners of small businesses. In 1969, the U.S. Office of Minority Business Enterprise was established within the U.S. Department of Commerce to mobilize federal resources to aid minorities in business. In 1978, Public Law 95507 mandated that bidders for federal contracts in excess of $500,000 for goods and services and $1,000,000 for construction submit, prior to contract award, a plan that includes percentage goals for the utilization of minority businesses. In 1983, President Ronald Reagan signed Executive Order 12432, which directs all federal agencies to develop specific goal-oriented plans for expanding procurement opportunities to minority businesses. The Federal Acquisition Streamlining Act established five percent government-wide agency goals for small disadvantaged business and five percent goals for women-owned business.

3)

ISSUES IN DEVELOPING PROGRAMS A) Organizational policies Most organizations have an SB/SDB statement in their policy manuals. The SB/SDB policy statement may include the following components: purpose of the program definition of a SB/SDB scope of the program objectives and benefits of the program responsibility of the organization toward the SB/SDB exceptions to the program execution strategies and tracking methodologies reporting procedures the person in the organization who has the responsibility for coordinating the program

The CEO or some other top executive of the organization generally signs the policy statement. Most organizations also have a separate SB/SDB procedure in their procedures manuals. Many organizations also have a designated minority-supplier coordinator to deal with SB/SDB businesses. 259

Task 216 B)

Module 2 Impediments Some organizations may encounter varying degrees of hostility, as well as active or passive resistance, to SB/SDB efforts. Prejudicial attitudes should be overcome through education and training. Another impediment to the SB/SDB initiative is a lack of purchaser training in minority business matters. This can be alleviated through seminars, networking, associations, leadership, and guidance from the minority supplier coordinator. Benefits Establishment of an active SB/SDB initiative enhances an organizations image with the community, and with its minority and female customers. It will also help organizations that are government contractors meet government requirements. If an organization is in a consumer-based business or supports such a business, image is very important to the organization and to the bottom line. Assessing program goals Accurate assessment of initiative goals should begin with the proper coding of the supplier base, which lists all the organizations large, small, minority-, and women-owned suppliers. Periodic reports of all supplier activity within these categories should be generated, to compare goals with actual performance and to take corrective action where goals are not being met. Customer-driven requirements Due to the demographic changes in the United States today, SB/SDB initiatives are becoming more market driven than compliance driven. With more than 3.2 million minority businesses and 9.1 million women-owned businesses in the United States, consumer-related businesses and those that sell to them are very conscious of the changing demographic of the consumer base, and the need for inclusion of minorities and women-owned businesses in the procurement process.

C)

D)

E)

BIBLIOGRAPHY Auskalnis, R.J., C.L. Ketchum, and C. R. Carter. Purchasing From Minority Business Enterprises: Best Practices, Center for Advanced Purchasing Studies, Tempe, AZ, 1995. Nesby, T. and A. Yeater. Creating an MBE Supplier Program, NAPM InfoEdge, (1:10), April 1996.

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TASK 217: Represent the buying organization in meetings with corporations, government agencies, professional associations, media, and other organizations.
1) MEETING DYNAMICS The professional purchaser will be involved in many types of meetings with suppliers, staff, and professional organizations. Many purchasers also make presentations at professional conferences, to top management, and to suppliers. It is important that the purchaser know how to run an effective meeting and make an effective presentation. A) Effective Meetings To ensure productive meetings, the following actions are required before, during, and after the meeting. Before the meeting: - Have a clear purpose and desired outcome of the meeting. - Provide an agenda in advance. - nvite only those individuals who are needed to achieve the desired outcome. - Make sure the necessary supplies and equipment are available (flip chart, white board, overhead projector, markers, laptop computers, and LDC). During the meeting: - Clarify meeting purpose and desired outcome with the participants. - Encourage participation by everyone. - Start and finish on-time. - Do not dominate the meeting. - Record the ideas generated, solutions proposed, and recommendations made (on a flip chart, overhead transparency, white board, or computer). - Assign responsibilities and set deadlines. After the meeting: - Distribute the minutes in a timely fashion. - Follow up on decisions made.

B)

Effective Presentations Often the professional purchaser will be called upon to present proposals, report on projects to other members of the supply management team, and make presentations at professional conferences and to top management. Effective communication requires anticipation of difficulties and the ability to adapt the presentation to that environment. More specifically: It considers the communication objective, the subject, and the audience. It recognizes the factors affecting the environment in which the communication is to take place, and what the sender and receiver must do to overcome any distractions. It recognizes the importance of selecting the appropriate medium. 261

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Module 2 Presentations offer the advantage of gathering all participants together in a decisionmaking process. Presentations can be used to: Ensure uniform understanding. Help reach group consensus. Obtain a group reaction to a situation. Identify or solve a problem. Obtain group approval or acceptance of a program, idea, or plan. Resolve conflicts. Assign responsibility.

There are seven steps to an effective presentation. Step 1. Define the objective What is the focus of the presentation? What does the presenter wish the audience to know, believe, or do as a result (the objective lies outside of the presentation itself; it is audience-centered, not presenter-centered)? Step 2. Analyze the audience - Know the audiences background and their general level of understanding of the topic. - Know the disposition of the audience. This refers to the audience's attitude toward the presenter and the topic. - Put yourself in the audience's position. Step 3. Plan the presentation tactics - Decide if one presentation or several is needed. - Decide on length and timing. - Determine who should attend. - Plan how to overcome identifiable obstacles. Step 4. Organize the presentation - The opening should generally be strong and should convey basic information the audience has a right to know, including: identification of the presenter, including professional background; the presenter's subject and objective; the scope of the presentation; the criteria on which the issue will be decided; and what is expected of the audience. - The main theme is the basic information the presenter wants to get across to the audience. - The ending and how it is structured usually depend on the subject and the objective. Step 5. Prepare the script - Avoid unnecessary jargon. - If unfamiliar terms are necessary, define them along the way. - Dont use acronyms. They are short forms of jargon. - Consider the details. Too little detail will confuse; too much will be tedious. - Come to the point quickly. - Do not emphasize differences between you and your audience. 262

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- Maintain unity. Make one point per visual aid. - Keep visual aids simple. - Use detail in visual aids sparingly. The speaker provides the details. - Keep all visuals in one presentation consistent in design. - Make visuals readable by using bold, large type. - Integrate audio and visuals. Let each channel do some of the work. Step 6. Consider the physical factors that may affect the audience in a particular room (for example, temperature, size, shape, acoustics, air circulation, ability to darken the room, seating arrangement, or needed sound amplification). Step 7. Deliver the presentation - Remember that its acceptable if you're not perfect. - Be yourself. - Engage your audience by using eye contact and involvement. - Be energetic. - Be empathetic with the audience. - Be aware of distractions. Repetitive body movements can become distracting, and should be avoided. This includes playing with objects and adjusting a microphone. - When things go wrong, keep going.

2)

ASSOCIATIONS In the United States, there are more than 7,600 active national trade associations, professional societies, technical organizations, and labor unions. A) Trade associations Nearly every industrial, commercial, and government activity has its own trade association. Associations typically lobby for the interests of the industries they represent. They also frequently make contributions to political campaigns. Examples of trade associations include the American Insurance Association, the American Paper Institute, the National Electrical Manufacturers Association, and the National Association of Realtors. Professional associations Professional associations are groups of individuals within an occupation who seek to advance the cause of their profession through evaluation, training, the exchange of ideas, and accreditation. Examples of professional associations are the American Medical Association, the American Bar Association, and the American Institute of Certified Public Accountants. Purchasing is recognized as a profession, and purchasing associations are appropriately classed as professional associations. These associations are organized in a number of countries around the world. Most provide regular meetings and special programs where members get together, exchange ideas, learn new techniques, and engage in real learning experiences.

B)

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Module 2 The better-known purchasing management associations in the United States include the Institute for Supply Management , the National Institute of Governmental Purchasing, the National Association of State Purchasing Officials, the California Association of Public Purchasing Officials, the National Contract Management Association, the National Association of Educational Buyers, and the Newspaper Purchasing Management Association. Major purchasing management associations outside the United States include the International Federation of Purchasing and Materials Management, the Purchasing Management Association of Canada, the Chartered Institute of Purchasing and Supply (Great Britain), the Institute of Purchasing and Supply Management (Australia), the Irish Institute of Purchasing and Materials Management, and the Indian Institute of Materials Management, to name a few.

3)

ISSUES IN THE EXTERNAL ROLE AND PERCEPTION OF PURCHASING Purchasing contributes heavily to the shaping of an organization's image, because it is responsible (along with sales) for most of an organization's contacts with the business community. Good supplier relations contribute to the formation of a good public image. Relations can be enhanced through fair and courteous treatment of salespeople, the preparation of orientation booklets for suppliers who call on purchasing departments, the establishment of definite policies on competitive bidding, the testing of samples offered by the supplier, and periodic visits to major suppliers.

4)

OTHER ORGANIZATIONS A) Group Purchasing Organizations (GPO) The term GPO is found primarily in the healthcare sector. In the public and educational sectors, the more common term is cooperative purchasing. Cooperative purchasing is an approach in which several organizations form or use a centralized buying service that purchases specified types of items for all members of the group. The resulting volume buying usually produces significant cost savings for group members. The purchaser usually represents the buying organization and provides information to the GPO or cooperative. Purchasers have a responsibility do what is best for their organizations but, if they belong to a cooperative or GPO, they have responsibilities to the GPO as well. The GPO has represented its members in good faith to suppliers. The members have a responsibility to use the cooperative or GPO where appropriate. It is not appropriate to use the cooperative contract as a lever against the supplier to avoid using the cooperative. By so doing, the purchaser undermines the cooperative's credibility and reduces its effectiveness (see also Task 107).

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Part E: External Relationships 5) ANTITRUST RESTRICTIONS

Task 217

Purchasing professionals should be careful not to disclose or discuss topics in meetings that would violate antitrust law. This deals specifically with pricing and with other relationships with suppliers (see Task 108). 6) PROFESSIONAL DECORUM Professional decorum can be difficult to describe. What is considered acceptable in one sector or industry in the United States may not be acceptable in another. The subject is further complicated when discussing professional decorum within and across various cultures. The first principle and standard listed in the ISM Principles and Standards of Ethical Supply Management Conduct With Accompanying Guidelines offers some insight into this topic. The standard reads, Avoid the intent and appearance of unethical or compromising practice in relationships, actions, and communications. Further comment reminds the purchaser that the results of perceived impropriety may become, over time, more disruptive or damaging than an actual transgression. It is important to avoid any activity or involvement between purchasing, current and potential suppliers, and the customers of purchasing that in any way diminishes, or appears to diminish, open and fair treatment. Purchasers must consider potential and actual conflicts of interest, choose meeting locations wisely, and use care when developing personal relationships with suppliers and others with whom they do business. Business courtesy and sound business practice are important to the purchasing and supply professional (see Task 119 for a discussion of ISM's Principles and Standards of Ethical Supply Management Conduct). 7) FEEDBACK TO MANAGEMENT In 1997, A.T. Kearney asked top CEOs what they felt were the most important concerns for businesses. The top five responses were: customer relationships cost competitiveness effective use of information technology managing change shareholder value

Purchasers should identify managements concerns, and develop information and messages using the language of management. This is likely to ensure more effective communication, and may help management understand the value of purchasing and supply management. Communication with management can be either oral or written. For oral presentations, see the guidelines for effective presentations in Section 1 of this task. Following are some things to keep in mind when making written reports: 265

Task 217

Module 2 Be concise in written communications, including e-mail. Use proper grammar and spelling, even in e-mail. An opinion may be formed of a purchaser and his or her skills based on the purchasers writing ability. Focus on strategic aspects, instead of the operational details. Support the analysis with facts. Use tables and graphs to get a point across. Use a standard format for presentations and reports: problem identification, alternatives, recommendations, and then supporting analysis. Use the language of management when communicating with senior-level people.

Some general guidelines for communicating orally or written with top management include: If presenting a new idea, concept, and/or method, thoroughly research the subject. Understand who the decision makers are and what their objectives are. Fit the communication style to the personality of the decision maker. Use language that mirrors the decision maker's way of thinking. Understand the organizational politics involved. Try to develop relations with the decision maker or the decision maker's staff in advance to pre-sell the proposal.

BIBLIOGRAPHY Gettinger, M. The Language of Senior Management A Whole New Way of Communicating, Proceedings of the 1999 International Purchasing Conference, NAPM, Tempe, AZ, 1999, pp. 211-215. Wining, C.L. Straight to the Top, Purchasing Today , February 1997, p. 8.

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MODULE 3: VALUE ENHANCEMENT STRATEGIES

TASK 301: Conduct decisions to make-or-buy, privatize, or outsource products or services.

Make-or-buy decisions often arise in an organization and purchasing should play a critical role in the decision process. A make-or-buy decision involves the choice of whether the organization should directly buy an item from a supplier or acquire the raw materials, components, and/or equipment to make it inhouse. Similarly, an organization must consider whether to have required services, such as security and maintenance, performed by employees or by an outside supplier. An alternate form of the decision, outsourcing, is very popular today. This involves analyzing the use of an outside organization for (1) making an item instead of producing it in-house, or (2) eliminating a production or service activity in the organization by having an outside organization perform the activity. For example, American automobile manufacturers outsourced many processes during the 1980s, such as car seats. Traditionally the automobile manufacturer would purchase raw materials, assemble the seats, and place them into cars. Although the car seat operation was divested, the automobile manufacturer continued to use output from the same plant, but purchased completed seats from the outside supplier. Many activities are candidates for outsourcing, including information systems management, software programming, facilities management, and fleet services. Many organizations are turning over their office goods, parts, and tools operations to integrated suppliers who manage the purchasing, inventory, and disbursement of such items (see Task 107 for a discussion of integrated supply). Privatization has received increasing emphasis in selected governmental jurisdictions and subdivisions. The concept can be controversial and politically charged. Privatization is defined as the partial or complete transfer of control over government-owned assets to the public or private sector organizations. It is the act of transferring responsibility for selected government functions and services to the private sector. 1) PROCEDURES FOR CONDUCTING MAKE-OR-BUY ANALYSIS A) Determining feasibility The first step in a make-or-buy analysis involves determining the feasibility of the idea. Is it possible for the organization to make the product or provide the service? To do so requires equipment, personnel, material, space, supervision, overhead, maintenance, taxes, insurance, and other costs. Inability to meet these requirements would favor a buy decision, which involves lower investments in facilities; smaller labor forces; lower plant costs; reduced overhead, taxes, and insurance; and less supervision. For most service, institutional, and government organizations, it is usually not feasible to manufacture a needed item. Determining need The organization also must determine need. What is to be bought? In what quantities? What part or parts can be manufactured by the organization and what

B)

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Module 3 can outside suppliers produce? Similarly, what services can be rendered most effectively by the organization and which ones by outside suppliers?

C)

Methods/processes The basic approach to make-or-buy analysis involves determining the total of all costs to the organization with and without the product. After dependability of supply, cost is usually the overriding factor in a make-or-buy decision. Can the part be made less expensively or faster than it can be purchased? To answer this question, the incremental costs for that individual organization must be analyzed and compared. 1.0 Analysis of components All cost components must be analyzed, including direct costs of materials, labor, energy, overhead, transportation, inventory, quality, obsolescence, disposal costs, and capital costs. Break-even analysis Because volume is an important consideration in a make-or-buy decision, the use of a break-even analysis is advantageous. It can show at what volume one system of activity might be more economical than another. It also shows at what volume of production the organization will stop incurring losses and begin producing profits from the activity. Cost estimation processes The purchaser needs to make sure the estimates reflect any additions in space, equipment, inventory, and labor that will be required with each option. 3.1 Buying costs Costs that should be considered when buying include price, shipping, receiving, inventory, transaction costs, and additional costs incurred from quality, delivery, or service problems. Making costs When considering the costs of making, include all of the buying costs plus labor, scrap, equipment, design documentation, and disposal costs.

2.0

3.0

3.2

2)

FACTORS INFLUENCING MAKE-OR-BUY DECISIONS A number of strategic and management factors enter into the make-or-buy decision. These factors include: A) Long-term supply implications Once an organization is committed to making a product or rendering a service itself, an element of inflexibility is introduced into the procurement process, particularly when the operation requires special tooling or equipment. Freedom of selection in the procurement process is therefore sacrificed. The assurance of supply that is gained must be considered against the loss of alternative sources for the needed product. The purchaser should also consider the ability (or inability) of the purchasing organization or the supplier to obtain necessary materials over time.

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Task 301

Strategic factors An overriding factor in a make-or-buy analysis is the organizations desire to be involved in the business activity in question. On one hand, an organization might seek to make a product because such an activity may give it a technological edge in a new product area that it would like to pursue. On the other hand, the activity might not represent a strategic advantage, or it might be outside of the organizations area of core competency, and would be better avoided. Labor and other organizational constraints The availability of a stable and trained workforce to perform the needed work favors a make decision. This is particularly true in times of business decline, when there is excess capacity in the plant, or when the organization is trying to avoid layoffs. But if the decision to make the component or service involves an increase in staff and capacity, the organizations management will need to consider recruitment and training of the new personnel, competitive labor rates, union pressures, personnel benefits, and any additional requirements for maintaining the operation. Quality considerations When the quality requirements for a particular product or service are extremely tight and very close control is required, many organizations traditionally have found it advantageous to make instead of buy. Today, this is not always the case. Many suppliers effectively compete on the basis of meeting strict specifications for individual customers. In fact, obtaining better quality may be a factor in deciding to produce outside the organization. Risk An organization that chooses to make a product must face the hazards of business and changing economic conditions factors over which it will have little control. Such factors include cyclical and long-term trends in the industry for the product to be made, changes in demand, technological advances, and unpredictable factors, such as government regulations, tax policies, and international conflict. Risk also includes the loss of skills and knowledge that can happen in some outsourcing situations, and the potential disclosure of confidential or proprietary information. Supplier technical support capability A buying organization may not have the expertise to make or acquire certain critical components of a product it is seeking to produce. In such circumstances, buying the component from current or potential suppliers will be advantageous. Socioeconomic goals/objectives Should small and minority suppliers be considered? Are suppliers in the community operating below capacity? Expertise in the area It is possible that only the organization has the technological ability to manufacture a component. Is it feasible or practical to work with a supplier? Can the supplier gain the expertise necessary in the time required? Assistance in development Outsourcing may make additional design and engineering talent available. Using a combination of internal and external personnel with special knowledge, skills, or experience might assist in development efforts. 271

C)

D)

E)

F)

G) H)

I)

Task 301 J)

Module 3 Speed to market Outsourcing to suppliers with available capacity in marketing, design, and manufacturing may be the fastest way to get a product ready for market (see Task 101 for a discussion of conditions leading to decisions to buy).

3)

POST-AUDIT EVALUATION OF MAKE-OR-BUY DECISIONS Organizations increasingly use post audits of make-or-buy decisions to determine if they realized the expected results or financial returns. This post-audit process either results in a satisfactory analysis, a fine-tuning of the details of the decision, or a reversal of the decision.

4)

PRIVATIZATION/OUTSOURCING A) Definition Privatization is the partial or complete transfer of control over government-owned assets to the public or private sector firms. It is also the act of transferring responsibility for selected government functions and services to the private sector. Privatization is the transfer of public service delivery to private suppliers (e.g., a municipality hires a sanitation contractor instead of maintaining its own sanitation department). Privatization also refers to the transfer of government-owned enterprises to private investors. B) Applicability Because there are more than 80,000 government entities in the United States (one federal, 50 state, and the remainder local), privatization is widely applicable to the public sector. Competition, as provided by the private sector, is healthy and often makes government agencies more responsive. Privatization is a worldwide trend and has been pursued vigorously in the international arena. Outsourcing refers to a version of a make-or-buy decision, whereby organizations practice buying goods or services that previously were part of their own responsibilities. As organizations downsize and they start to examine the value added by internal functions, many such functions are being outsourced. Examples include graphics, janitorial services, computer support services, and cafeteria operations. Privatization and outsourcing involve examining a number of key questions: Is the process or function part of the organizations core capabilities? What type of supplier relationship is needed? How much will be saved in direct and indirect costs? What is the current level of integration with other parts of the organization? What type of delivery, quality, capacity, price, and service level must the supplier provide? Are there any intellectual property issues that need to be considered? Will the privatization or outsourcing decision affect current union-represented employees? 272

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Procedures for conducting the decision Outsourcing increased dramatically as a trend in the mid-1980s. Because it extends to much more than the traditional make vs. buy decision related to production materials, many organizations are starting to adopt procedures for conducting a sound outsource decision. Basic procedural steps for conducting an outsourcing decision might include any or all of the following: Select a team. Identify the organizations cost structure. Develop a draft agreement (including the expected term, statement of work, and other information). Select the appropriate procurement methodology. Obtain and analyze information from suppliers. Select supplier and manage transition. Measure and evaluate performance. Identify successes and problems. Enhance steps for next project.

D)

Criteria Seven criteria drive privatization and outsourcing initiatives: 1.0 Cost An accurate and comprehensive cost analysis is a basic part of any decision to privatize or outsource a current operation. Due to competitive marketplace pressures, private suppliers may be more efficient, thereby providing services more quickly and at a lower cost. Technology Private suppliers may be able to offer more advanced technology (because they are not subject to the vagaries of the budget process to the same degree as government entities), and may serve larger territories. In terms of outsourcing, it is important to consider that the process to be outsourced may include strategic or core technology that should be kept confidential or in-house. Investment Decisions to privatize and outsource need to be considered from two perspectives that of the purchaser and that of the supplier. From the purchasers perspective, a decision to privatize or outsource a function currently performed in-house will need to include consideration of present facilities. Is there a function for the equipment no longer in use? Is there a market for it? Can the vacated space be used in a more productive manner? On the other hand, the purchaser should consider the likelihood that the outside supplier may be able to invest in better equipment and facilities. Service level (flexibility) Part of any decision to outsource or privatize should be the ability to respond better to customer needs. If the outsourcing of a service or product line will increase flexibility, outsourcing should be

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Module 3 considered. Outside contractors can also offer different service levels at different rates more readily than government agencies. 5.0 6.0 Differentiation Private suppliers may have the ability to provide levels of service differentiation not available to government entities. Quality The ability to maintain and ensure an acceptable level of quality will be an important decision that can tip the decision to outsource or maintain a process in-house. Political considerations In many public organizations, outsourcing to businesses in the community can often be a factor, though not the controlling one. The criteria mentioned above must be considered and, if a task can be accomplished on a less-costly basis with equal benefits, then outsourcing or privatization may be an option. Many public/governmental functions such as public transportation, incarceration facilities, and utilities can be viable candidates for outsourcing or privatization. The prime factors are total life-cycle cost to the taxpayers, and the level of service or product received. Some functions of the public sector, such as police protection and the courts must remain in governmental control. On the public side, the desire of taxpayers for less government involvement may play a more dominant role than economics in the decision process.

7.0

E)

Monitoring/evaluating the project The need to evaluate whether or not the organization attained the benefits expected from an outsourced project is crucial; however, some field surveys have indicated that few organizations conduct this type of analysis on an ongoing basis. Public/private partnerships Government agencies and private organizations may work together to provide a service. Examples may include health services, public educational services at private schools, and toll roads or bridges run by private companies.

F)

BIBLIOGRAPHY Karoway, C. Outsourcing Purchasing Responsibilities, NAPM Insights, July 1995, pp. 54-56. Miller, M. Making the Transition, Purchasing Today , September 1996, pp. 33-34. Patton, M.G. Outsourcing A Strategy Whose Time Has Arrived, Proceedings of the 1999 NAPM International Purchasing Conference, NAPM, Tempe, AZ, pp. 211-216. Ore, N. A Clear View of Outsourcing, Purchasing Today , September 1996, pp. 28-31. Prod, G. Avoiding the Pitfalls, Purchasing Today , September 1996, pp. 36-38.

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TASK 302: Conduct decisions to lease or buy equipment.

A lease is a contract in which one party (the lessee) has use and possession of an asset owned by another party (the lessor) for a period of time in return for a monetary payment. The lessee makes scheduled payments (usually monthly) to the lessor. The lessor typically makes a profit on the difference between the rental payments and the cost of asset ownership. Lessees do not own the assets, but are permitted to claim rental payments made on such assets as expenses on the organizations income statement. At the end of the lease term, the lessee may have the option to purchase the asset, return it to the lessor, or renew the lease for a longer time period, depending upon the lease contract and needs at that time. The lessee could be an organization of any size, providing a product or service in the public or private sector. 1) TYPES OF LEASING ARRANGEMENTS The major types of leasing arrangements are: A) Operating lease This type of lease is used by organizations to satisfy internal customer needs or help facilitate business operations. Most often, these types of leases satisfy short-term requirements, and are used for a period of time considerably shorter than the assets useful life. They are used when capital intensive equipment is required for short periods or is subject to rapid obsolescence, and when the leasing organization is not interested in owning the equipment. Rental of an automobile for a week, or rental of a copier to support short-term conference needs are examples of this type of lease. Financial lease This type of lease runs for the full life of the equipment, and is typically entered into for financial considerations when the lessee seeks to gain financial leverage and related long-term financial benefits. A financial, or capital, lease is represented as an asset on the lessees books. There are three major types of financial leases: 1.0 2.0 Full payout With this type of lease, the lessee pays the full purchase price, plus interest charges, maintenance, insurance, and administrative costs. Partial payout This type of lease gives the lessee credit for the residual value of the leased item after the lease period is completed. The lessee pays the difference between the original purchase price and the resale value, plus interest charges. A typical automobile lease is an example of this kind of lease. Lease/purchase Under this type of contract, the lessee has the option to purchase the equipment at the end of the lease, or at specific time intervals. Typically, this option is exercised at the end of the lease. The purchase price is representative of the residual value of the asset. It may be determined at the outset, or may be based on market value at the time the asset is purchased.

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Module 3 Purchasing an automobile at the end of a three-year lease is an example of this alternative.

C)

Leveraged lease A leveraged lease is one that involves a third-party lessor that buys the asset from an equipment producer and leases it to another organization. Such leasing arrangements become available due to unique tax arrangements and borrowing power the lease provides the lessor. Typical lessors are large investors, such as insurance companies, pension funds, or investment groups. The lenders debt is primarily secured by an asset and to some extent by the financial capacity of the lessee. Master lease A master lease is similar to a blanket order contract. It uses predetermined and negotiated terms and conditions for various equipment leased over a given period. A master lease is more applicable for operating type leases when needs are for shorter periods. It allows the purchaser to negotiate set terms and conditions, and, when different short-term needs arise, to merely negotiate price and length of use. In addition, a purchaser could negotiate rates for a category of equipment and extend master lease terms to all the equipment. For example, if an organization agrees to lease forklift trucks from a local equipment dealer, terms and conditions of the standard lease might also apply to pickup trucks. Dry lease/Wet lease These types of leases originated in the aircraft industry, and address the amount of service provided under the contract. A dry lease provides only for financing and is often called a straight lease. A wet lease includes not only financing, but also fuel and maintenance for the piece of equipment. Sale and leaseback In a sale and leaseback arrangement, the owner of the equipment or property sells the asset to a second party and then leases it back. The primary reason for this type of lease is to generate capital. Proceeds from the sale of the equipment or property can be put to alternate uses, while the asset continues to be used on a leased basis. This method provides a good way for an organization to obtain needed capital, while maintaining the use of the asset. Other leasing considerations Methods of leasing vary greatly and are limited only by the ability of the manufacturer or other lessors marketing creativity. Offers such as pre-trading automobiles, or leasing of land and buildings for long periods all carry the same fundamental principle. The lessor seeks to increase the sale of equipment and/or make a profit on the difference between the cost of the asset and the payments received, while the lessee seeks to minimize cash outlay. The lessee may be short of cash, or may have more attractive options for available capital. Whatever conditions allow both parties to meet their needs can constitute a leasing arrangement. Options on leases can include service additions for the equipment, maintenance, and software, or upgrades to newer models. When reviewing these options, the lessee should be aware that costs for these additions are being rolled into the equipment lease, and will restrict future flexibility. Also, the equipment owner may restrict what type and brand of enhancements are allowed on, or used in conjunction with, the leased equipment. 276

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Part A: Sourcing Analysis 2) TYPES OF LESSORS A)

Task 302

Third-party lessors Third-party lessors produce no actual product. Instead, they purchase equipment from manufacturers and, in turn, lease the equipment. Third-party lessors are sometimes referred to as full-service lessors. These normally include organizations or individuals who find returns from this type of investment attractive, making a profit on the difference between lease payments received, less the total cost of the asset. Manufacturers Manufacturers who make high-technology or high-cost products often find that offering leasing options can increase sales. For example, the high cost and potential obsolescence of large computers often make them more desirable to users as leased items. Thus, manufacturers will often become lessors of their products. Often this can be a mechanism for managing demand and moving products, such as new, luxury automobiles, into the marketplace. Because there is no choice of alternate products (the manufacturer only leases its own equipment), this type of lease is normally referred to as a captive lease. Banks Banks operate as lessors in a similar fashion to that of third-party lessors. Typically, banks put up a portion of the capital (15 to 30 percent), borrow the remainder, and use the lessees payments to cover the costs of borrowing, plus profit. Internal lessor Leasing arrangements can also be made within an organization, particularly in large multi-divisional or multi-national organizations. Investment decisions in one area of the organization might be maximized by purchasing and leasing equipment elsewhere within the organization. Also, equipment produced by one division might be offered for lease within the organization itself. Other lessors At times, institutional investors and/or wealthy individuals may form financial consortiums to supply capital for leasing arrangements. The investors put up a proportion (10 to 20 percent) of the purchase price, and financing is obtained on the remainder. The debt is secured through lease payments. The lessee can benefit through receiving lower lease rates, because the individual lessors (who put up only a fraction of money) claim tax deductions on the entire cost of the equipment. Therefore, to get quality leases, the lessor is willing to provide favorable rates.

B)

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3)

FACTORS IN A LEASE/BUY DECISION A number of factors weigh for and against a decision to lease instead of purchase a piece of equipment. These include: A) Inflation As a general rule, leasing is a more costly way to obtain a piece of equipment than purchasing because, in addition to covering finance charges, the lessor bears all risks

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Module 3 associated with ownership, including inflation. This risk is consequently reflected as a cost component of rental payments.

B)

Obsolescence By leasing instead of buying a piece of capital equipment the risk of obsolescence is reduced or eliminated for the lessee. Lessees can even negotiate a lease in which the leased equipment is replaced by new or updated models on a predetermined schedule. Maintenance services The lessor bears the cost of maintenance in most leases. This frees the lessee from administration of service matters, and provides properly trained labor to maintain the equipment. Maintenance becomes particularly important if the item is complex. Some lessors own and operate their own production and repair shops, and will usually provide expert service. Often, as a provision of the lease, the lessor provides alternate equipment during any extended downtime. Capital/budget considerations One of the chief advantages of leasing is that it makes capital available for other, more profitable, purposes. A large outlay of capital is replaced by smaller regular payments, as the asset is used. On the other hand, the total leasing charges over the life of the equipment normally exceed the cost of the equipment. Although leasing is usually more costly than purchasing in the long run, this must be weighed against the need of the asset when funds are limited, or when alternate opportunities for use of those funds are available. Administrative overhead A lease may eliminate the need for extensive record keeping and management of labor, thereby reducing the need for direct overhead expenses. As with other decisions to outsource, the cost is known and fixed. The cost structure is simple, freeing administrative time to concentrate on the organizations value-added activities. Reimbursement from third parties Many equipment manufacturers sell their leasing contracts. This typically results from a leveraged lease when the manufacturer or equipment provider is not interested in collection activities. Payments by the lessee are then made to a third party, who pays the manufacturer directly. Interest If a purchaser is considering purchasing instead of leasing equipment, interest costs on financing must be considered. Rates and the burden of long-term debt may make the purchase of equipment less attractive. Ownership benefits Lessees can be restricted as to the use of the equipment they lease, and may be required to provide lessors with access to it, upon request. By owning instead of leasing equipment, the purchaser has the benefit of having complete control of the asset and the ability to use the equipment as he or she pleases. This also includes the ability to add components that are off brand (e.g., external disk drives from another manufacturer). Although ownership carries the burden of disposing of the asset at the end of its useful life or when it is no longer needed, the

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owner enjoys the benefits of any residual value. In addition, the asset might provide value to the organization for years after it has been fully depreciated. I) Limitation of sources of supply When suppliers are limited, leasing offers an alternative to purchasing. By considering leasing, a purchaser may negotiate with a number of lessors and then consider the best option. Also, considering leasing may entice the supplier to provide a better offer than might otherwise have been presented. The act of increasing competition might lead to a better procurement. Balance sheet considerations Leasing can make an organizations balance sheet appear to be stronger than it would if the equipment was financed. Because leasing is shown as an expense on the income statement in the period it is incurred, no debt is shown on the balance sheet. When financing an asset, the amount financed is shown as a liability until it is paid off. The use of leased assets may allow the organization to show a greater return on assets than if the assets were owned, by understating the assets used to create income. Given equal profits and the same assets, the organization that leases its assets will show the higher return on assets. Cash flow analysis Purchase and lease options can have different effects on cash flow, depending upon tax implications and structure of the lease payments. Generally, leasing enhances the cash flow of an organization. Depreciation Typically, the owner of the asset has the ability to depreciate the asset. When a decision is made to lease, the lessee forgoes the opportunity to depreciate the asset for the other benefits of leasing. Tax considerations Classified as operating expenses, lease payments are completely deductible from taxable income, while owned equipment must be depreciated over the assets useful life. The lessee may realize tax savings if lease payments exceed allowable depreciable amounts. Operating costs Costs to be considered include utility, energy, air, environmental, water, and labor required in putting the asset to use. The administrative costs of monitoring these activities can be minimized through various leasing arrangements. Life of the asset By purchasing instead of leasing an asset, the purchaser has control over the asset throughout its entire life. An asset, when fully depreciated, may still provide value that exceeds its residual value. Some assets may even appreciate over time, such as land. Residual value When a lease is over the lessee does not own the equipment and is precluded from reaping any residual value that the asset may have in the marketplace. The purchaser should be aware of the type of equipment being leased and the relationship between allowable depreciation and residual value for that type of asset.

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Module 3 Customization of asset Because a lessee does not own the piece of equipment, it cannot be modified or altered without the permission of the lessor. These restrictions may also extend to the addition of accessories that interact with the equipment. Early termination When entering into a leasing agreement, a purchaser should fully understand the implications of early termination, should that become desirable or necessary. The longer the life of the lease, the more important this becomes. Payment schedules Payment schedules reflect the due dates for lease payments and are useful in preparing cash flow analyses. Insurance When entering into a lease, insurance requirements should be fully understood. For example, which organization will be responsible for insurance and which one will benefit from any insurance payoff? Company/organization policy Many organizations maintain formal or informal policies regarding leasing. For example, in high-tech industries there is a tendency to lease because of the fast pace of technology changes. Organizations with a high rate of growth may also have leasing policies to minimize debt and increase working capital. Term of lease The length of the lease is determined by contract, and reflects the time the asset will be needed. Some leases are open-ended, and can be canceled following a formal notification period. Emergency situations Leasing can provide equipment for short-term requirements. If a particular piece of equipment is temporarily out of service, leased equipment can provide operating continuity. If funds are not approved, or if products do not justify short-term capital outlay, leased equipment may fill the need. Leasing can also provide access to equipment in short supply or with long leadtimes. Lessors may have focused on these market conditions or, through leverage with suppliers, have these assets available for lease.

R)

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4)

LEGAL/ACCOUNTING CONSIDERATIONS The financial, tax, and legal implications for organizations involved in leasing are generally covered by the Uniform Commercial Code (Article 2A), and the Financial Accounting Standards Board (Statement Number 13). Major topics under each are discussed below. Financial Accounting Standards Board (FASB) references to capital leases apply to financial leases as previously described in this section. A) Uniform Commercial Code 2A-Leasing Article 2A of the Uniform Commercial Code covers leases and legal implications for merchants. The section has five parts:

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Task 302

PART 5:

General Provisions Formation and Construction of Lease Contract includes offers, performance, warranties, casualties to identified goods. Effect of Lease Contract includes enforceability, title, sublease, liens on assets or equipment, and creditor rights. Performance of Lease Contract: Repudiated, Substituted, and Excused includes assurance of performance, anticipatory repudiation, excused or substituted performance, and irrevocable promises. Default includes notices of default, lessor/lessee remedies, waiver of objections, liquidation of damages, cancellation, and termination.

Purchasers should be aware of these provisions and their implications on leasing contracts. B) FASB-13 FASB details proper methods for recording accounting transactions in business. Statement 13 deals with leases, and lists appropriate transactions for lessors, lessees, and third parties in various types of leasing arrangements. A lease is described as an agreement conveying the right to use plant, property, or equipment for an agreed upon period. FASB differentiates between two basic kinds of leases. The first is a capital lease. Under this type of contract, the benefits and risk of ownership are transferred to the lessee. In this case, the property or equipment should be recorded as an acquisition by the lessee, and a sale by the lessor. This is similar to a financial or leveraged lease (see section 1B). FASB considers all other types of leases as operating leases the rental of property. Under an operating lease, neither an asset nor an obligation is recorded on the lessees balance sheet. Instead, rental payments are shown as an expense on the income statement in the period in which it occurred. The standards also discuss a sales-type lease, which is used by a manufacturer in order to sell its products. This is similar to a captive lease as described in section 2B. Overall, FASB-13 delineates proper methods to account for various types of activities that result from leasing. The standards provide guidance for various leasing alternatives and their implications in a financial environment. A purchaser involved in leasing should become aware of these accounting standards and the various alternatives to acquisition that they represent. C) Other As alternative forms of financing become more of an issue in supplying an organizations assets, legal concerns and the issue of how to properly record activity on financial statements will grow in complexity. Aside from the actual equipment or property, decisions will be based more and more on the tax and/or legal implications of the financing options. For this reason, a working knowledge of the issues will be required of the purchaser. Professional support from legal and accounting disciplines will also be needed.

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TASK 303: Develop financing and leveraging strategies for purchases.

Purchasing and supply management professionals can add value to the organization by developing an understanding of financing and leveraging strategies. Knowledge of these strategies is helpful to the purchaser working on cross-functional teams, when such matters are raised by others on the team. Purchasers are in an excellent position to watch conditions in the marketplace and can be the eyes and ears of management. For example, they can identify trends, and watch for economic conditions that will favor or harm the organization. 1) DEPRECIATION AND APPRECIATION Depreciation is a process of cost allocation not asset valuation. The depreciation of assets is of concern to the purchaser as it relates to the decision to buy, lease capital equipment, or outsource processes. Failure to depreciate properly can lead to poor decisions. Normally, purchasings objectives do not include purchasing goods that will appreciate in value for the purposes of reselling them at a profit. Purchasings primary objective is to ensure that goods are available when needed. 2) BOND AND CURRENCY MARKETS If an organization is sourcing internationally, purchasing may be involved in deciding whether to purchase in the suppliers local currency or in the purchasers currency. If the contract is negotiated in the suppliers currency, purchasing must be aware of the situation, understand the implications of exchange rate fluctuations, and work with the appropriate department to manage effects of exchange rates. Normally, purchasings objective is to maintain the profit margin if the exchange rate varies. This can be done by hedging on the exchange rate or by negotiating the contract in the purchasers currency. Purchasing has little, if any, direct interaction with bond markets, but can integrate a general understanding of these markets with other data collected, for forecasting and strategy planning and development (see Tasks 312-313 for more information about hedging). 3) MARKET CONDITIONS Market conditions can be categorized using several dimensions. Possible dimensions include stage of product life cycle, buyers or sellers market, and product risk/value matrix. A) Product Life Cycle One way to categorize market conditions is through the concept of the stages of a product life cycle. The product life cycle consists of five stages or phases: pre-commercialization, introduction, growth, maturity, and decline. In the pre-commercialization phase, purchasing seeks flexibility because the project (e.g., to manufacture an item) is still uncertain. Purchasing would be involved in supplier selection, product design, and early supplier involvement. Purchasing would focus on the selection of components, prompt delivery of materials for research and development (R&D), standardization, and product redesign, to reduce potential supply problems. 283

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Module 3 In the introduction phase, the purchaser seeks to balance the chances of product failure with the need for adequate materials to be available if the product succeeds in the marketplace. The purchaser would likely favor subcontracting to avoid risking assets, developing preferred and standby suppliers, working with suppliers to correct quality problems, dealing with engineering changes, and focusing on leasing equipment to reduce risk. In the growth phase, the purchasers main responsibility is to ensure continuity of supply. The purchaser would favor a make strategy to ensure continuity by having greater control over product inputs. The purchaser might also look at developing additional sources of supply and begin negotiating for lower input prices. In the maturity phase, the purchasers goal is to reduce leadtimes, reduce costs, and ensure continuity of supply. The supply strategy would include long-term contracts, and use of aggressive price negotiation and continuous improvement to drive down costs. In the decline stage, the purchaser continues to look for lower-cost sources, may have to deal with asset recovery of equipment and inventory, and may begin to use subcontractors, as assets are reassigned to new products. Rapid adaptability to changing conditions is more important than input prices at this stage.

B)

Buyers versus sellers market Another classification system for market conditions is whether it is a buyers market or sellers market that is, is supply greater than demand or demand greater than supply. In the buyers market, the purchaser has greater leverage than the seller. The buyer may be able to obtain concessions, not only on price, but also on payment terms, inventory stocking levels, and delivery. In the sellers market, the purchaser cultivates relationships with as many suppliers as possible to ensure continuity of supply. If the supply and demand are somewhat balanced, the purchaser will pursue a mixed strategy, depending on the current market conditions. Risk/value matrix A market conditions dimension model uses a risk/value matrix in which the horizontal axis is the value of the item and the vertical axis is the risk of supply. In the high-risk, high-value quadrant, the purchasing strategy would focus on strategic relationships to build competitive advantage. For high-risk, low-value items the goal should be to reduce risk. For low-risk, high-value items, the purchaser should take a leverage strategy to maximize profits. For the low-risk, low-value quadrant, the goal is to acquire items at minimum cost.

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TYPE OF ORGANIZATIONS Different types of organizations, and even similar organizations with dissimilar missions, will have contrasting financing and leveraging strategies. Strategies are likely to be affected by the ability of the organization to raise capital, whether or not it is in business to increase shareholder value, the source of its income, and to whom it must answer for its performance. 284

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Private Organizations in the private sector are in business to make a profit and provide a return to the owners. Purchasing professionals need to establish profitability as the basis for decisionmaking. Purchasing needs to show how it increases profit and especially how it helps the organization achieve its strategic objectives (see Task 210 for more information). Non-profit As in the private and government sectors, non-profit organizations buy goods and services to accomplish objectives; maintain, repair, and operate facilities; and perform research and development. An example of non-profit purchasing includes buying for a charitable organization or a university. In such situations the profit motive and competitive factors are absent, and the primary goal is to get the maximum value from the expenditure of a fixed budget appropriation for materials/ services. Public Local, state, and federal laws were created to protect taxpayers from government purchase decisions being made on the basis of fraud or favoritism. Unfortunately, the result has been an abundance of laws that often hamper effective purchasing. Public sector purchasers must find efficient ways to procure goods and services within the boundaries of these laws. The public purchaser is constantly challenged to conduct business based upon performance and results, instead of paper and process. Governments spend billions of dollars annually to purchase goods and services, construction, and capital equipment. Through effective purchasing, government agencies ensure more funds are available to procure additional goods and services for new or expanded initiatives. Alternatively, governments may need less money to maintain the status quo, and may opt to return resources to business and citizens by reducing taxes. One tool provided by statute that is helpful for many governments is cooperative purchasing. This allows a group of government agencies to combine their requirements for better overall pricing and other beneficial terms and conditions (see Task 101 for a discussion of cooperative purchasing).

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COMMODITY MARKETS In commodity markets buyers and sellers can freely interact. The commodity must be able to be graded reasonably accurately and be large enough that no single buyer or seller can influence the market. When dealing with a commodity, the purchaser needs to consider the organizations objectives and philosophy, the commoditys importance to profit or loss, and price volatility of the commodity. When a volatile commodity is a major cost factor to an organization, the risk of the price change at the time of raw material purchase and the sale of the finished product is often used as a measure of risk.

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One method for evaluating risk is to ask management to rank the various kinds of risk, such as highly fluctuating material costs, product vulnerability to competition, the cost of expanding existing facilities, the cost of new product introduction, and changes in economic conditions. For the purchaser to manage the risks associated with commodities, good forecasting systems and good information databases are required. Control methods may include: Establishing coverage or commitment limits. Implementing an organizational safeguards-review committee. Having a formal upper management oversight process. Having multiple purchasers in different parts of the organization work together. Monitoring by the finance department of strategies and purchases paperwork.

A possible performance measure for evaluating commodity purchasing is a comparison of weekly purchases to the actual buying price, including all costs of delivery. An important part of managing a commodity is the forecast. In developing a commodity forecast the purchaser should include the use of supply factors, such as inventory levels of suppliers and internal customers, future production outlook, transportation availability, and government programs that may influence commodities. The purchaser should also include demand factors, such as consumption trends, real versus artificial demand, and government actions. 6) TAX LAWS Many purchasers are concerned with tax laws for a variety of reasons. First, if the organization is subject to a tax on inventory, the purchaser may have to plan acquisitions to minimize taxes. It would not be desirable to receive a large order the day before the tax liability is determined. Second, tax laws may affect decisions such as leasing versus purchasing and make versus buy through the treatment of depreciation. Third, the purchaser needs to keep accurate records of all transactions including transactions via EDI and procurement cards and work with accounting to determine sales tax liabilities. 7) INTEREST RATES Interest rates are of concern to the purchaser for a variety of reasons. For example, as interest rates rise, the purchasing organizations cost of capital will increase. This will increase inventory carrying costs and would lead the purchaser to buy smaller quantities more frequently. Rising interest rates would cause the supplier to try to maintain smaller inventories, potentially increasing the risk of stockout, because the supplier would be less likely to be able to fill all orders. The movement of interest rates may influence the financial viability of marginal suppliers, increase or decrease an organizations cash flow, affect prices paid for products or services, or have other consequences that impact purchasing and leasing decisions. Purchasers have the responsibility of developing the sophistication needed to understand how financial aspects of the economy may impact the decisions they make for their organizations. 286

Part A: Sourcing Analysis 8) PAYMENT TERMS

Task 303

The logic of payment terms involves the discount rate and the amount of time the purchaser is able to keep the money before paying. Typical payment terms include: Net 30 days Payment of the entire invoiced amount is to be made within 30 days of invoice date. Net 10th prox Payment of the entire amount is to be made by the 10th of the month following the invoice date. 2 percent 10/net 30 Payments received within 10 days from the date of invoice receive a 2 percent discount, otherwise the full amount is due in 30 days. This is equivalent to an annual interest rate of 36 percent.

A payment terms tool available to the purchaser is the negotiation of an extension of the terms of payment to 60 days, 80 days, or even longer, depending on the needs of the purchasers organization. 9) CASH FLOW The purchaser must plan acquisitions within the context of the organizations cash flow. The purchaser has a responsibility to not place an order with a supplier knowing the funds are not available to pay for the goods or service. Therefore, the purchaser may have to buy smaller quantities than might be economically desirable. Purchasing also needs to consider how contract terms and conditions will affect the organizations cash flow, and how the contract fits into the organizations cash flow situation. 10) REGULATIONS There are numerous regulations the purchaser should know about. Some general categories include the Uniform Commercial Code, antitrust and trade, federal procurement, international trade, intellectual property, health and safety, and environmental (see Tasks 108, 113, 119, and 307 for more information). In many instances purchasers are in a position to track regulation trends and develop a sense of how potential and actual regulations may affect the organization. This information should be shared with internal customers and upper management, as appropriate, and used in the planning process. For example, not long ago the United States signed a treaty that significantly reduced access to CFCs, including Freon. Organizations had to plan for the phase out of equipment using Freon or find a substitute product. Companies manufacturing products, such as refrigerators and air conditioners, had to redesign products to accommodate the chemical products that were being produced to replace Freon. It is easy to see by this example that the forward-thinking purchaser can use such information to help internal customers plan for the future.

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Task 303 11) SUPPLIER FINANCING

Module 3

Sometimes it is advantageous to help suppliers in the acquisition of resources in order to improve their capacity, or to get them through a tough financial situation. This can be done in a number of ways. A direct loan to the supplier, a partnership arrangement, co-signing a loan, or providing other financial backing can be beneficial to the purchasing organization. The purchaser must avoid violating any state and federal regulations concerning collusion or favoritism when working in this area. 12) CENTRALIZED PURCHASING In centralized purchasing a central purchasing department determines the needs of the various divisions or facilities, selects suppliers, and negotiates the purchases for the entire organization. The strategy makes sense when there is commonality of materials across divisions or locations, and when consolidating the requirements gives the organization more leverage with suppliers. 13) LEAD DIVISIONAL PURCHASING When one division of an organization is the primary user of a commodity or product, that division negotiates the contracts with the supplier and the other divisions or locations purchase off the contract. The organization is able to obtain lower prices due to the higher total volume, and because the supplier has to negotiate with only one entity. 14) COOPERATIVE PURCHASING Cooperative purchasing is a strategy in which several organizations form or use a centralized buying service that purchases specified types of items for all members of the group. The resulting volume buying usually produces significant cost savings for group members (see also Tasks 107 and 217). 15) GROUP PURCHASING ORGANIZATIONS Group purchasing organizations, cooperatives, and consortiums are buying arrangements that enable smaller users to secure the price, and other advantages of large-volume purchasing. 16) IMPORT/EXPORT QUOTAS The purchaser must be particularly aware of import quotas that may restrict supply, especially later in the year. It may be advantageous to purchase the years requirements as quickly as possible to reduce the organizations chances of not being able to acquire material. If the quota is reached before year-end, the purchasing organization may have to lobby with government regulators to relax the quota or give an exception. 288

Part A: Sourcing Analysis 17) CORPORATE PURCHASING

Task 303

Corporate purchasing is responsible for purchasing goods and services that are used across the various divisions of the organization, or for commodities. This keeps divisions from bidding against each other for purchases, especially in tight markets or in markets where shortages exist. BIBLIOGRAPHY Baker, J.D. Purchasing Price-Volatile Commodities: Risk Control and Forecasting, Proceedings of the 1995 NAPM International Purchasing Conference, NAPM, Tempe, AZ, 1995, pp. 257-261. Barns, C.A. Show Your Depreciation, Purchasing Today , May 1998, p. 14. Rink, D.R., H.W. Fox, and K. Parkison. Strategic Procurement Planning under Changing Product and Market Conditions, First Worldwide Research Symposium Proceedings, March 1995, pp. 315-327. Cushman, C. Transforming Purchasing, Transforming Government: Professional Public Purchasing for the Next Millennium, Proceedings of the 1997 NAPM International Purchasing Conference, NAPM, Tempe, AZ, May 1997, pp. 415-420. Duffy, R. Accounting for the Cash, Purchasing Today , August 1998, pp. 37-38. Gonzalez, O. The Thirteen Commandments of Export and Import Compliance Program, Proceedings of the 1998 NAPM International Purchasing Conference, NAPM, Tempe, AZ, 1998, pp. 354-359. Reichard, R.S. Upgrade Your Commodity Buying Strategy, Purchasing, Sept. 9, 1993, pp. 19-23. Wright, B.J. Decoding Payment Terms, Purchasing Today , November 1996, pp. 112-113.

289

TASK 304: Organize, control, and minimize the storage of materials.

1) FUNCTIONS OF INVENTORY Organizations have inventories for a number of reasons that can be classified into the five functions listed below. A) Uncertainty Organizations face uncertainty of supply and demand. Uncertainty can take two forms, variation in quantity and variation in timing. Quantity uncertainty can be caused by back ordering by the supplier, defects received from the supplier, or industry standard variable quantities (e.g., steel by the melt). The usual method for dealing with quantity uncertainty is to use safety stock. For timing uncertainty, the most appropriate tool is safety leadtime. Safety leadtime involves looking at the suppliers variation in leadtime and ordering far enough in advance to reduce the risk of late delivery. Decoupling Decoupling is the use of inventory to isolate one internal process from another. By putting inventory between two processes, each process is unaffected by the performance of the other process. The inventory serves to protect each process from variations in output caused by different changeover times or maintenance shutdowns. Anticipation Anticipation inventories are created for a special purpose, such as seasonality, special promotions, anticipation of shortages, anticipation of strikes, political instabilities, end-of-life runs, or anticipated price increases. When a special cause has ended, the inventory is no longer maintained. Economies of scale Economies of scale inventories are created by ordering or producing in quantities to obtain the lowest unit cost. Examples would be the use of the economic order quantity, price discounts, or ordering in truckload quantities to get the lowest transportation rates possible. Transportation Transportation inventories, also called pipeline inventories, are the inventories that are in transit between supplier and purchaser. No matter whether the goods are shipped FOB suppliers dock, or purchasers dock, someone will own the inventory.

B)

C)

D)

E)

Financial implications of carrying inventory are discussed in Task 305. 2) INVENTORY CLASSIFICATIONS A) B) Raw materials Raw materials are input goods intended for combination and/or conversion through the manufacturing process into semi-finished or finished goods. In-process goods These are goods in the process of being manufactured and are only partially completed. In-process inventories provide the flexibility necessary to deal with variations in demand between different phases of manufacturing. 291

Task 304 C) D)

Module 3 Finished goods These represent the completed conversion of raw materials and components into the final product. They are goods ready for sale and shipment. Maintenance, repair, and operating supplies (MRO) These inventories include parts, supplies, and materials used in or consumed by routine maintenance and repair of operating equipment, or in support of operations of the organization. Resale goods These are goods acquired for resale. Such goods may be purchased by a wholesaler for resale to distributors, or by distributors for resale to consumers. Capital goods These are items (such as equipment) that will not be used up or consumed during a single operating period. They have extended useful lives and must be expensed over multiple operating periods. Tax laws require that such items be capitalized, and a predetermined percentage of their costs be recognized as an expense each operating period, over a predetermined timeframe, according to equipment classes. Construction materials These are raw materials and components for construction projects (e.g., buildings, bridges). Hard goods/soft goods The definition of hard goods and soft goods will vary by industry. For example, in data processing hard goods include apparatus such as computers and terminals, while soft goods include software and data storage media. Hard goods in the retail sector include appliances, luggage, and electronics while soft goods include clothing, linens, and bedding. Components These are the raw materials of assembly operations. Just as raw materials are converted to finished goods in a manufacturing operation, components and parts are assembled into finished goods in an assembly operation. Obsolete Finished goods, raw materials, resale goods, or components are no longer needed when technically obsolete or when the product is no longer produced or sold. Equipment may also be considered obsolete inventory if it is no longer needed (see Task 307 for a discussion of disposal of obsolete materials). Defective Items that have been rejected for use and are waiting to be returned to the supplier, or to be scrapped, or reworked.

E) F)

G) H)

I)

J)

K)

3)

INVENTORY MANAGEMENT SYSTEMS An early priority in designing inventory control systems is to determine the demand pattern as independent or dependent, because the control approaches are different for each. A) Order-point systems Independent demand patterns occur when future demand for an inventory item is unrelated to, and unaffected by, previous demand. For a given item, each incidence of demand is independent of any other. For example, consider

292

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Task 304

maintenance, repair, and operating supplies. A given bearing may be used by many operating departments, and demand by each department likely will depend on many factors over which the inventory manager has no control. Therefore, overall demand rates for the bearing may vary unpredictably from period to period. In such cases, inventory levels include a quantity of safety stock, over and above the average demand rate, as a means of stockout prevention. Management control of inventories serving independent demand is based on either continuous review models or time-based models. Such systems are designed to trigger a reorder whenever a predetermined inventory level or point in time is reached. 1.0 Economic order quantity (EOQ) EOQ is the order quantity where the time period cost of ordering equals the time period cost of holding that inventory, thereby minimizing the sum of the total of these two costs. Any order quantity above or below the EOQ will result in a higher total of order and holding costs. Continuous review models may take two forms, and their EOQ calculations are slightly different. Most production planning, inventory control, and purchasing software use at least one version of the fundamental EOQ formulation to estimate order quantities. It is important for the purchaser to understand what information the model requires, the assumptions the model operates under, and how the model works. EXHIBIT 4 BASIC ECONOMIC ORDER QUANTITY MODEL

Order Quantity Inventory Level in units Reorder Point

Lead Time

Time Periods

Instantaneous replenishment EOQ The basic EOQ system model assumes that reorders are placed at the beginning of leadtime and received at the end of leadtime, and that the goods are used down to a predetermined minimum, at which point a reorder is triggered and the process repeats. The basic EOQ system model is in Exhibit 4. 293

Task 304 EOQ for a basic continuous review system is calculated as follows: EOQ = 2DS/H where: D S H = = =

Module 3

Period demand for the item Cost to place an order Cost to hold one unit of the item in inventory for one period

EOQ with simultaneous usage There are cases when first produced units of an item on order may be used while the balance of that reorder quantity is still being produced, such as when a production department is supplied by an in-house machine shop or another production department. Such simultaneous usage and production of a reorder requires modification of both the model and the EOQ formula, as shown in Exhibit 5. EXHIBIT 5 FIXED-ORDER QUANTITY MODEL WITH USAGE DURING PRODUCTION TIME

In-Out Inventory Level in units Reorder Point

Time Periods

Lead Time

When an item reorder quantity is being used simultaneously with its production, the EOQ is calculated as follows: EOQ = (2DS/H)(p/(p-d)) where: p d = = Rate at which the item is being produced in units per period Rate at which the item is used simultaneous with its production in units per period 294

Part B: Supply and Inventory Management 2.0

Task 304

Fixed time systems (cyclical systems) Time-based systems (often called cyclical systems) are designed so that each inventoried item is reviewed and reorders are placed after a predetermined time interval (e.g., every two weeks, every 30 days). Orders are placed for each item equal to the difference between current inventory level and a predetermined maximum. In cyclical systems, the time between reorders is constant, but the reorder quantity is variable. Predetermined maximums are set with a consideration of order leadtime. Major disadvantages of cyclical systems are that purchasing workload peaks around the review date; there is no automatic trigger for reorder before the review time in the event of increased usage, which generally leads to increased inventory levels as a means of stockout prevention. Also, fixed time systems do not permit effective use of economic order quantities.

B)

Just-In-Time (JIT) JIT is an operations management philosophy of continuous improvement whose dual objectives are to reduce waste and reduce cycle time. Operationally, JIT minimizes inventory at all levels. Materials are purchased, transported, and processed just in time for their use in a subsequent stage of the manufacturing process. Waste is anything that does not add value for the customer. In general, reducing the various forms of waste will result in a reduction of inventories that are held to deal with the cause of the waste. For example, reducing process leadtime will allow reduction of safety stocks in finished goods. Purchasing can help reduce waste in an organization in a number of ways: Overproduction Overproduction waste results from making or purchasing beyond what is needed now. Purchasing can reduce inventories by developing contracts with regular releases to the supplier to eliminate receiving large orders. Waiting Reducing order processing time shortens leadtime, thus reducing the required inventory levels. Transportation Using local suppliers reduces the transit time for delivery. Purchasing can also work to have one truckload shared by several suppliers, reducing the quantities received at one time from each supplier and reducing inventory levels. Processing Through the use of tools such as value analysis and engineering, purchasing can help reduce the cost of products or services. Through standardization it can reduce the number of part numbers, thereby reducing inventories. Quality Using early supplier involvement, supplier evaluation, supplier development, and certification, purchasing can improve the quality of goods coming into the organization, reducing the uncertainty of supply and lowering inventories.

295

Task 304

Module 3 A popular type of inventory control system often discussed in conjunction with JIT is the use of kanbans. Loosely translated, kanban means card and is used to authorize the replacement of material as it is consumed. Kanbans are used in the JIT philosophy to control the flow of materials through the organization. In reality, kanbans are nothing more than a sales replacement system. They control inventory levels, primarily work-in-process, by allowing each operation to replace only what the next operation has used. The inventory level is controlled by setting the number of kanbans to be used in a process. This system presupposes a relative uniform demand for items over time. A kanban system consists of two parts: standard containers and production cards. The standard container is, in essence, a standard lot size, because each container holds a specified number of items. The kanban system works best when there is a relatively smooth flow in the operation and the demand is constant from day to day. It also assumes that the process changeover times are relatively short, preferably less than ten minutes. In addition, kanbans are best applied when two operations are separated from each other so that one operation cannot see what is going on in the other operation. The kanbans serve to prevent the buildup of inventory: If the customer process should slow down or stop. When the supply process capacity exceeds the customer process usage. When there is a significant difference in changeover times between successive operations. When different work cells share a common piece of equipment or work center, kanbans serve to keep the volume of work balanced from the supplying operations. By temporarily decoupling an operation that is having quality, capacity, or reliability problems. The kanbans isolate the troublesome operation until the problem is resolved, at which time the kanbans are removed.

JIT is also covered in Tasks 312 and 313. C) JIT II This is an evolution of the traditional JIT practice, but includes the presence in the purchasers facility of a supplier representative responsible for scheduling and coordinating deliveries. ABC concept Paretos Rule (sometimes called the 80/20 rule) is applied to inventory management as a rule-of-thumb. Essentially, it says that about 80 percent of the dollar value of an inventory will be contained in about 20 percent of the items. With some minor variations, this rule generally holds and can be used by inventory managers to aim their efforts where they can reap the greatest benefits. The ABC concept is derived from the 80/20 rule. Typically, inventories are placed into three categories, as follows:

D)

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Task 304

A items Items with high-dollar volume, or items that are considered strategically important due to critical need or long leadtime. A items usually include 10 to 20 percent of all inventory items, and account for 70 to 80 percent of the total dollar volume. B items Items that are still important, but not critical, and that are not expected to pose sourcing difficulties. B items include 15 to 25 percent of all inventory items, and account for 10 to 20 percent of the total-dollar volume. C items C items tend to be standard, low-cost, highly competitive, and readily available. C items account for 60 to 75 percent of all inventory items, but only 5 to 10 percent of the total dollar volume.

ABC classifications allow the manager to direct priorities for inventory control. In general, higher turnover goals should be established for A and B items than for C items. More control needs to be kept on A and B items, with low levels of safety stock. On the other hand, C items can be maintained with looser control but with higher amounts of safety stock. The ABC concept recognizes that each item of inventory is critical and could halt production or sales to a customer or operations. In addition to other management procedures, ABC classifications are used to design cycle counting schemes. For example, A items may be counted monthly, B items quarterly, and C items only once, or not at all. The emphasis is on putting effort where it will have the most benefit or value. E) Supplier managed systems When business volume is sufficiently large, suppliers may operate an organizations supply or inventory storage facility using supplier personnel, under contract with the using organization. Depending on the agreement, a contractor may either acquire on-site inventories or just manage them. In some cases, supply contractors have branches built next door to industrial plants for the sole purpose of supplying all the needs of the plant. In some cases, a common wall separates the two facilities and supplies are issued through an opening in the wall. This is an emerging trend for MRO and office supply goods. 1.0 Vendor managed inventory (VMI) Vendor managed inventories are inventories the supplier delivers to the work area or store and replenishes on a regular basis. The supplier bills the buying organization for usage. Consignment Consignment inventories are inventories that are owned by the supplier. The using organization pays only for the units used. Integrated supply Integrated supply is a special type of partnering arrangement usually developed between a purchaser and a distributor on an intermediate to long-term basis. The objective of an integrated supply relationship is to optimize, for both the purchaser and supplier, the labor and expense involved

2.0 3.0

297

Task 304

Module 3 in the acquisition and possession of MRO products items that are repetitive, generic, high-transaction, and have a low unit cost. The single supplier may be very large or may be a conglomeration of smaller suppliers working together.

F)

Point of sale/point of use/auto replenishment Point-of-sale replenishment systems collect data on the sale of items through use of bar codes and scanning technology. The data is automatically transferred to the inventory records. When a reorder point is reached an order is automatically generated by the inventory control system and sent to the supplier.

4)

PROCEDURES FOR DETERMINING ORDER TIMING A) Usage rates/demand variation The greater the stability in usage or item demand, the easier it is to plan order timing. If an item has a wide variation in usage quantities, it is much more difficult to determine when the items demand may create an out-ofstock situation. Safety stock determination Safety stock can be calculated in a number of ways. If the distribution of the demand is known, or can assumed to be normal, the safety stock for a given service level is calculated as: Safety stock = zs L where: z = the number of standard deviations required to provide the desired service level (i.e., z = 1.645 will provide a 95 percent service level) standard deviation of the demand per period leadtime in periods

B)

s L For example:

= =

Average demand per period = 100 units per period s = 10 units per period z = 1.645 standard deviations L = 4 periods Then: Safety stock = zs L = (1.645)(10)( 4) = 32.9 = 33 units An alternate method is to set the safety stock based on the maximum observed demand during leadtime in the past. This provides protection in a worst-case scenario but may result in carrying excess inventories. 298

Part B: Supply and Inventory Management C)

Task 304

Unique items Order timing decisions may be affected by the uniqueness of an item. For example, an item may be classified as unique because it is strategically important, difficult to make or source, or made from exotic or hard-to-find materials, or for any other reason that would cause order timing to require special attention. Many organizations place such items in the A category in the ABC classifications, while others create special categories of greater importance. Leadtime Leadtime is the elapsed time between placing an order and receiving the product or service. An order must be placed far enough in advance to have it on hand at the time of need. Most purchasing activities are striving to reduce both the total average time, as well as the variability, in each of the following three principal components: 1.0 Purchase order cycle time This includes several factors internal to the purchasers own organization, including the time to communicate demand from internal customer to purchaser, the order preparation time within the purchasing activity, and the time necessary to transmit the order information to the supplier. Supplier leadtime Not only does this variable contain the time needed to manufacture goods in the event that they are not in inventory, but it includes the time required for order entry, order processing, picking and packing, and staging for transportation. Transportation leadtime This is the time goods take to move between the supplier and the purchaser. It is also what transport people call dwell time, the amount of time that goods stand waiting enroute before proceeding on the next part of their journey.

D)

2.0

3.0

5)

STORES MANAGEMENT SYSTEMS The basic responsibilities of stores are to act as custodian and controlling agent for parts, supplies, and materials, and to provide service to users of those goods. Well-designed systems provide flexibility to absorb demand variation, and enable purchasing to plan, and practice forward buying. A) Open stores There are instances when the cost of closely controlling inventories outweighs expected losses in an uncontrolled environment. In such cases, inventory storage areas may be left open or kept close to the point of use for efficient user access. Such inventories are available for use as needed, with emphasis on expediting production or operations rather than on security. Closed stores Closed systems are used when close control and accounting of inventories are desirable. In such cases, storage areas are kept locked and entry is limited to stores employees, or to others only on an authorized basis. Goods enter inventory through a formal receiving process and leave through an authorized requisition or bill

B)

299

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Module 3 of materials. Closed systems typically include industrial or business stores operations, and involve repair parts, consumables, tools, and materials or components for assembly when ongoing control and accuracy is essential.

C)

Random access In random access systems, goods are stored without regard for commodity groupings. Instead, goods are stored in the next or nearest available space of suitable size. However, when selecting available space, it is good planning to consider the anticipated frequency of issue. Locating items in random access storage usually requires a computerized system. Random access systems tend to be used in conjunction with a closed stores system. Automated warehouse A large variety of automatic storage and retrieval systems (ASRS) are being used today. ASRS systems have the capability of bringing goods from storage or placing goods into storage upon computer entry of the item identification and/or storage location. Such systems may range in size from small rooms to whole warehouses. They may handle items ranging from small parts in tote pans to large materials on pallets.

D)

6)

INVENTORY PERFORMANCE A) Turnover rate/Investment Just as inventory stockouts may cause losses or slowdowns in operations due to equipment downtime, excessive or slow turning inventory ties up capital that could otherwise be generating a return. Either situation is to be avoided. Turnover rate is a common measure of inventory performance. It is calculated by dividing the cost of goods sold for a time period by the average inventory value for the time period. There is no universal standard for an acceptable level of inventory, although smaller is better from a financial point view. When evaluating inventory levels, each manager must consider all the dimensions, including costs, service levels, availability of goods, market conditions, seasonality, and capacity. B) Service level Service level can be measured in a number of ways. Example criteria include order periods without a stockout, units supplied on time, operating days without a stockout, expediting expense, and number of production stoppages. These can be reported on an absolute basis or on a percentage basis. Care must be taken in defining the measure so that it will result in the desired actions and outcomes for the organization.

7)

PURCHASINGS ROLE IN DEPENDENT DEMAND SYSTEMS Dependent demand occurs when the need for parts, supplies, or materials is dependent upon a predetermined usage or production schedule. In such cases, a description and quantity of components needed, and the exact date of each need, will be defined by a production schedule. Required delivery dates for each component will then be offset by leadtime, and orders will be 300

Part B: Supply and Inventory Management

Task 304

placed accordingly. For example, if a pump manufacturing organization plans to produce 300 units of a given pump model next month, it will need 300 impellers and 300 housings at the rate they will be installed in the finished pumps. Such needs, with consideration for leadtime, are the subjects of a dependent demand planned order schedule. Material Requirements Planning is one example of a system specifically designed to manage dependent demand reorders. A) Material Requirements Planning (MRP) MRP is a system of determining the quantity and timing of various materials and components required to produce a specified quantity of a finished product over a given period of time. The focus of MRP differs from traditional reorder point (ROP) systems in that actual requirements rather than replenishment of inventory drive the suggested release of orders. The system reviews future demands of forecasted items, calculates component requirements, and recommends orders based on the time material will be needed. Because orders are linked to requirements, a lower inventory usually can be achieved. Purchasing is involved with MRP in two dimensions. The first is as a provider of information, and the second is as a user of the MRP system. Because the success of an MRP system is dependent on the quality of information within the system, purchasing has a major responsibility for providing good leadtime information. Purchasing typically also has a responsibility to update delivery information, as it becomes available, to keep the planning information current, and to allow for changes in priorities when material is not available as scheduled. Purchasing is also responsible for maintaining pertinent information in the item database, which will be considered by MRP logic. This includes such information as item/supplier part numbers, ordering policy, primary supplier designation, and product specifications. As a user of MRP systems, purchasing executes the material plans, sources and releases purchase orders, and ensures timely delivery of quality material at an acceptable price. This includes not only the minimization of late deliveries that can interrupt planned production, but also early deliveries that can lead to inflated inventories. In essence, purchasings goal should be scheduling reliable deliveries as close to the time needed as possible. The ability of the MRP system to provide planning information by product for future periods has great benefit to purchasing. Negotiations can be conducted with suppliers for long-term contracts based on anticipated volumes from a production plan. Additionally, supplier relations can be improved as the planning information improves, because the supplier knows what will be required in the future. Order releases can replace purchase orders, freeing purchasing to spend more time on supplier development, new product development, and supplier certification. Purchasing can focus on developing capacity needs with suppliers, to help reduce product leadtime. B) MRP II Manufacturing Resource Planning (MRP II) is a term that is largely misunderstood and is used interchangeably (albeit incorrectly) with MRP. While MRP is a projection of materials and components required by timeframe to meet a master schedule, MRP

301

Task 304

Module 3 II goes far beyond this. MRP II evaluates not only the material resources of an organization, but also all other related resources necessary for schedule attainment. These include machine capacity, labor, and financial resources. Only after evaluation of what will be required, when it will be required, and whether or not the schedule is achievable, will resources be committed. This can result in a significant increase in the velocity of product movement through the manufacturing process, as well as a corresponding decrease in inventory investment. MRP II can be defined as a system that turns a manufacturing plan into valid schedules. Priorities and achievement of due dates are constantly being monitored, while variances are communicated to those responsible for required action. The system rests upon the integrity of dates and the data that support them. MRP II is not a computer system. It is a style of management or a corporate culture within which the organization is run. To be successful, it requires education, commitment, and, most important, involvement of top management. Measuring performance is key to the systems success. It provides the discipline necessary to adhere to its principles, and to maintain the endless goal of continuous improvement.

C)

Distribution Requirements Planning (DRP) Because a Material Requirements Planning system calculates requirements of dependent demand items, a logical extension of the process has been made to distribution. Distribution Requirements Planning (DRP) optimizes planning for product distribution by determining time phased net requirements for distribution points. As in MRP, because shipping orders are based upon time-phased net requirements instead of reorder points, an overall lower level of inventory can be achieved at the central distribution point. Requirements, in fact, can be an integrated part of the MRP II process. Elements of MRP such as leadtime, order policy, and date sensitivity allow for optimum use of resources for receipt, storage, packaging, and shipment of products. Incorporation of distribution into the MRP II environment allows for greater understanding and sensitivity to required performance. Output reports in DRP also parallel MRP, and through action messages bring attention to orders that will be late and unavailable for shipment. Earlier notification provides increased time to develop and review alternatives. This process also allows for easier tracking of new products and promotions, when demand can be erratic. DRP complements an MRP II system, because objectives are consistent and all units use the same database in achieving optimum service to customers. Benefits of a Distribution Requirements Planning system include: Increased ability to plan resources to receive, move, store, and ship inventory to warehouses and/or customers. Increased response to changes in demand or required warehouse buildups for promotions. 302

Part B: Supply and Inventory Management D)

Task 304

mproved control of transportation and material handling costs through better planning. A combination of shipments from supply points to warehouses and customers. Reduced inventory levels through date-sensitive, time-phased planning.

Enterprise Resource Planning (ERP) ERP is a term used to describe a variety of advanced MRP II systems that integrate interfaces with customers, suppliers, and the global enterprise. ERP provides a distributed application for planning, scheduling, and costing to the multiple layers of the organization, including work centers, plants, divisions, and the corporate organization. The application can handle different languages and currencies. The exact processes included will vary with each organization.

8)

SHELF LIFE, EXPIRATION DATES, AND STORAGE CONDITIONS Any goods with a limited shelf life or expiration date should be ordered and stored with the intention of being consumed within those timeframes. Shelf life and expiration dates of medicinal and similar goods may dictate special ordering and storage procedures. In addition to providing for first-in, first-out issues (see below), inventory control managers must examine order quantities to ensure the use of goods within specified times. This may necessitate EOQ adjustments. Shelf life also can be affected by other factors besides age. For example, some leather goods and certain plastics will deteriorate under prolonged exposure to ultraviolet light.

9)

ACCOUNTING VALUATION OF INVENTORY The method used to value inventories will affect the amount of expense associated with drawing from the inventory. Accordingly, reportable operating incomes will be higher or lower, depending on the valuation method. This, in turn, will affect the amount of taxes owed by the organization. The following are commonly used methods of valuation: A) Last-in, first-out (LIFO) In LIFO systems, the last goods received will be the next issued. If the price of inventoried goods rises, higher reported expense and lower reported income for a given period will result. Accordingly, the taxes due will be lower. First-in, first-out (FIFO) In FIFO systems, the oldest goods in inventory will be the next issued. If the price of inventoried goods rises, lower reported expense and higher reported income for a given period will result. Accordingly, the taxes due will be higher. Average cost in storage This method averages the cost per unit of an item in inventory by adding the value of goods received and those already on hand, and dividing that sum by the total number of units. The result is a weighted average value per unit. Goods are then issued, charged to internal customers, and reported as expenses using the average value.

B)

C)

303

Task 304 D)

Module 3 Lower of cost or market Under this method, an organization is permitted to value inventory at its cost or fair market value, whichever is lower. Devaluing inventory when market value has fallen enables the organization to show the difference as an inventory adjustment and include it in the period expense as a cost-of-sales expense. Retail inventory method With this method the closing inventory value is determined by calculating the average relationship between the cost and retail values of merchandise available for sale during a period.

E)

BIBLIOGRAPHY Lamperti, S. Getting a Handle on Leadtime, Purchasing Today , May 1997, p. 14. Oreskovich, R. Purchasings Role in Inventory Management, NAPM InfoEdge, (2:11), July 1997. Sloboda, D.S. The Ins and Outs of Minimum Reorder Point, NAPM Insights, September 1995, p. 9. Yates, R.A. MRP II: Purchaser and Supplier Management, NAPM Insights, July 1995, p. 21.

304

TASK 305: Meet with appropriate departments to discuss current material inventories, and establish restock levels or Just-In-Time strategies.
1) FINANCIAL IMPLICATIONS OF INVENTORY A) Working capital Working capital is defined as the current assets (the sum of cash, marketable securities, inventories, and accounts receivable) minus current liabilities (accounts payable plus short-term debt). If too much of the organizations working capital is tied up in inventories, the organizations liquidity may be negatively affected. Without adequate working capital the organization may have difficulty paying its employees and its suppliers. If the working capital is negative, the organization is technically bankrupt. Cash flow Cash flow deals with the sources and uses of cash. Cash is generated from the sale of goods and services, and is used to acquire goods and services. If too many of an organizations assets are tied up in inventory, the organization may have an acceptable current ratio (current assets minus current liabilities) but be cash poor. To obtain cash, the organization must turn the raw material and work-in-process inventories into finished goods that are then sold. The age of the accounts receivable is a measure of how long it takes to obtain cash from a sale. Asset turnover Asset turnover is calculated by dividing the cost of goods sold by the average value of the assets over a specific period. This is a measure of the productivity of the organizations assets. The magnitude of the number is less important than how it compares to the competition and its direction of movement. Inventory affects this ratio because inventory is an asset. The higher the inventory, the greater the value of the assets and the lower the asset turnover ratio. Return on investment (ROI) Return on investment (ROI) is a measure of return to the shareholder. ROI is calculated by dividing net profit by equity. It is the ratio of annual operating income to the total capital invested in the business. As inventory increases, carrying costs (such as interest costs, insurance, damage, and obsolescence) increase, reducing profits and decreasing the return on investment. Inventory costs Inventory is not free. There are three major categories of costs associated with having inventory: carrying, ordering, and stockout. Traditionally inventory is considered an asset, but inventory may be thought of as a liability because it incurs costs. When trying to evaluate the costs of inventory, the decision maker needs to consider all the relevant costs associated with each category. A relevant cost is one that will change in the short-term as the level of inventory or the number of orders changes. The acid test is whether money will be saved if the inventory is reduced, the number of orders is reduced, or the number of stockouts is reduced. This concept is based on the assumption that one purchase order results in one order receipt. Application 305

B)

C)

D)

E)

Task 305

Module 3 of the newer materials management strategies may result in one purchase order with multiple receipts over time. 1.0 Carrying costs Carrying costs, also called holding costs, are the costs associated with having inventory available. Carrying costs can be divided into four components: finance costs, ownership costs, risk costs, and overhead costs. Finance costs recognize that capital is required to finance the inventory. One approach for determining the finance costs is to use the interest rate associated with the organizations source of funds. This is usually the organizations short-term borrowing rate. A second approach is to use the opportunity cost associated with the rate of return required of investments elsewhere in the organization. For example, if the interest rate for short-term borrowing was 12 percent but the organization required all investments to return at least 18 percent, the opportunity cost approach would use 18 percent as the financing cost. The interest rate approach would use 12 percent. Ownership costs are those associated with having material on hand. The two main components of ownership are insurance and taxes. Insurance costs are the premiums paid for fire and theft protection of the inventory. Taxes are property taxes paid based on the value of the inventory at a particular time. Risk costs are costs associated with having material on hand for a period of time. Examples include obsolescence, theft, damage, and shrinkage. Obsolescence costs are the costs for material or product inventories that are no longer useful to the organization. They could be products that are technologically obsolete or components that have been replaced with a different part. The obsolescence rate also may be a function of the inventory turnover. Theft and damage are losses due to products being stolen or unusable because of damage. Shrinkage has different meanings in different industries. In retail, shrinkage may mean items lost by theft or improper recordkeeping. In agricultural products, shrinkage can mean the change in the weight of the product due to moisture loss. Overhead costs are costs associated with space, handling, and control. Space costs that may be relevant are warehouse space (especially if the charges are incurred based on the space occupied or volume of business, such as in a public warehouse), security for a bonded warehouse, or utilities for a cold storage facility. Handling costs are those

306

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Task 305

associated with the warehouse personnel. Control costs are those associated with operating and maintaining the materials control system. 2.0 Ordering costs Ordering costs are the costs incurred to place an order with an external supplier. Ordering costs are incurred in the process of identifying suppliers and placing replenishment orders. Examples include forms, telephone charges, computer time, postage, direct clerical labor, and the costs of the purchasing professionals. Other related costs are receiving and accounts payable. When the order is to be produced internally, the term setup cost is used in place of order cost. Setup costs may include direct setup labor, setup scrap, lost productivity, and tooling costs. 3.0 Stockout Stockout costs are the costs of not having the proper material on hand when it is needed. In general, stockout costs are among the hardest to measure because many organizations do not regularly collect this data. Stockout costs can be divided into several categories, including extra production costs, extra transportation costs, extra clerical costs, costs of a lost customer, and lost revenue costs. Extra production costs include costs incurred due to: The need to pay workers who are idle because of a lack of material. Extra setup costs, including direct labor and waste. The need to use overtime. Lost productivity.

Extra transportation costs may include premium freight charges, such as airfreight charges; higher LTL/LCL rates because the order could not be shipped at one time; or demurrage or detention charges caused by missing the scheduled ship date. Extra clerical costs are incurred when additional paperwork for backorders must be generated, orders must be split, or partial shipments must be received. Less obvious are costs such as lost revenue, lost profit margin, or a lost customer. Although these may be real costs, measuring them can be difficult. F) Commodity speculation The functions of inventory are to provide continuity of supply and protect the organization from variations in supply (see Task 304). When buying commodities, the purchasers primary objective is to ensure a consistent price even though the market prices are volatile. Commodity speculation involves purchasing quantities beyond normal or forecast usage (forward buying) in the belief that the price will go up and the organization will be able to sell the excess inventory at a substantial profit.

307

Task 305 G)

Module 3 Exchange rate issues Exchange rate issues are similar to commodities issues. If the organization is purchasing imported goods in U.S. dollars, then the supplier has taken on the exchange rate risk. If the purchaser has negotiated the deal in the suppliers currency, then the purchaser has taken on the exchange rate risk. If the exchange rate moves in a direction favorable to the buyer (for example from 4 Deutsch marks per U.S. dollar to 5 Deutsch marks per dollar) the purchaser may consider forward buying to take advantage of the greater purchasing power of the dollar. On the other hand, if the exchange rate moves to 3 Deutsch marks to the dollar, the purchaser has experienced a 32 percent increase in that items cost. The purchaser would then scale back purchases, hoping for an exchange rate reversal. Like commodities, the purchaser could use hedging to stabilize the exchange rate in order to maintain the negotiated cost.

2)

CAPACITY ISSUES A) Seasonality The seasonal variation in usage of an item interacts with the capacity of the organization and the suppliers capacity to supply that item. The inability to provide enough capacity in peak periods may include a lack of labor, high capital equipment costs, or seasonal variations that make it uneconomical to purchase equipment and facilities that may sit idle a major portion of the year. If it is undesirable to match production and purchasing levels with usage of an item, the organization may elect to build inventory during nonpeak periods to provide adequate material or product availability during peak periods. Contingency plans (e.g., disasters, strikes) Inventories may be increased in anticipation of special events, such as threats of shortages caused by strikes, political instabilities, or natural disasters. In conjunction with the internal customers, purchasing should develop a contingency plan based on up-to-date market analyses of all critical materials and services. Process variation All processes have variation. One of the functions of inventory is to provide protection against such variation (see Task 304). Purchasing needs to develop information on the natural variations of internal processes, as well as supplier production and delivery processes, in order to establish appropriate safety stocks and reorder points.

B)

C)

3)

SALES AND MARKETING RELATED ISSUES In todays environment it is not uncommon for purchasing to interact closely with sales and marketing. A) New product introduction Purchasing needs to be involved with marketing to ensure that the necessary raw materials, components, and/or products are available when production begins on a new product, or when a new product is offered for sale. The unavailability of materials, causing late entry into the market, can result in diminished market share and loss of profitability. 308

Part B: Supply and Inventory Management B)

Task 305

Product discontinuance Purchasing needs to be in contact with sales and engineering regarding the planned discontinuance of a product. The goal is to prevent the purchase of materials and components that are no longer needed by the organization. Purchasing organizations with an effective link to sales and marketing will be in a better position to add value as the organization shifts its focus and priorities. Obsolescence Purchasing has a responsibility to monitor the marketplace and work with internal departments to identify products and services being replaced with new technology or phased out by regulation. Promotional activities Marketing and supply management need to coordinate the availability of materials and products in anticipation of product promotions that result in increased production or demand because of the need to purchase additional raw materials, components, or products to meet the expected increase in demand. Forecasting errors Purchasing has a responsibility to work with internal customers and suppliers to identify the causes of forecast errors and to determine when a shift in operations, marketing, sales, customer demand, or other indicators may affect the need for a certain inventory level, restock level, or other inventory strategies. Purchasing is in a position to add value when it incorporates problem-solving techniques into its day-to-day interactions with other departments forecasting processes to detect variations from expected operations (see Tasks 312, 313, and 316 for a discussion of forecasting). Sales plan interface Sales, production planning, and purchasing must work together to ensure compatibility between the sales plan and the supply plan. By carefully linking purchasing activity and the planning and assignment of purchasing resources to the sales plan, purchasing can help ensure the organizations inventory decisionmaking system is effectively positioned to meet production, sales, and other performance targets.

C)

D)

E)

F)

BIBLIOGRAPHY Oreskovich, R. Purchasings Role in Inventory Management, NAPM InfoEdge, (2:11), July 1997.

309

TASK 306: Determine sources of and reconcile inventory discrepancies.

Inventory discrepancies commonly result from incorrect bar-coding and labeling, inadequate storage, misplacement, pilferage, inaccurate receiving documents, clerical input errors, and physical counting errors. Inventory control constitutes a series of feedback loops, or mechanisms, that generate information for evaluation. Results of the evaluation can be used to classify errors and to determine what corrective action is needed to protect inventory and decrease inventory discrepancies. The choice of inventory control techniques is influenced by financial considerations including the value of the inventory, the level of the inventory, the type of organization, and the degree of likelihood the inventory is attractive (i.e., having use beyond that of the organization). The following material identifies a variety of control concepts and techniques used to identify sources of inventory discrepancies and to reconcile inventory levels. 1) CONCEPTS OF INVENTORY CONTROL A) Perpetual vs. periodic A periodic system is so named because inventory level records are updated on a periodic basis (e.g., daily, weekly). Inventory level records are maintained by periodically checking inventory levels, or by accumulating transaction documents and regularly posting them to a card file or into a computerized system. Perpetual inventory systems are current because they are updated after each receiving or withdrawal transaction is posted to a card file, or entered into an on-line computer system. B) Inventory flow control procedures In addition to establishing specific methods by which inventories are to be controlled, inventory control procedures are an acceptable system of recordkeeping. Good records systems provide clear trails by which prior transactions may be audited. 1.0 Record systems Records systems refer to a linked system of transaction records, sufficient to identify the goods involved and to describe the nature, volume, value, and disposition of those goods. Records systems for inventory control usually include purchase authorizations, purchase orders and related documents, transportation and receiving documents, records of additions to inventories, records of issue of the goods to internal customers, and records of charges of the value of those goods to the internal customers account. In each case, the goods should be identifiable for source, description, value, and disposition. Audit trails Audit trails provide for periodic verification that proper procedures were followed, transactions were authorized, and the value of goods received was properly assigned. An audit may be performed at any time to evaluate purchasing performance. However, it is usually performed at year-

2.0

311

Task 306

Module 3 end by a professional team, before financial statements are prepared. Typically, an auditor will look for adherence to proper procedures and the use of proper documentation. For example, an auditor may randomly select a paid invoice and follow the trail backward to ensure that the payment was legitimate, that an authorized purchase order was issued, and that records verify receipt of the goods. In the case of inventory, the audit trail is used to verify that the goods are in the proper location and in the correct quantities. 3.0 Cycle counting Cycle counting is a physical counting process performed to verify inventory levels and to audit the accuracy of inventory records. It refers to routinely counting quantities on hand of inventoried items. Differences between inventory records and actual physical counts must then be accounted for, and the records must be adjusted, with respect to both value and quantity. Cycle counting schemes typically are used after inventories are classified according to Paretos rule, ABC analysis, or some other system designed to focus management priority on the most important items based on cost, strategic importance, and the like. The goal is to count the most important items more frequently for better control (see Task 304 for a discussion of ABC analysis). 3.1 Frequency Cycle counting is based on the fact that the probability of an error in inventory data is directly related to the number of transactions that take place within a specific period. The greater the number of transactions, the greater the probability of an error. Therefore, items that are used more frequently or are of high value should be counted more frequently than items that are used infrequently or are of low value. The greater the risk of discrepancy with the item, the more frequently counts should be made. Triggering criteria Using the ABC classification of inventory, a cycle counting system might have the A items counted monthly, the B items counted quarterly, and the C items counted semiannually or annually. Some C items are expensed upon receipt and will not need to be counted. Other trigger mechanisms for cycle counting include: receipt of an item, a negative or zero balance in the inventory report, the passage of a specified number of inventory transactions, or the passage of time.

3.2

4.0 C)

Physical counting This refers to physically counting the quantity of an item in inventory.

Inventory reconciliation procedures Inventory reconciliation procedures typically involve a comparison of physical inventory quantities to current quantities on record. If the two do not match, it is customary to change records to reflect actual on-hand quantities, and to account for the difference in quantity and value by debiting or crediting appropriate accounts. How an organization accounts for the value of

312

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Task 306

reconciliation depends on its management objectives and accounting practices. The key is that both quantity and value must be accounted for in a way that provides an audit trail. In all cases, the cause of such variation should be determined and eliminated. In the case of consignment inventories, the initial consignment agreement should contain procedures for inventory reconciliation. Typically, under and over shipments are handled according to routine receiving procedures. Inventory losses are debited to the appropriate account, as if the goods were used. D) External inventory specialists External inventory specialists can be hired from companies that specialize in inventory control. In the role of consultant, these companies will study an inventory situation, set up management and control procedures, and train in-house inventory control personnel. They typically offer the latest technology and methodology. Sources of error The probability of an error in inventory data is directly related to the number of transactions that take place within a specific period. The greater the number of transactions, the greater the probability of an error. Errors can be caused by data entry mistakes, putting an item in or removing an item from the wrong location, substitution of one item for another, not counting inventory in process but not yet deducted from the records, and items damaged or lost and not recorded as such.

E)

313

TASK 307: Handle obsolete equipment/materials, surplus equipment/materials, and scrap.

1) REASONS FOR THE DISPOSITION OF SURPLUS/OBSOLETE MATERIALS AND EQUIPMENT Surplus materials and obsolete equipment are present in all organizations and tie up capital that could otherwise be put to productive use. Sound practice dictates disposal of such materials by the best available means, with the goal of maximizing recovery of capital, and limiting the cost and exposure of disposal. The main objectives of this activity are to produce revenue from non-productive assets, to minimize costs associated with disposal, to conserve resources, and to take care of the environment. Generally, the following considerations enter the evaluation: A) Investment recovery Surplus and obsolete goods may be converted to cash through sales or through tax credits on approved disposal of capital goods not fully depreciated, thereby recovering some of the initial investment in those goods. Space management The space occupied by surplus or obsolete goods and equipment has an opportunity cost attached to it. If not used to store surplus and obsolete goods, the space could be used for other benefit-producing purposes. As a minimum, it could be sold or leased to generate income. Technical and economic obsolescence The economic life of equipment or materials is defined as that period of time during which they offer the most beneficial alternative for performance of their particular function. Economic obsolescence occurs when, from an investment point of view, it is economically advantageous to replace materials or equipment with better alternatives. Technical obsolescence happens when material or equipment becomes outdated due to a new or more advanced technology. Technical obsolescence may occur long before the equipment is worn out or inventory is completely consumed.

B)

C)

2)

REASONS FOR PLACING DISPOSAL RESPONSIBILITY WITH PURCHASING A) Access to services/sources Purchasing is the liaison between organizational users and outside suppliers of goods and services. No other function in an organization is likely to be as aware of goods available for disposal, alternate uses within the organization, or to have as many diverse outside contacts. Therefore, in the absence of a formal disposal function, purchasing is in the best position to most effectively handle an organizations disposal program. Knowledge of requisitioners ordering habits Purchasing is able to note and investigate irregularities in ordering quantities and frequencies relative to need that might lead to surplus/obsolescence. 315

B)

Task 307 C)

Module 3 Knowledge of the market The diversity of supplier contacts and ongoing market studies places purchasing in an advantageous position relative to other functions in matching surplus/obsolete goods to potential users, and in assessing the fair market value of such goods. Knowledge of legal issues regarding disposal A critical activity of purchasing is maintaining a steady stream of marketplace intelligence that includes not only changes to supply and demand and assessment of overall economic conditions, but also current and proposed legal requirements applicable to the disposal of goods. Product line discontinuance Changes in customer tastes and competitive pressures cause continual evolution in product offerings. Properly timing when these changes occur is essential in minimizing surplus/obsolete inventories. Communication between marketing and purchasing can provide the planning and demand management techniques necessary to reduce or eliminate surplus due to discontinued merchandise. Changes in labeling requirements Product labeling regulations can also create obsolete inventories. Purchasing will likely be aware of upcoming labeling changes and their impact on the organization through contacts in the supply chain. Purchasings subsequent communication with marketing will ensure implementation of a strategy to comply with requirements that will help minimize costs.

D)

E)

F)

3)

CLASSES OF MATERIALS SUBJECT TO DISPOSAL A) Surplus/obsolete inventory Surplus or obsolete inventories can result when purchases exceed requirements, when production exceeds sales, or when the reason for acquiring the inventory has changed. Surplus inventory is still usable, but the quantity on hand exceeds requirements. Obsolete inventory is not usable to the organization, because the intended use no longer exists. Both of these categories reflect product that is not damaged and, should demand levels resume, could provide their full value to the organization. The following are typical sources of surplus/obsolete inventory: B) Overly optimistic sales forecasts. Production in excess of requirements (this may result from market changes or from purposely extending production runs to lower set-up costs). Extensive forward buying. It may well be more economical to purchase largerthan-needed quantities, even though some units end up as surplus. Changes in materials, designs, or specifications before on-hand inventories can be consumed. This inventory is normally referred to as obsolete. Seasonality conditions that did not materialize (e.g., a warmer winter than expected).

Surplus/obsolete equipment, tooling, and fixtures Equipment, tooling, and fixtures may be rendered surplus or obsolete when:

316

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Task 307

Product lines are discontinued or slowed in response to decreased product demand. It is economically advantageous to replace operating equipment with newer, more productive, or technologically superior equipment, even though the older equipment may have remaining operating life.

C)

Scrap Scrap results from worn-out equipment, tooling, and fixtures, and is a residue from normal operations. There are two classes of scrap: process scrap and product scrap. Process scrap is a normal by-product of manufacturing, such as sawdust from a cabinetmaker. Product scrap is the result of quality issues, and refers to rejected end products. The major classes of scrap include ferrous metals, non-ferrous metals, plastics, paper, wood, glass, petroleum, and petroleum products. Waste Waste is a by-product of manufacturing similar to scrap, but the material is contaminated and does not carry the residual value of clean scrap. This material might be mixed with oils, chemicals, or dust. Waste is not easily disposed of. It may represent a cost to the organization that carries little or no residual value in its present form. Typically, cost must be incurred to maximize the return on waste product from disposal.

D)

4)

HAZARDOUS MATERIALS A) Material Safety Data Sheets Material Safety Data Sheets (MSDS) are part of the Federal Hazard Communication Standard issued by OSHA in 1983. Their purpose is to inform workers of products that are used in conjunction with their work. These sheets inform the user of physical dangers associated with the products, of safety procedures, and of emergency response techniques. Specific information includes the products identity, hazardous ingredients, chemical and physical properties, hazards, emergency telephone numbers, and revision date. MSDS must be available in the area when the products are used. Purchasing normally is responsible for acquiring MSDS, because they are provided by suppliers for those products consumed by the organization that are affected by this standard. Manifesting A manifest is a form used to document the movement of hazardous waste from a generators facility to a disposal site. The process was developed in conjunction with the U.S. Department of Transportation and the Environmental Protection Agency (EPA). The manifest tracks the shipment from the generators site to its final destination. The generator completes the multiple copy form. The primary carrier retains a copy and the remaining copies go to the organization taking possession of the shipment. A copy of the manifest is forwarded to the generator as proof of arrival at the final destination for disposal. If the generator does not receive the manifest copy in 45 days, an exception report must be filed with the local EPA administrator. ISO 14000 ISO 14000 is an international environmental standard developed by the International Organization for Standardization (ISO). Modeled after ISO 9000, it 317

B)

C)

Task 307

Module 3 provides for a voluntary approach to protecting the quality of the environment by an organization. Developed in 1996, its goal is to provide a framework for organizations to establish environmental policies and objectives, and to establish measures to evaluate progress toward the organizations objectives. The program is designed around the establishment of an environmental management system (EMS) that can be integrated with other management requirements within an organization. The formalization of this program allows for better visibility of hazardous materials generation and their impact on the environment. This visibility and knowledge can help lead an organization to more effectively plan for the containment and reduction of waste.

5)

METHODS OF DISPOSAL Proper planning is necessary to maximize return from any disposal process regardless of the type of organization. While the disposal process will vary, depending on the type of organization (e.g., manufacturer, retail store), it normally includes the following elements: List and classify the materials. It is important when beginning a disposal process to understand all of the material that is available. Collection of this information might begin with a tour of the facility to identify materials, items, and/or equipment no longer being used. The items identified then must be listed and classified into groups. Identify the reason for the accumulation. Perhaps the most important aspect of the preparation for disposal is understanding why the listed items or equipment are no longer useful. Ideally, the goal of the organization should be to reduce or eliminate the accumulation of surplus. Understanding the cause of obsolescence and its financial impact could lead to future reductions of such material. Sort and segregate the materials. The more the product or equipment can be sorted by type, color, size, etc., the easier the items will be to dispose of and the higher the return is likely to be. Recognize any secondary value of the material. Simply because material, product, or equipment is no longer useful to an organization does not necessarily mean that it is of no value. Other organizations or industries may need the material. Such alternatives should be pursued as disposal options before settling on smaller returns from less effective disposal options. Determine the impact of timing. Timing and current market conditions can have a significant impact on returns for surplus/obsolete materials or equipment. Shortages, for example, can make a product attractive that would otherwise not be so. Market conditions for certain materials (e.g., precious metals) can make scrap disposal an attractive or losing proposition. Return, resale, or trade-in to suppliers On occasion, suppliers will permit purchasers to return unused goods for a refund, or permit the purchaser to trade the unused material for some other goods. It should be pointed out, however, that suppliers with small volumes are unlikely to be as cooperative and liberal with return and restocking policies. 318

A)

Part B: Supply and Inventory Management

Task 307

If the product is a commodity or one in general use, surplus/obsolete material might even be offered for sale to potential suppliers for a credit on future purchases. If there is a known future need for the items, a purchaser might weigh the cost of reacquiring the product later against the cost of holding present stock. This is usually only done if there is an organizational future need and time in which the product will be used. B) Use by other parts of the organization By far the greatest return from surplus/ obsolete materials results from use by some other part of the buying organization. It is common practice to circulate excess/surplus/obsolete lists internally before offers are made to outside scrap or salvage purchasers. Sale The fair market value of surplus/obsolete goods will vary depending on the potential purchaser. Possible purchasers for surplus materials include current customers, other organizations, the public, primary dealers, recycling centers, auctions, and barter and trading companies. Fair market value should be determined before any sales effort is undertaken. Sources used to determine fair market value include publications, the Internet, suppliers, and trading organizations. Prices will vary depending on the need and perception of a potential purchaser. Sometimes surplus/obsolete goods can be offered for sale to employees. Sales to employees sometimes, however, can become a two-edged sword. Employees who are not happy with the product or who do not perceive equity in the process can adversely affect how they perceive the organization. Dealers and brokers are sometimes a good source of disposal because they have many alternatives to move a product. Often, prices offered are minimal and care must be taken to ensure that branded goods do not enter the organizations normal distribution channels. Demand management techniques such as discounts, special offers, rebates, or other techniques often are helpful in moving surplus and even obsolete products that are still of good quality. This is especially appropriate with items that carry no time significance deemed important by customers, such as model years for furniture. In the public sector, surplus materials and equipment may be disposed of through competitive bidding processes, auctions, or open stores. Private industry also makes use of some of these techniques. D) Donations Current tax law allows deductions for donations of material to approved organizations, educational institutions, and other non-profit agencies. Although there is technically no cash given for the merchandise, savings in tax dollars offer compensation to the donating organization. In some cases, this can represent a considerable part of the assets residual value. Generally, guidelines require that the product must be donated

C)

319

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Module 3 to an agency that is not-for-profit and serves the social needs of the community. Also, nothing of value is to be received in return as this would constitute a sale, trade, or barter.

E)

Disposal/recycling Depending on the nature of goods, disposal considerations may range from simply placing them into general disposal containers to treatment under hazardous materials regulations. On occasion, the owner may recycle surplus materials. This is particularly true in primary manufacturing, where clean process scrap can become part of a new cast of material. Product may be offered to suppliers for recycling as well. Segregated, clean material can raise value considerably. Also, reworking the product may raise its residual value. Another disposal option is listing materials with waste exchange agencies. These organizations publish catalogs that list numerous products available for sale or that are being sought. A developing source for materials exchange is the Internet at sites such as Recyclers World (www.recycle.net/recycle/index.html), United Computer Exchange (www.uce.com), and Tecnet (www.tecnet.com). When there is interest, product can often be obtained for little investment, sometimes for payment of the cost of transportation.

F)

Abandon in place This implies simply walking away from the goods, leaving them where and as they are. Such actions must be considered carefully due to future liabilities. Cannibalization Cannibalization refers to the removal of all useful parts or components from surplus/obsolete goods, for use within the organization or for sale. Sometimes parts sold separately return far more than a piece of obsolete equipment would. Reclamation Reclamation refers to the process of adding some cost to a product in order to raise its residual value. This can involve cleaning, sorting, reconditioning, or refining. The purpose is to make a product more usable to the organization or more saleable in the marketplace. Often scrap from manufacturing can be converted to other uses, such as in new product offerings. Precious stones not suitable for a particular application may be used in a new design at a new price point and be perfectly acceptable. Pressboard made from sawdust, and decking material incorporating recycled plastics are all examples of this type of disposal method.

G)

H)

I)

Barter Bartering allows products to be traded for other merchandise. This often occurs through bartering or trading companies, although it can occur directly between two organizations. Typically, rather than a direct trade for product, the owner is given trade credits that can be used to acquire product through the bartering organization. Product barter offerings are widespread and include travel, long distance telephone service, insurance, printing, office supplies, and advertising. When entering into a bartering arrangement, it is important that there is a high probability of using trade

320

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credits offered, because this is how value will ultimately be received for the disposed merchandise. 6) LEGAL ISSUES RELATED TO DISPOSAL OF MATERIALS/EQUIPMENT A) Warranties When selling surplus/obsolete materials or equipment, it is important to consider the application of warranties, particularly implied warranties. For example, when selling used equipment the implied warranties of merchantability and fitness for a particular purpose may apply, unless they are specifically disclaimed. When selling goods as scrap or surplus the documentation should specifically identify the goods as such. The same is true for product being sold as seconds. Liability Liability associated with disposal through the sale of surplus/obsolete goods can be reduced or eliminated through proper attention to disclaimers in the documentation. If, for example, an auto is sold as an auto, the purchaser may reasonably expect it to perform as an auto. If someone is injured in the auto through failure in operation the seller may be liable. If the auto is sold as scrap, and is not reasonably safe to operate as an auto, then a disclaimer should specifically say so to protect the seller. In the case of regulated disposal of hazardous material, liability will follow ownership, and anything that connects hazardous goods to its owner will generally be sufficient to establish a link and subsequent liability. Also, it is fair to assume that some currently approved and legal disposal methods may become illegal in the future, necessitating costly cleanup and remedial activity. Current disposal plans should consider both present and possible future liability. A common term for this concept is cradle-tograve, meaning the organization takes responsibility for a product from raw material through production to final use and ultimately to disposal. C) Tax implications and benefits Income from a sale of surplus/obsolete materials and equipment may be subject to taxation. If partially depreciated goods are sold, or donated to an approved organization, any remaining value may be reported as a loss. In the case of donation, this would be a net loss. In the case of sale, it may be a net loss or gain. Net gains are taxed as income and net losses are deducted from taxable income. Applicable regulations Purchasing managers engaged in disposal should keep abreast of applicable regulations. The primary law dealing with disposal is the Resource Conservation and Recovery Act of 1976 (RCRA), designed to control the disposal of hazardous goods, particularly chemicals, in a landfill. This Act created the cradle-to-grave control system that places responsibility for any hazardous waste on the generator. This applies even if the purchasers disposal contract contains indemnification clauses, warranties, or guarantees. If the handler disposes of the material improperly, the owner is responsible. In disposing of materials, one of purchasings most significant contributions is the proper qualification of sources. It is important to deal only with competent, reputable sources that know and follow all regulations. 321

B)

D)

Task 307 BIBLIOGRAPHY Hachmann, J.O. How High is Your EQ? Purchasing Today , July 1996, p. 4. Peterson, J. Stop It and Shrink It, Purchasing Today , July 1996, pp. 28-31. Scheck, S. Green Policies Catching On, Electronic Buyers News, July 6, 1998, p. 46. Worl, K.M. MSDS: Being in the Know, NAPM Insights, April 1994, p. 6-7.

Module 3

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TASK 308: Develop/implement a standardization program.

A standard is defined as an agreement on definite characteristics of quality, design, performance, or service. Standards typically fall into three categories: governmental, industry based, or organization-specific. Government standards include regulations and codes, such as those covering the packaging, labeling, handling, storage, and transportation of hazardous materials. Similarly, regulations require standard content labeling of foods and standard descriptions of products such as gasoline. Industry standards take two forms: form and format, and product interchangeability. Form and format standards specify organization and structure, such as the terms and syntax of a computer language. National and international standards may be established by organizations such as the American National Standards Institute (ANSI), American Society for Testing and Materials (ASTM), American Society of Mechanical Engineers (ASME), the Society of Automotive Engineers (SAE), Underwriters Laboratories (UL), and International Organization for Standardization (ISO). These organizations develop national and international form and format standards by consensus of the participating organizations. For example, there are approximately 12,000 ANSI-approved standards for such areas as computer languages, electronic data interchange protocols and forms, and quality certification requirements. Product interchangeability standards create an industry standard product that is produced to similar specifications, measurements, and design across the entire industry. Regardless of who produces the product, it is functionally interchangeable. For example, it makes little difference who manufactures a light switch. All are made to the same dimensions to fit a standard electrical box. All will fit the standard switch cover. All operate the same way and have the same current-carrying capacity. Another example is machine bolts and hex nuts. All are made to fixed sets of specifications. Machine bolts made by a Korean manufacturer will accept hex nuts of the same size produced by American or Brazilian manufacturers. Framing lumber made in the northwest from fir or hemlock should be interchangeable with that made from southern pine. Organizational standardization, on the other hand, is a managerial decisionmaking process that examines need and function and then selects the best available product to fill that need. The most effective solution is for an organization to use an industry standard. Industry standards have been shown to be 25 to 50 percent less expensive than similar, custom products. If the organization cannot find an industry standard to fill the need, then a customized product may be selected as the standard. This customized product will then be used whenever that recurring need arises. 1) GENERAL ISSUES IN STANDARDIZATION AND SIMPLIFICATION Every organization uses standards, and practices some form of standardization. Every organization, no matter how small, can use an organized standardization program. Such a program, regardless of size, can identify conditions, practices and situations that create inefficiencies that can be eliminated or reduced by standardization. The group responsible for the standardization program typically works with all operating units to review existing practices and standards, and to detect the need for modification as conditions change. It publishes revised

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and new standards and assists in required educational and implementation efforts. Once an organizational standard has been selected, it will remain in place until a demonstrably superior product arises. While standards are intended to have long lives, they are not intended to last forever. Significant product improvements may be justification for an upgraded standard, if the gain from the improvement has substantial value. Simplification differs from standardization in that simplification eliminates unnecessary functions, features, or tasks. Standardization is reducing the number of different parts that perform the same or similar tasks. A) Advantages and disadvantages Standardization can be an effective cost reduction technique. It can reduce the number of items in inventory having a common use. This can increase the quantity of each item retained, producing lower costs through quantity discounts, as well as lowering administrative costs through fewer transactions. Quite often, freight costs can be reduced as well. In many cases, standardization can eliminate inventories entirely by allowing an organization to use immediately available off the shelf standard items in lieu of specials that often require significant leadtime inventories. Standardization promotes competition because it is likely that many suppliers will be able to furnish the product or service. It also cuts production costs by increasing efficiency, decreasing material and labor waste, and increasing productivity. It relieves design engineers of routine work, allowing for more creative use of their time. It reduces administrative paperwork, and simplifies buying and cataloging. It also facilitates storage, warehousing, and stocking decisions. Standardization helps to avoid misunderstandings. When a purchaser requests a standard item there is little chance of getting something else. Standardization also results in simplification of the buying function. When standard specifications for a particular item are known the purchaser is left to concentrate on such issues as availability, delivery, warranties, and terms of sale. An internal customer is assured that the quality will remain the same when buying a standardized item. Standardization results in fewer items in inventory, as well as the possibility of lower inventory levels because of readily available stock from suppliers. In such instances, inventory procedures may be simplified and less warehouse space may be required. The need for quality inspections is often minimized because of the uniformity and accuracy of standard specifications. Obsolescence or loss through the inadvertent retention of items with limited shelf life can be avoided more easily under simplified inventory procedures with standardization. Carelessly created or applied standards may result in unsatisfactory performance. Failure to involve all major internal customers in the standard selection process may mean lack of acceptance and compliance. Neglecting to regularly review and assess standards for applicability to current requirements may promote standard violations. Failure to assess state-of-the-art technology may cause the organization to use less 324

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than competitive products. Each of these may represent disadvantages if the principles of standardization are not diligently applied. B) Procedures/steps in applying An organizational standardization program often has as its first step, the application of value analysis to the requirement (see Task 310). This process analyzes the necessary functional characteristics and how the need can be met at the lowest total cost. Even items such as office products may benefit from this approach. If the underlying function of a pencil is to make marks on paper, then does the two-tone blue and red pencil make a better mark than the yellow one? Is it necessary to pay significantly more for the fancy paint that contributes nothing to functionality? The impetus for standardization may logically come from the purchasing department because it is responsible for economic procurement, and because it is in the strategic position of dealing with both internal customers and external suppliers. For this reason, purchasing often administers the program. Collect data Before proceeding with standardization the organization needs to gather information regarding the products or procedures that are candidates for standardization. This means gathering information on how much money is involved, the possible savings, the number of users, the frequency of use, the quantity used, and other related data, in order to make reasonable choices regarding resource allocation and prioritization. Create a proposal The data should be developed into a proposal for management to obtain formal support for the program. Included in the proposal are short- and long-term objectives, a timetable for reporting progress, and operational aspects of the program. Top management endorsement will be crucial to allocate resources to the program and to promote widespread participation in it. Market the program Widespread awareness is an important factor in maximizing success. Enlist the participation of employees. They may be used on investigating subcommittees or research projects. This will expand the base of knowledge and experience involved in working on specific problems, and will enhance the overall success of the program. Standardization awareness should be promoted as a way of thinking at all levels of the company. Establish an operating mechanism (usually a standards committee) Representatives from each appropriate discipline should be appointed as standing members of the team, with special interest members from other disciplines active on an as required basis. The disciplines may vary from organization to organization, but typical areas include purchasing, material control, operations, engineering, research, and quality. One individual should be responsible for the overall management of the program. This is essential to ensure continuity and follow through. Someone with broad knowledge of organizational operations and products is usually best suited for this assignment.

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Module 3 Establish objectives Once established, the standards committee must develop meaningful and measurable objectives so that solid performance data can be generated. Projects must be selected. It is best to first take on projects that can yield early successes to publicize and promote participation. In establishing a specific standard, all major users of the product should participate. This includes those who design or use the item and those who purchase it; deal with suppliers; and handle, inspect, and store it. Acceptance and use of a standard is ensured if all major users make the standard selection. Simplify standards Standards should be as simple to interpret and use as possible. They should be readily available to those who need them, and reviewed and updated regularly. Complex or obscure standards will only minimize their usefulness and reduce the overall value of the program. Monitor and report results Activities of the committee should be recorded, and the accomplishments published to reinforce support for the program. Periodic detailed reports of costs of implementation versus cost savings should be a part of the committees routine activities. Top management, as well as the internal customers, should be informed of all significant accomplishments. Standardization is a dynamic process. Each standard should be reviewed periodically in light of intended use, volume, technological changes, and other issues that might indicate the need to revisit the choice. Standardization committees It is unlikely that a standardization decision will be made by just one individual. Typically, standardization committees are convened to determine the specific function for which the standard is to be selected, and to make the selection. As noted above, these committees are typically composed of the major users of the product to be standardized, in addition to appropriate supply and logistics personnel. Involvement of other departments As noted above, many other departments may be involved in standardization decisions. Production, maintenance, engineering, information systems, marketing, and other departments may participate, depending on the specific standardization decision under consideration. Effects on production methods/operations Standardizing components affects production and operations in several ways. By creating design standards and parts commonality, an organization minimizes the number of parts required for production, thereby reducing inventories and space requirements. Standardization of machinery and equipment minimizes training requirements for both machine operators and repair personnel. It also reduces repair parts inventories and increases inventory performance. Standardization of processes improves workflow, productivity, and quality.

1.0

2.0

3.0

C)

Application to high-use or high-volume items The most beneficial application of standardization will be to the highest volume requirements. Diversity within usage creates additional stock numbers, complicates recordkeeping, and lowers purchasing leverage, among other detrimental effects. The standards committee may review low 326

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usage items only after the high volume (and high standardization benefit) items have been finalized. D) Application to procurement of facilities Like capital equipment, facilities can benefit from standardization. For example, if multiple installations are required, one standard design minimizes architectural and design costs, improves construction efficiencies, and increases purchasing leverage. The principles of standardization are as applicable to facilities as they are to any other repetitive requirement. Application to procurement of MRO items Maintenance, repair, and operating supplies are a particularly lucrative area for standardization savings. MRO items comprise all indirect materials, such as electrical, plumbing, and janitorial supplies. Also included might be bearings, office supplies, fasteners, and many other non-production requirements. These items also represent some of the most difficult standardization projects, as maintenance personnel often have individual favorites for tools and other daily use items that make it difficult to reach consensus on a standard. Brand names versus generic names Brand name products are useful for purchasers as a way to ensure that a specific quality and functionality is obtained. Brand name products often exhibit little variation, because their manufacturers strive for consistency to maintain the brands reputation. Brand name products often cost more than similar generic products, but some of this cost can be justified by the reduced purchasing time and expense needed to order the item, and by the greatly reduced inspection time. A purchaser should carefully investigate to ensure equivalency before purchasing generic products. If they truly are equal, cost savings may be realized. If not, significant problems and failures can be averted by use of the brand name item. G) Administration cost per part number Administrative costs of non-standardization include maintenance of large databases, large inventories and inventory carrying costs, and other administrative costs such as ordering and receiving. As the number of part numbers maintained by an organization decreases through standardization, these costs should decrease accordingly. If, however, staff reductions are not brought about as variety decreases, administrative costs per part may actually increase in the short-term, as fixed costs are allocated across fewer parts. When administrative resources are reduced to balance decreased part numbers, costs per part number will decline as well. Maintenance cost An area demanding increased analysis by purchasers is the impact that non-standard capital equipment purchases have on spare parts inventories and maintenance costs. For example, Southwest Airlines has standardized on the Boeing 737. This has caused a significant simplification in the number of spare parts required, limited the breadth of training required of their maintenance personnel, and reduced the number of outside specialized services required.

E)

F)

H)

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Module 3 Legislative issues For governmental organizations there may be concerns that result from standardization efforts. Some agencies require competition for certain types of transactions. If, in the standardization process, certain suppliers are precluded from bidding, legislative or administrative rules may be violated. Purchasers should be aware of these issues. Cost-benefit analysis pertaining to standardization Standardization programs require an initial investment in employee time to research and select appropriate organizational standards. In addition, there is the ongoing investment to maintain the program and conduct the necessary standards reviews. Benefits include reduced purchase costs, reduced inventory investments, and lower carrying costs. In addition, maintenance, training, and operational costs all decline. Together, these cost reductions typically total several times the program investment.

J)

2)

ORGANIZATION STANDARDS Each organization is responsible for agreeing on standards across the organization. Such standards may be unique to the organization, may be an industry standard, or may be a governmental standard. Organizational standards can be separated into four basic categories: material supplies equipment procedure or process

Each operating environment will determine which of these categories is the most lucrative from a cost reduction point of view. In most organizations there is plenty of opportunity for cost savings in a variety of categories. The opportunities for standardizing operating materials and supplies have been discussed above. However, a word should be said about standardizing equipment and operating procedures. When an organization includes equipment in its standardization program, it is not only possible to reduce the cost of the equipment itself, but even greater savings may be realized relative to operating costs, training, maintenance, spare parts, and supplies. Some of the advantages of standardizing equipment were identified earlier in this task. Standardizing processes and procedures is another significant cost-saving opportunity. Examples are the requisition approval process or the return material authorization process. This enables an organization to minimize training time and costs, increase personnel flexibility, and maximize internal and external consistency, among many other benefits. Such standards, like those for materials and supplies, must be regularly reviewed and updated.

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Part C: Value Enhancing Methods 3) GOVERNMENT STANDARDS A)

Task 308

National Institute of Standards and Technology (formerly National Bureau of Standards) The National Institute of Standards and Technology (NIST) (www.nist. gov) is an agency of the U.S. Department of Commerces Technology Administration. It was established by Congress to assist industry in the development of technology needed to improve product quality, to modernize manufacturing processes, to ensure product reliability and to facilitate rapid commercialization of products based on new scientific discoveries. NIST has four major programs: Measurement and Standards Laboratories Advanced Technology Program Manufacturing Extension Partnership Malcolm Baldridge National Quality Award

B)

Other agencies Throughout the U.S. government, other standard-setting bodies can be found, whether they delineate the physical characteristics of an item or the manner in which it is to be tested.

4)

INTERNATIONAL STANDARDS International standards reduce trade barriers and facilitate international trade. The United States Trade Act, passed in 1979, created the Multilateral Trade Agreements, which included an international standards code. Actual adoption of this code by industrialized nations has not yet been fully realized.

5)

STANDARDS ASSOCIATIONS/ORGANIZATIONS Standards are developed by standards associations to provide uniform specification data, and to ensure the interchangeability of components and processes in a multi-supplier environment. A) Society of Automotive Engineers (SAE) The Society (www.sae.org) is comprised of nearly 80,000 members from almost 100 countries who share technical information and advance engineering of mobility systems. They have standards development and research committees for ground vehicles, aerospace, advanced technologies, and intelligent transportation systems. American National Standards Institute (ANSI) The American Standards Association (ASA) was founded in 1918 by five engineering societies in order to remove the confusion resulting from the several hundred groups that were engaged in issuing standards. Three departments of the federal government soon joined ASA. Later the membership was broadened to include all nationally recognized technical societies and professional trade associations having an interest in standards. The National 329

B)

Task 308

Module 3 Association of Purchasing Agents, which later became NAPM, became a member of ASA in 1950. ASA changed its name to the American National Standards Institute in 1969. Currently, ANSI has several major functions: Coordinate the development of national consensus standards by helping participants reach agreement on needs for standards and on priorities. Approve standards as American national standards when it has verified evidence that consensus exists. Evidence is provided by organizations and committees that voluntarily submit standards to the Institute for approval. Coordinate and manage representation of U.S. voluntary standards interests in non-governmental international standards organizations, in particular the International Organization for Standardization (ISO) and the International Electrotechnical Commission (IEC). Furnish advice, counsel, and testimony on standards-related issues to congressional committees, and state and local legislative bodies.

ANSI does not develop standards. It facilitates development by establishing consensus among qualified groups. There are more than 175 entities with whom ANSI coordinates. Currently there are more than 13,000 ANSI-approved American national standards, and more than 6,000 ISO and IEC international standards. ANSI acts as a clearinghouse and information center for these publications. C) American Society for Testing and Materials (ASTM) The mission of ASTM (www.astm.org) is to promote public health and safety; to contribute to the reliability of materials, products, systems and services; and to facilitate national, regional, and international commerce. ASTM was created in 1898 by employees of the Pennsylvania Railroad in recognition of the need for standards for the materials the railroad purchased in large quantities. It first developed standards for structural steel for bridges and cement. It now consists of more than 100 technical committees developing standards for highway transportation, petrochemicals, electronics, aerospace, consumer products, hazardous substances, and oil spill response. Today, ASTM has more than 10,000 standards in 129 different technical areas. D) International Organization for Standardization (ISO) ISO (www.iso.ch) is an international federation of national standards bodies from more than 130 countries one from each country. Its purpose is to promote the development of standardization and related activities, to facilitate the international exchange of goods and services, and to develop cooperation in intellectual, scientific, technological, and economic activity. In addition to the ISO 9000 framework for quality management and the ISO 14000 framework for environmental management, ISO has developed standards for such 330

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things as film speed, telephone and bank cards, freight containers, paper sizes, automobile control symbols, and many other areas (see Task 207). E) Underwriters Laboratories Inc. (UL) UL (www.ul.com) is an independent, notfor-profit product safety testing and certification organization. Founded in 1894, UL has five testing laboratories in the United States, as well as in Mexico, Denmark, England, Italy, India, Singapore, Taiwan, Hong Kong, and Japan. UL maintains more than 170 inspection centers in more than 70 countries. They also coordinate UL standards with Canadian, IEC, and other international standards. Others Other standards organizations/associations are: American Society of Mechanical Engineers (ASME) (www.asme.org) Institute of Electrical and Electronic Engineers (IEEE) (www.ieee.org) American Chemical Society (ACS) (www.acs.org)

F)

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TASK 309: Develop/implement a process improvement program.

Any process can be improved. Continuous process improvement can yield productivity improvements for the organization. It can also help shape a culture in which people take ownership of their processes and work to improve them on an ongoing basis. Before initiating a process improvement program, it is imperative that everyone involved is clear about the goals (Why are we doing this?) and expected results (What do we hope to achieve?). 1) STEPS IN CONTINUOUS IMPROVEMENT Process improvement is itself a process. The steps include: A) Definition of the process Decide what process to improve and flowchart the steps in that process. Decisions at this step include: Defining the boundaries of the process. Boundaries will also define the inputs and outputs of the process and who its customers are. Defining who should be involved in the improvement process. Everyone working inside the boundaries will be involved. The team driving the process improvement should have a representative from each job area included. It is better if everyone can directly participate on the team. Defining the level of detail to flowchart. More than one will be necessary. A high-level flowchart of the process generates understanding and agreement on the process itself, and can be used for establishing measurement points. A tasklevel flowchart will be necessary as improvement work begins. This defines in detail what people do. Simplification and improvement often occur at the task level. Defining what information to include. A task-level process improvement flowchart should include: - A brief description of the task. - Who does the task (by job title, not name). - How long it takes to do the task, on average (if there is a very large spread from maximum to minimum time, then note it). - What is the reason for doing this task? Why is it necessary?

This provides the basis for measuring improvements in time and process costs. B) Definition of the measurement system Two sets of measurements are included in process improvement: Business result measurements, which are permanent measures of effectiveness. Improvement measurements, which are temporary measures to determine whether changes to the process are making it better or worse. 333

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Module 3 An example of a business result measurement is supplier delivery performance. Improvement measurements may include cycle time reduction (for a transaction), the amount of a purchasers time spent on a certain task, or a reduction in process cost. Both types of measurements should result in improvements, but the temporary measures will cease as the revised process becomes ingrained. If either type of measurement indicates a worsening of performance, then changes must be made before process improvement can continue.

C)

Improvement of methodology This is the actual work of examining the process and designing simpler alternatives to the process. Areas for improvement include: Eliminating unnecessary or redundant tasks. Redesigning and simplifying the necessary tasks Eliminating rework (e.g., the need to do work over because of mistakes).

D)

Execution of the action plan Once the idea for an improvement has been agreed upon, it must be implemented and the results measured. If the improvement team does not include everyone involved in the process, then those who were not part of the redesign must be trained in the change. Results measurement Did the change to the process result in a change in either business performance or process performance? Were those results positive or negative? If the results were positive, keep the change. If they were negative, then the change should be undone and reassessed. Benchmarking Benchmarking is the comparison of ones own process to the best process for accomplishing that business result that exists anywhere. Frequently, the best may be in a different industry or sector. Searching for the best to benchmark leads to an ever-widening perspective regarding what is possible, and may generate ideas for improvement. Evaluation and follow-up When participants believe they are finished they need to ask: What total benefits were achieved? Were the original target goals met? What rewards are appropriate for those who accomplished the improvements? Where does the organization want to go from here? How should the process improvement program continue to be used within the organization? Is the program in place effective? How might it be changed or modified to be more effective?

E)

F)

G)

BIBLIOGRAPHY McKellar, J.M. Redesigning the Purchasing Process for Maximum Effectiveness, NAPM InfoEdge, (1:9), March 1996.

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TASK 310: Develop a cost reduction, cost avoidance, cost containment program (e.g., value analysis, consolidation of orders/suppliers, leadtime reduction).
1) ISSUES TO BE CONSIDERED WHEN ESTABLISHING A COST CONTROL PROGRAM Cost control programs provide a systematic forum for reducing the total cost of acquiring and using a product or service. However, cost control should not be achieved at the expense of quality. The principal objective should be to take advantage of the changes in technology, environment, and on-the-job experience to control costs. Cost reduction is defined as an effort to trim the costs associated with acquiring and using a particular product or service. Cost reductions may be obtained by selecting alternative materials, processes, services, sources, and purchasing methods. For example, as more organizations adopt Just-In-Time (JIT) inventory methods, they tend to work with little or no supply buffers, which reduces inventory costs. However, if a supply or delivery problem occurs, the supplier will have to use a premium form of transportation to ensure the continuity of production (in a manufacturing environment) or product availability (in a hospital environment), which will raise costs. As purchasers and internal customers gain experience with JIT conditions, they will have to work together to identify why problems occur and develop solutions to reduce costs. Cost avoidance is defined as an effort to prevent/reduce supplier price increases or ancillary charges. This may be accomplished through the use of value analysis, negotiations, and a variety of other techniques. Because these savings are less tangible, there is continuing debate over reporting cost avoidance savings. They may become more important in an inflationary market. Cost containment is typically a detailed plan to hold costs and purchased prices within certain target limits over a specific period. For example, a car manufacturer might work with a supplier to remove $1,000 in cost to produce the car over a period of four years. This may be accomplished through the use of value analysis, negotiations, and a variety of other techniques. A) Status of the standards program When implementing a cost reduction program, standards are of great importance. Clear standards help reduce costs by eliminating unnecessary variations in products and services. Standardization of equipment increases the use of that equipment, reduces spare parts inventories, and reduces maintenance downtime. This reduces the unit cost of service (see Task 308). Coordination with other departments Coordination with other departments enables a purchaser to better understand the needs of internal customers, which will help the purchaser to provide the right kind of service, while still reducing costs. In price negotiation, an in-depth knowledge of internal customer requirements enables the purchaser to obtain the required product and services on the best possible terms. 335

B)

Task 310 C)

Module 3 Time requirements The choice of a cost-reduction approach must consider the time required to make an improvement. For example, the use of value analysis or a commodity council made up of members from many parts of the organization will undoubtedly require significant resources, effort, and time. Effect on quality and service The goal of any cost-control program is to obtain better value for the resources to be expended while maintaining the required quality of a product or service. Guidelines must be put in place to ensure that the most effective technique is selected, so that cost-control is not simply practiced without regard to other needs of internal customers. Effect on operations Value-analysis teams involving operations personnel bring a practical dimension to the critical examination of each part and each operation. Decisions reached by such cross-functional groups usually are accepted easily by line managers and employees, and are implemented faster. Calculating cost avoidance/reduction The objectives of cost-reduction methods like value analysis and freight consolidation include tangible cost savings and future cost avoidance. If, by using freight consolidation, lower truckload rates can be obtained from a carrier, the amount of cost savings clearly is tangible. However, negotiating a smaller rate increase may mean cost avoidance that is less tangible. In evaluating the performance of any cost reduction program, it is important not to lose sight of cost avoidance benefits, as well as direct cost savings. Market testing It is important to involve internal customers and sometimes even end customers to test market changes that result from a cost-control effort. Top management support Some cost-control programs, such as value analysis, involve fundamental changes in the design of products and services. This requires willing participation and wholehearted cooperation from many departments or functions. A clear mandate and participation from top management help ensure the close coordination necessary in such programs. Lack of top management support is detrimental to morale, and could result in the inability of the cost control program to reach its full potential. Design flexibility The establishment of designs that may have multiple applications as well as those that can be easily adapted to other uses, reducing costs by rationalizing inventories and delaying costly total redesigns will be required. Product longevity Careful consideration needs to be given to the potential useful life of a product. Some are expected to work for long periods under adverse conditions without the probability of failure. Conversely, product development life cycles continue to compress, and the longevity issue for many products has considerably less merit. Consequently, longevity becomes a factor to consider as an element for cost control.

D)

E)

F)

G) H)

I)

J)

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Part C: Value Enhancing Methods 2) ELEMENTS OF A COST CONTROL PROGRAM A cost control program aims to: A)

Task 310

Identify and eliminate unnecessary costs. Obtain cost efficiency without affecting the quality of the raw material, component parts, or systems involved. Organizationwide buying agreements 1.0 Centralized buying In centralized buying, a specific department or individual is given total authority and responsibility for purchasing for the organization. Centralized buying has the following advantages: By consolidating purchases of all departments/divisions, the purchasing department obtains greater clout and can obtain better prices. Standardization among operating units helps an organization obtain better prices by taking advantage of supplier economies of scale and reduced inventories. It reduces administrative expenditures both for the supplier and the buying organization. The purchasing department can develop specialization and greater expertise in source development.

Critics of centralized buying believe that it slows the acquisition process and increases leadtimes. They also argue that being away from the point of use makes it difficult to understand the internal customers needs and can stifle innovation. 2.0 Lead-divisional buying A compromise between centralized buying and decentralized buying is lead-divisional buying. Under this scheme, the division that consumes the largest quantities of a material consolidates the total requirement, and is made responsible for procurement of the item for all internal customers in the organization. While this gives the organization clout in negotiations and achieves other benefits of centralized buying, it also ensures that the buying department is closer to the internal customers needs. Commodity councils Commodity councils are often used to obtain the advantages of both centralized and decentralized buying. Under this method, a committee composed of representatives from various user divisions is formed. Decisions made by commodity councils capture the needs of various internal customers, yet result in the clout achieved through centralized buying.

3.0

B)

Pool buying and cooperative purchasing Pool buying involves the consolidation of requirements of multiple organizations into a single large order to obtain better pricing. At the same time suppliers can use the economies of scale and pass on part 337

Task 310

Module 3 of their savings to the purchaser. As a result, both parties win. The costs of administering a pool buying or cooperative purchasing program are shared by the participants, who in some cases may have been unable to afford the administration costs if purchasing individually.

C)

Long-term agreements Previous Japanese business success has led many business analysts and researchers to investigate Japanese business practices. One of the characteristics identified is the long-term association between purchaser and supplier organizations. Further research uncovered the Japanese understanding of the need for significant operating efficiency, and dedication in all phases of the business processes. A major requirement for achieving efficiency is sustained research and development, and investment in technology by all members of the supply chain. In addition, close cooperation between all members of the supply chain is needed. Suppliers look for stability in exchange for increased proactive participation with purchasers, and the willingness to invest in technology and management processes. The purchaser is in a position to influence stability through the use of long-term agreements. This can help ensure longer-term returns from the business investments made by the suppliers and purchasers organizations.

D)

Contracting for total requirements Another way of creating interest among suppliers in closer supplier-purchaser cooperation is to procure total lifetime requirements of a certain part from a single supplier. This gives a much more accurate picture of the extent of the business a supplier is likely to have for a particular part or family of parts. Consequently, the supplier is better able to gauge the level of business and make judicious decisions as to the extent of cooperation and business investment. Supplier productivity As the purchaser and supplier work together to find ways to lower costs, they should share the productivity gains. The exact nature of the sharing will vary by supplier and commodity. This will encourage both parties to continue looking for improvements. Target cost This is the determination of the cost of an item that both purchaser and supplier believe will be the likely outcome, given: (1) normal business conditions, and (2) the application of learning curves to recognize efficiencies derived from experience. Target price This is the practice of identifying a selling price and working with suppliers to arrive at appropriate costs for achieving profitable sales. This is also called price-based costing. Consortia Consortia are another form of pool or cooperative purchasing (see Task 107).

E)

F)

G)

H)

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Part C: Value Enhancing Methods 3) QUALITY ISSUES

Task 310

Purchasings impact and influence on quality will be affected by its relationships with other parts of the organization, and its understanding and application of various principles and practices. A) Purchaser coordination with quality assurance/control A purchaser must understand the organizations quality needs and communicate those needs to the supplier. The purchaser is also responsible for understanding the suppliers quality limitations, and soliciting the advice and technical help of the purchasers quality assurance staff to assist the supplier. In todays competitive environment, it is necessary to treat the supplier as an extension of the purchasers organization, and to provide the supplier assistance in developing an adequate level of technical and managerial expertise. This involves coordinating with quality assurance for correct interpretations of needs, assessing the suppliers capabilities, and providing the quality control tools needed to ensure the desired results are achieved. Purchaser coordination with receiving/using departments One means of achieving close cooperation with suppliers is to involve them with internal customers early enough so they can better understand the internal customers needs, and reflect those needs in the design and production of the item. As a conduit between the two groups, purchasing has a major responsibility in coordinating the interactions between the supplier and internal customers. Coordination with supplier quality assurance/control efforts Much of the close cooperation between the supplier and the purchasers organization involves communicating needs and instituting reasonable control procedures at supplier facilities. This involves close coordination between the suppliers and the purchasers quality control departments. Purchasing, working as the link between the two, has an important responsibility in the coordination process. Mutual cost reduction Understanding the actual needs early in the design process helps suppliers optimize design, production, and service processes. This can lead to more effective choices in design, production, assembly, and delivery. Solutions may be found that reduce production, assembly, and delivery costs. Intelligent and optimum designs also often led to simpler fabrication, assembly, and inspection.

B)

C)

D)

4)

VALUE ANALYSIS/VALUE ENGINEERING Value analysis is a systematic analytical approach for obtaining the maximum value for each dollar spent. Its focus is determining the value of the function performed by a product or process, and comparing that value with its cost. This ties in with purchasings objectives related to cost reduction and cost avoidance. The analysis must consider factors beyond cost (such as market acceptability), because in the end, these elements have a cost associated with them as well.

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Module 3

The terms value analysis and value engineering are used interchangeably in some environments. Value analysis relates to a management process that focuses on existing products and systems. It coordinates all functions in an operation with a view toward reducing the overall cost of the production and sale of the product. Value engineering is a system that analyzes the functional requirements of a new product the equipment, facilities, and procedures used in production; and the materials that comprise it, to achieve the lowest cost without loss of performance, quality, or reliability. A) Process Value analysis involves the careful evaluation of a product or part from all aspects of design and function. Every part or process is critically examined with a view toward finding a better alternative. Value analysis aims to eliminate, simplify, or combine parts and/or processes to achieve a more efficient and effective use of resources. Progressive purchasing managers do not buy parts, they buy functions. Value analysis leads to the redesign of parts and processes to achieve required functions for less cost. Value engineering involves designing new products with a value orientation. Techniques The principal objective of value analysis is the procurement of materials, components, and services that render the best value for the money. Controlling the cost of materials is a key element in this process. Design analysis systematically examines all items relative to the functions they perform. The following questions are asked: Can we eliminate the part without affecting the operation of the end product? Can the design be simplified to reduce its cost? Can the design be altered to obtain more versatile parts that perform multiple functions? Can we use materials that are in greater supply or that cost less?

B)

Purchasing can play an important role in this process by involving suppliers in value analysis. Suppliers bring important resources to the process, and their participation helps to instill a value orientation. C) Organizational requirements The success of a value analysis program depends on the organizational framework, and the extent of top management support. A popular value analysis approach consists of a team chaired by purchasing. The team may include members from design, quality control, operations, and accounting. As purchasing managers intensify a program of value analysis, they often encounter resistance based on a lack of understanding and misinformation. The multi-disciplinary team approach ensures the dissemination of factual information throughout the organization. A team-based approach also ensures input from all concerned employees. As a result, implementation becomes easier. Careful selection of members is essential. Members of the team should be competent, creative, and held in high esteem by coworkers. Of crucial importance in establishing credibility of the value analysis process are top management participation and support. Top management support guarantees a perceived importance of the process and ensures participation of all concerned functions.

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Task 310

Function in relation to cost and quality In value analysis, the emphasis is on obtaining maximum functional value for a product, part, or process, relative to cost and quality. Some products may be over-engineered and be more expensive than necessary. Some may have higher quality than what is needed, and thus are unnecessarily expensive. Some may be poorly designed and expensive to assemble or service. Value analysis aims to uncover these and other weaknesses in products and parts by critical examination of all aspects of design, production, and serviceability. By engaging in the value analysis process, purchasing managers help ensure that procured products, parts, and processes result in the best value for the organization.

5)

OTHER FORMS OF COST CONTROL A) Improved form, fit, and function Form, fit, and function is an overall qualityrelated term common in purchase agreements that encompasses the physical attributes of something (form), its desired output or performance (function), and its fitness (appropriateness for the application or use to which it is to be put or used). In a cost control context, the fabrication and assembly of a product contributes significantly to the product cost. Intelligent designs leading to easier fit or form can reduce assembly and/or machine time appreciably. Purchasing managers can play an important role in promoting supplier-user cooperation in improving a products value by striving to obtain better form, fit, and function. Easier use Easier use of parts leads to savings in assembly time and after-sales service. Such parts reduce the chances for error in fabrication, assembly, or servicing. This adds to the quality of a product. Easier use of products is appreciated by customers, and gives an organization a good reputation in the marketplace. Administrative savings Administrative costs represent a significant factor in the cost of procured raw materials, parts, and components. Efforts to increase administrative efficiency through the use of technology, forms standardization and control, process improvement, and training can help reduce the impact of administrative costs. Improved quality The quality of an end product or service depends largely upon the quality of the components and the parts that go into it. For example, good quality parts reduce the chance of process rejections. Improvement in end-product quality increases the likelihood of customer goodwill and a larger market share

B)

C)

D)

BIBLIOGRAPHY Ellram, L.M. Cost Reduction: Match the Tool to the Purchase, Purchasing Today , October 1998, p. 34 Haluch, F. and R.J. Trent. Creating Value Through Price/Cost Productivity, Proceedings of the 1997 NAPM International Purchasing Conference, Tempe, AZ, pp. 91-96. Miller, M.S. and C. Pye. Cost Reduction versus Cost Avoidance, Purchasing Today , January 1996, p. 5. 341

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Newman, R.G. Target Pricing: A Cost Reduction Strategy, NAPM Insights, September 1995, pp. 33-34. Smith, R.F. Ready, Aim, Reduce, Purchasing Today , October 1998, p. 18. White, J.A. Incentive-Based Cost Reduction Programs, Proceedings of the 1999 NAPM International Purchasing Conference, Tempe, AZ, pp. 176-178.

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TASK 311: Coordinate the introduction of new and modified products and services with appropriate departments.
One of the great challenges of business today is for organizations to make use of technology to better compete in world markets. This involves designing better, higher quality products and quickly getting them to market. Organizations today can make use of information technology to bring individual departments together as teams to work on releasing new products. Purchasing can play a key role in a new product handover to production. Concurrent engineering is a manufacturing strategy that provides the manufacturing system with a competitive advantage in the world marketplace. Concurrent engineering calls for the consideration and inclusion of product design attributes such as manufacturability, procurability, reliability, maintainability, schedulability, and marketability, in the early stages of product design. The natural focal point of concurrent design is product design. A decision concerning product design tends to have a number of significant manufacturing and non-manufacturing effects on the life cycle of the product. Crucial to this concept is design for manufacturability, assembly, and/or delivery, where engineering works with purchasing, manufacturing, operations, and marketing on the front end. This avoids errors that waste time and resources later in the product life cycle. Purchasing and design should work together in the areas below (see also Exhibit 6). 1) ROLE OF PURCHASING IN PRODUCT/SERVICE DESIGN A) Research and development Before the design drawings and specifications are released, there has to be a dialog between the designer and purchaser. Both bring desirable information to the table. Purchasings knowledge of the supply markets enables it to provide information about product or material availability, as well as information regarding new developments on the horizon. Working together improves speed of release, cost effectiveness, and total quality of a new product. Substitution Purchasing may be able to recommend parts or materials that meet functional requirements at the lowest practicable cost. Often suppliers can recommend newer or alternative components that do the job. Product innovation Purchasing is responsible for maintaining and developing relationships with suppliers that result in their sharing information on product innovations with the purchasers organization. If such relationships are carefully cultivated, suppliers may recommend new products on the market that enable the designer to make inventive or resourceful changes to a product. Contracting for design services During the design phase, scarce project resources (e.g., time of designers and engineers, computer capacity) can often delay release of the product into the marketplace. Procurement can contract with outside services to help ensure that each project stays on target. Design services that may be contracted

B)

C)

D)

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Module 3 include circuit design, software development and programming, prototype machine and assembly, graphic design, technical writing, modeling, testing, and equipment rental.

E)

Qualified products list The speed of the entire design process is dependent on the weakest link in the process. Consequently, it is advisable to avoid parts or processes that may impede the smooth flow of the operation. Purchasing can assist design and engineering teams by calling attention to parts that are on a qualified products list and those that may have long or unstable leadtimes. Early Supplier Involvement (ESI) A practice that involves one or more selected suppliers with a purchasers product design team early in the specification development process is defined as early supplier involvement. The objective is to use the suppliers expertise and experience in developing a product or service specification that is designed for effective and efficient manufacturability, assembly, and delivery (see Tasks 212 and 314). EXHIBIT 6 DESIGN AND PURCHASING INTERFACE

F)

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Part C: Value Enhancing Methods G)

Task 311

Early purchasing involvement Even before using ESI, purchasing should be involved in the product development and design process. Purchasing brings insight into supply market conditions, availability of materials and services, and potential sources of supply. Purchasing also is able to apply such tools as value engineering and analysis, and standardization to specification development (see Task 208). Sourcing and cost profitability issues Purchasing can get involved upfront to make sure all potential costs are identified accurately early in a product design project. With its knowledge of suppliers products, services, and know-how, purchasing is in a position to suggest materials and component substitutions; items ripe for standardization; how processes might be modified; and if specifications are clearly and effectively written, to enhance competition. Use of such information, and the application of costsaving concepts, ensure that purchasing is adding value and contributing to the successful decisionmaking processes within the organization. Speed to market Global competition, accelerated technological advances, and market demands for new merchandise and services are key reasons to reduce productto-market leadtimes. Purchasing must take a more effective role in new product development through its cooperation in a multi-department team approach. This partnership can reduce time-to-market and increase product acceptability in the marketplace. Purchasings crucial contributions are in the selection of suppliers that provide a continuous supply of materials, components, and services; the certification of suppliers in accordance with quality; and evaluation of make-buy decisions. Purchasers must facilitate the development of strategic alliances and partnerships. They work with suppliers and designers to develop proposals for alternative materials, and to purchase tooling and equipment. The purchasing professional can provide insights into a competitive supply environment. Additional areas of collaboration include the development of specifications, part standardization and simplification, value analysis, part substitutions, and part exclusions. New product development efforts must take full advantage of the strategic positioning aspect of the purchasing operation. Suppliers must also be considered critical members of this team. Purchasing is pivotal to the flow and interchange of useful information between the supplier and end user. Successful organizations must introduce new products and services that fulfill the customers expectations for quality, price, safety, and appearance. These new products and services must reach the consumer in a shorter period of time.

H)

I)

BIBLIOGRAPHY Dowlatshahi, S. Purchasings Role in a Concurrent Engineering Environment, International Journal of Purchasing and Materials Management, (28:1), Winter 1992, pp. 21-25. 345

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McGinnis, M.A. and R.M. Vallopra. Purchasing and Supplier Involvement: New Product Development and Production/Operations Process Development and Improvement, NAPM, Center for Advanced Purchasing Studies, Tempe, AZ, 1998. Mendez, E. and J. Pearson. Purchasings Role in Product Development: The Case for Time-Based Strategies, International Journal of Purchasing and Materials Management, (30:1), Winter 1994, pp. 3-11.

346

TASK 312: Plan purchasing, sourcing, and supply strategies based on forecasted data. TASK 313: Develop supply plans and strategies based on forecasts of future demand.
1) BUYING STRATEGIES Among the strategies available to purchasing and supply managers is purchase timing. Use of forecast data can assist in selection of one of the following appropriate options: A) Hand-to-mouth buying This is a short-term strategy, with frequent purchases in small quantities to meet only immediate short-term requirements. This strategy might be employed in falling markets where purchasers wish to take advantage of decreasing prices with each successive purchase. Cash flow constraints, or goods that are perishable or subject to rapid technological change, are other factors that might make this approach appropriate. Buying to requirements Advance purchases for use in the three weeks to three months timeframe might be classified as buying to current requirements. This practice is probably the most common, because it ensures supply while avoiding excessive inventory carrying costs. Even in a JIT environment, the purchaser needs to look at future requirements. Organizations often will guarantee a percentage of the forecasted requirements to maintain flexibility. For example, the organization guarantees the next four weeks requirements. For weeks five through eight, the purchaser guaranties 90 percent of the forecasted requirements, and for weeks nine through 12, 75 percent. Forward buying Frequently, conditions such as potential supply constrictions or inflationary markets cause purchasing managers to hedge price or supply by buying more of a product than is required. This practice is called forward buying and protects the organization from shortages, or delays the impact of rising prices. The trade-off is, increased inventory carrying costs. The mindful purchasing manager will evaluate the trade-off between inventory carrying cost increases, and decreased risk of supply constriction or decreased prices. Speculative buying/volume purchase agreements Speculative buying refers to purchases made not for internal consumption, but with the intent to resell at a later date for a profit. These speculative goods may be the same as those purchased for consumption, but quantities purchased will be in excess of current or future needs. The intent is to take advantage of expected increases in price to profit from the resale of the goods. When significant quantities of specific products or commodities are needed, these requirements may be met through volume purchase agreements. The primary 347

B)

C)

D)

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Module 3

objectives of these agreements are to ensure supply and to consolidate requirements to maximize purchase leverage. Depending on the duration of the demand, these agreements may be either short- or long-term, and may take many forms. These agreements range from specific descriptions of volumes to be purchased to very nebulous descriptions. E) Life-of-product supply For several reasons it may be desirable to award contracts to suppliers of raw materials or components for the life of the product. If duration of the need is limited, it may not be cost-effective to rebid or renegotiate. Familiarity with need, use, or special supplier capabilities are other reasons for this type of supply strategy. Often the agreement is developed between purchasers and suppliers with a long, collaborative history. It may include activities such as joint engineering of the components to be supplied. Just-In-Time (JIT) JIT manufacturing is more a philosophy of doing business than a specific technique. The JIT philosophy focuses on the identification and elimination of waste wherever it is found in the manufacturing system. The concept of continuous improvement becomes the central managerial focus. Several of the more highly publicized results of JIT implementation are the initiation of a pull system of manufacturing; significant reductions of raw material, work-in-progress, and finished goods inventories; significant reductions in through-put time; and large decreases in the amount of space required for the manufacturing process. The greatest improvement for an organization implementing JIT is usually in the area of quality. If there is little or no raw material inventory, then incoming raw material and components must be of impeccable quality, or manufacturing will cease. Similarly, each intermediate manufacturing step must yield high-quality output, or the process will stop. JIT philosophy focuses on the elimination of waste wherever it is found in the business system, including the supplier. The aim is to reduce waste and cost throughout the entire supply chain. If a manufacturer decides that it will no longer carry raw material inventory and that its suppliers must carry the inventory, this does not reduce supply chain cost. It only transfers costs from one link in the supply chain to another. While those additional inventory carrying costs may be borne for the short term by the supplier, they eventually must be passed on in the form of higher prices. One of the most often cited difficulties in the implementation of JIT is a lack of cooperation from suppliers, due to the changes required in their systems. In addition to changing from traditional quality control inspection practices to the implementation of statistical process control, the supplier is asked to manufacture in other than the usual lot sizes, and to make frequent deliveries of small lots with precise timing. Additionally, the supplier normally is required to provide the purchaser access to its master production schedule, shop floor schedule, materials requirements planning system, managerial system, and financial statements. Clearly, purchasers must be cooperative and persuasive in converting supply chains to JIT operations.

F)

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Tasks 312 & 313

Supplier selection, single sourcing, supplier management, and supplier communication become critical issues for purchasing and materials managers in implementing JIT. Critical issues in JIT supplier selection include quality control methods, proximity, manufacturing flexibility, and reliability. JIT organizations and their suppliers develop close collaborative relationships supported by long-term, single-source contracts. The concept of partnering is often applied to the JIT purchaser-supplier relationship. Following supplier selection, careful supplier performance measurement and management often lead to supplier certification a designation reserved for those suppliers whose quality, on-time delivery, and reliability have been proven over long periods of time. Close, frequent JIT purchaser-supplier communication is essential in both directions. Suppliers are given long-range insight into the purchasers production schedule. Often, this look ahead spans a dozen weeks or more, with the nearest several weeks schedule frozen. This allows the supplier to acquire raw materials in a stockless production mode, and to supply the purchaser without inventory build-ups. Suppliers provide daily updates of progress, and production schedules and problems. The functioning of the purchasing department is significantly changed under JIT from processing orders to supplier selection and long-term contract negotiation. Many times close communication is supported with electronic data interchange (EDI) capabilities (see Tasks 203 to 205). G) Consignment Inventories that are owned by a supplier but are stored at the purchasers facility are said to be on consignment. These goods are billed to the purchaser only after they have been consumed. At first glance, this practice seems to be advantageous to both purchaser and supplier. The supplier has a guaranteed sale, while the purchaser has the security of on-site inventory without inventory investment. However, there are potential problems with this procedure. For example, even though consignment inventory is stored at the purchasers warehouse, it is still owned by the supplier. As such, the supplier may want to remove some items to sell to another customer, while the purchaser, whose facility stores the goods, is counting on those items to cover his/her own requirements. The fact that the purchaser does not invest in consignment inventory, but only pays as it is used, does not relieve the buying organization of the remainder of the inventory carrying costs. It is still necessary to provide a secure facility for consignment inventory, to care for it, and perhaps to track it. H) Commodities A large number of agricultural, metals, other natural resources, and currencies are traded on dedicated exchanges. The exchanges create a marketplace where buyers and sellers may freely trade their commodities (see Task 303 for more information on the use of commodity exchanges).

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Module 3 Market dynamics The movement of prices on a commodity exchange may not be related to the supply or demand of an item. Often, a majority of the transactions that take place on a commodity exchange are not made by actual users or suppliers of the specific commodity. Additionally, the quality of goods being traded may not be adequate for actual use by the purchaser, or the commodity may not be traded on a spot or a futures market. Exchanges Commodity exchanges include the Chicago Board of Trade; Chicago Mercantile Exchange; Sugar and Cocoa Exchange, New York; COMEX, Division of New York Mercantile Exchange; International Petroleum Exchange; Kansas City Board of Trade; London International Financial Futures Exchange; Minneapolis Grain Exchange; Singapore International Monetary Exchange; and the Sidney Futures Exchange to name a few. Terminology Commodity terms include: Future A future is a contract for the purchase or sale and delivery of a commodity at some future date. Spot price A spot price is the price for a commodity if it is purchased for cash on an exchange.

2.0

3.0

I)

Supplier replenishment systems With supplier-managed inventories the supplier is responsible for ensuring stock levels are maintained at appropriate levels in the purchasers facility, and for replenishing items when stocks are low. Ownership of supplier-managed inventories depends on the arrangement between the purchaser and supplier (see Task 304). Outsourcing Outsourcing is the use of a supplier to provide a product or service that the organization may have the ability to supply internally (see Task 301 for a discussion of outsourcing decisions).

J)

2)

IMPLEMENTATION TECHNIQUES There are several common techniques for the implementation of purchase strategies based on forecast data: A) Hedging Hedging typically involves the sale of a futures contract to offset the purchase of a cash commodity. It can also involve the purchase of a futures contract to offset the sale of a cash commodity (that is included as part of an end product sold by the organization). An organization simultaneously enters into two contracts of an opposite nature one in a cash market and one in a futures market. For example, hedging is used to safeguard profit margins when a sales contract with fixed prices and extended delivery is negotiated, but the raw material purchase is postponed. If material prices were to rise between the time of the order and the actual

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purchase of raw material, the profitability of the entire contract could be jeopardized. Hedging is also used to protect inventory values in a declining market. If declining prices cause finished product prices to fall, the organization will lose money due to the relatively higher cost of raw materials. With a futures contract, the organization can protect itself against price fluctuations in raw materials. For example, consider an organization that contracts in April to supply generators to be delivered to a customer in December. The generators contain 25,000 pounds of copper, which were figured in the bid price at $1.04 per pound. Because of production leadtime, the copper will not be needed until October. To guard against a possible increase in the price of copper, the purchasing manager buys an October futures contract for 25,000 pounds of copper at $1.10 per pound, which is the April price of copper for delivery in October. If the spot (cash) price rises, typically the futures price will rise by a similar amount. If the spot price rises from $1.04 to $1.10 by October, and the October futures price rises to $1.16 per pound, the futures contract can be sold for a profit of $0.06 per pound, which offsets the rise of $0.06 in the price of spot copper when the purchasing manager buys the copper in October. B) C) Spot buying Spot buying is the practice of buying a commodity on the spot or open market. Dollar averaging When purchasing a commodity or component over a long period, the value of the items in inventory is an average, based on the mix of quantities and prices of items bought at different times. For example, if 10,000 pounds of copper is bought at $1.04 per pound, 7,000 pounds is bought at $1.07 per pound, and 13,000 pounds is bought at $1.09 per pound, the averaged price of the commodity would be $1.069 per pound. The averaging process dampens the departure of short-term price fluctuations from long-term averages. Contracting Rather than selecting a supplier and placing an order each time a requirement occurs, today most organizations select suppliers for longer-term agreements. These contracting activities typically involve products whose consumption represents a significant dollar value on a continuing basis. Contracts may also be written to cover families of products or classifications of products, such as office materials or electrical supplies. Agreements such as this may take many different forms, including multi-year contracts, life-of-product contracts, future delivery agreements, contracts for a percentage of a suppliers capacity, or options on products or capacity. 1.0 Long-term contracting If the selection of a group of world-class suppliers is required to provide the purchasers organization a competitive advantage, then those suppliers and the long-term relationships that are formed will typically be preserved with long-term contracts or agreements. Several types of these agreements; clauses to consider including in such an agreement; and their options, are discussed below:

D)

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Module 3 Price-change clauses (escalation/de-escalation clauses) In any contract of long duration, both parties are at risk from input cost changes. A buying organization would not want to agree to a fixed-price contract, only to watch the worldwide price of the basic raw material fall significantly. Entering into a long-term agreement, only to find labor or raw materials prices rising likewise would harm the supplier. The mechanism for sharing such risk is called a price-change clause (or an escalation clause), which provides for price adjustments based on indices that reflect material and labor cost changes. This is one of the most important elements of a long-term contract, as it may well be the focal point of the satisfaction that both parties derive from the agreement. It is an equitable method of ensuring that both parties share the risk of economic changes beyond their control. The fact that many price change clauses do not share risk or cost change burdens equally illustrates why this is an element of a long-term agreement that must be carefully crafted. Life-of-product contracts One of the options for long-term contracting is to agree with suppliers to provide materials, components, or services not for a specific period, but for the entire life span of the product. Life-of-product contracts can be useful in developing cooperation between a purchaser and a supplier for products that have short life cycles, for products that are highly complex, or for areas in which technology is rapidly changing. For longer-term situations, this contract form encourages the supplier to invest in necessary equipment and technology without the requirement that the investment be recovered during a short timeframe, such as a one-year contract.

1.2

1.3

Multi-year contracting In todays business environment, purchaser and supplier organizations are entering into close, collaborative relationships based on mutual benefit. Purchasers are reducing supply bases to those suppliers that are judged to be superior. In such cases, it is likely that the organizations will enter into agreements that represent the extent of the partnering commitment, and typically span several years. After very careful supplier selection procedures, some purchasing managers are entering into 6- to 10year contracts. The key factor in such long-term partnerships is the selection process. The selection process often takes 6 to 12 months, but need not be repeated until the long-term contract expires. In the formulation of such long-term agreements, it is important for purchasing and materials managers to be sure that provisions are made for specific, periodic performance and satisfaction reviews by both parties. Problems must be addressed in a timely and orderly fashion. As with any long-term agreement,

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provisions for dissolution should be agreed upon before contract signing. Words having the root partner carry specific legal meaning, and purchasers should exercise care in their use (see Task 212 for a discussion of supplier partnerships). 2.0 Future delivery contracting A purchasing managers organization may have only sporadic requirements that, nevertheless, are of major importance. In such cases, a purchaser may want to ensure that the goods will be available from a particular supplier. If this is the case, a future delivery contract can be negotiated to ensure that productive capacity is reserved. Sole-source suppliers of such things as capital equipment may fall into this category. Price change clauses, as discussed previously, are clearly critical to these contracts. Use of options A purchase option is the right to purchase something under agreed terms for a specified period. When the specified period expires, so does the right. Such rights are granted for a negotiable fee, which is forfeited if the right expires without the right having been exercised. If an organization is considering a project that has not been finalized, but which has an element with a time constraint, the organization may try to acquire an option on the time-critical element. For example, if the construction of a new factory is being considered, a suitable piece of land might be optioned. In exchange for a fee, the interested organization might be given an option to purchase that property until a specific date. Within that time the buying organization may exercise its option to purchase the property at a specified price. If the organization decides not to proceed with the project, it is not obliged to purchase the land, but will forfeit the option fee. Similar options are available for some commodities. 4.0 Buying capacity reserves In a fast-moving business environment, it may not be possible to precisely predict the specific number of products or components that a supplier will be required to produce. In cases where the volume can be estimated, but the exact product mix is unknown, organizations may reserve portions of suppliers manufacturing capacity. This practice ensures the availability of outside, subcontracted manufacturing capacity, even though the precise mix of products to be produced will not be known until later. This reduces the uncertainty and risk associated with insufficient capacity and potential lost orders. The tradeoff is the possibility that the full reserved capacity, for which the organization must pay, may not be needed.

3.0

E)

Decision-tree analysis The assessment of subjective probabilities can be combined with certain techniques into a mathematical framework for analyzing a proposed project. One of these techniques is called decision-tree analysis. In its simplest form, a decision tree is a diagram that shows several decisions or courses of action, and the possible consequences of each. The consequences are called events. In a more

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elaborate form the probabilities and the revenues or costs of each events outcomes are estimated, and they are combined to produce an expected value for the event. The decision tree shown in Exhibit 7 demonstrates how the technique works. In this hypothetical situation, an organization is considering whether to develop and market a new product. Development costs are estimated to be $100,000. There is a 0.7 probability that the development effort will succeed and that the product will be marketed. It is also estimated that: If the product is highly successful, it will produce differential income of ($500,000 $100,000 marketing costs) = $400,000 (or a net income of $300,000 after subtracting the development cost). If the product is moderately successful, it will break even the income of $200,000 will just offset the development cost. If the product is a failure, it will lose $100,000 (a total loss of $200,000 after taking into account the development cost).

The estimated probability of high success is 0.4; of moderate success, 0.4; and of failure 0.2. EXHIBIT 7 SIMPLE DECISION TREE

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The expected value of each outcome is the monetary income or loss multiplied by the probability of that outcomes occurrence: If development fails, the expected value is the development cost times the probability of failure: -$100,000 x 0.3 = -$30,000 (i.e., a $30,000 loss) If development succeeds, but the product is a failure, the loss is $100,000 in development costs, plus $100,000 marketing costs, for a total loss of $200,000. The total probability of development success and product failure is 0.7 x 0.2 = 0.14. The expected value of this outcome is 0.14 x -$200,000 = -$28,000. If development succeeds and the product is moderately successful, the probability is 0.28 (0.7 x 0.4) and the differential net income is zero. The expected value is 0.28 x $0 = $0. If development succeeds and the product is highly successful, the net income is $400,000 $100,000 in development costs, or $300,000, and the probability is again 0.28. The expected value of this outcome is 0.28 x $300,000 = $84,000.

The total expected value of develop product is the algebraic sum of the expected values of all possible outcomes on the develop product branch of the tree ($26,000). This amount is then compared with the expected value of the other alternative, dont develop. If the development is not undertaken, there is a 100 percent chance (1.0 probability) that the incremental income will be $0. The expected value of dont develop is zero. Because develop product has the larger expected value, the decision would be to proceed with the development effort. This does not mean that the ultimate outcome is guaranteed to be a differential income of $26,000. Rather, it means that, based on the estimates that have been made in considering this decision, management should gamble and go ahead with the development, because the expected payoff from this gamble is positive. If the gamble is not taken there will be zero payoff. This approach to decisionmaking is a powerful one if the probabilities can be estimated with reasonable accuracy. There are relatively few situations where such estimates can be made with enough reliability that the decision maker can entirely trust them. 3) FORECASTS OF VOLUME Based upon projected needs, there are several contract types, supply agreements, and buying strategies that may be appropriate for the purchaser to employ. Hand-to-mouth purchases, systems contracts to multi-year supply contracts, life-of-product agreements, and other purchase agreements are tools the purchaser uses to relate volume forecasts of need with supply market conditions. A) Determining annual requirements Sales and marketing studies and volume forecasts, coupled with historical usage data, allow purchasing managers to forecast needs, ranging from amounts of raw materials and components, to MRO supplies, to capital equipment purchases. 355

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Part or product life At times it is useful to forecast requirement volumes not by the month or year, but over the entire life of the product. This part or product life projection can form the basis of life-of-product contracts.

4)

SUPPLY MARKETS RELATIVE TO SHORT- AND LONG-TERM BUYING NEEDS Analysis, studies, and research necessary to support forecasts will vary, depending on the importance and duration of the need. As the need becomes more critical, the forecast becomes more thorough and complex. Short-term needs may require nothing more than a scan of the market. Long-term, more critical needs dictate extensive studies, including: Current and future technological impact assessments. The possibility and availability of material substitutes. Worldwide supply and demand. Price analysis. Development and use of other tracking mechanisms and information systems.

5)

SUPPLY CHAIN MANAGEMENT STRATEGIES A supply chain is a group of supplying organizations. It may include a series of companies that extract materials from the earth, perform a variety of value-added activities on the subsequent product, and eventually create goods or services that are purchased by an ultimate consumer. Supply chain management is the identification and management of specific supply chains that are critical to a purchasing organizations operations. Supply chain management strategies and supply chain optimization will vary according to the type of industry or sector within which the strategy is implemented. It may include supplier reduction, supplier alliance and partnership arrangements, integrated supply, distributive cooperatives, lead suppliers, and other techniques. A) Integrated Suppliers Suppliers come on to the purchasers property and take over the inventory and the required space to provide management control of the goods. This relieves the buying organization of having to invest in the inventory until the moment of need. In the railroad industry this concept has been developed to the point of locomotive manufacturers providing the locomotives and maintaining them, while the railroad pays for power by the hour (see Task 107 for a discussion of integrated supply).

BIBLIOGRAPHY Birou, L.M. and L.M. Ellram. Spirit in the Supply Chain: Alignment of Culture and Values, Proceedings of the 1999 NAPM International Purchasing Conference, Tempe, AZ, 1999, pp. 324-325. Kauffman, R.G. Supply Chain Cost Reduction Strategies, Proceedings of the 1998 NAPM International Purchasing Conference, Tempe, AZ, 1998, pp. 328-333. 356

TASK 314: Provide forecasted data of future organization buying requirements to suppliers.
1) ELEMENTS OF EARLY SUPPLIER INVOLVEMENT (ESI) The successful organization is one that works as a team. The team functions most effectively when all its members know the overall organizational game plan. Because purchasers are responsible for managing the front end of a business, and are the primary contacts with the organizations suppliers, it is purchasings responsibility to keep suppliers as up-to-date as possible with regard to future organizational needs. In this way, suppliers will be able to provide the maximum amount of technological expertise and support for an organizations goals. Early supplier involvement (ESI) is a practice that brings together one or more suppliers with a purchasers product design team early in the product development process. The objective is to use the suppliers expertise and experience in developing a product specification that enables effective and efficient manufacturability, assembly, and delivery. The following are areas in which early supplier involvement (ESI) can have a particularly beneficial effect on the procurement process: A) Manufacturing process Knowledge of both the suppliers and the customers manufacturing procedures is important to the development of the most effective process to produce a product or develop a service. Purchasers and suppliers working together can eliminate many cost redundancies. For example, an organization can buy a product that is semi-finished and introduce it to its process at an earlier stage; or a supplier can take on some of the customers operations if that would lead to lower costs and improved quality. A buying organization has a greater opportunity to come up with cost efficiencies if it understands the suppliers processes. Significant time and money can be saved if the supplier is on the team early in the development of the manufacturing process. Suppliers can also suggest the type of equipment that might be more compatible with their processes. Capital acquisitions budget Purchasing can make the most significant contribution to the budget/approval process if it is involved early with the engineering, manufacturing, or internal customer that is developing the need. This involvement is called early purchasing involvement (EPI). The purchaser who is aware of a need for a capital asset can then develop a list of suppliers that can satisfy that need. This not only speeds up the development of a capital project proposal, but also shortens the later acquisition process. Forecasting a need for equipment or facilities will allow potential suppliers to allocate manufacturing or human resources time in advance of the need. This will also assist in shortening the acquisition for long leadtime items. Capital asset availability can provide a competitive advantage in new product introduction. Product or service development/implementation Suppliers can be of assistance in early product development by providing prototypes, models, or preproduction

B)

C)

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Module 3 samples for testing and/or use in the customers product development cycle. Good communication and feedback between the customer and the supplier are important if early product development efforts are to provide maximum value.

D)

Cost Suppliers can provide useful insight into the costs of manufacturing a product, and realistic assessments of what the product development will entail before the product is introduced into the market or purchased by the buying organization. Having cost projections on a new product from a supplier can keep an organization from making expensive errors in judgment, and enhance the decisionmaking ability of the buying organization. Quality Early involvement of suppliers in the development of specifications for products and processes will help to reduce the costs of quality of a product or service. Suppliers can help with the development of quality requirements that will serve the customer in the most effective manner. If suppliers are made aware of what a customers needs are, they can prepare their organizations to satisfy those needs through human resource development and training, process development and capability studies, and equipment acquisition. Quality is the result of preplanning and preparation. Suppliers that have knowledge of future quality requirements can eliminate problems that lead to rejections or rework at later stages. Availability Suppliers need to have the capacity to serve a customers needs when they are required. If a supplier is aware of forecasted needs, then it can let the potential customer know what support it can provide. Purchasers are responsible for working with their internal customers to provide forecasted data to the supplier base. This will help eliminate future supplier delivery problems. Technology Supplier expertise in the technology arena can be helpful to a design person and will increase the chances of producing a quality and cost-effective product early in the design-marketing cycle. Supplier technological understanding may influence final material selection and many other areas, especially when the designer does not have a broad knowledge of technological advances occurring in the marketplace. Purchasing can assist in the transfer of information by getting an organizations technical staff together with the suppliers technologically qualified personnel. However, such exchanges can take place only if the supplier believes there is a chance to develop future business. Early in the process, the purchasers and the designers should choose a group of suppliers they are willing to work with. Purchasers must understand that suppliers share information on advances in technology and related intelligence on a selected basis.

E)

F)

G)

H)

Design Suppliers can provide key elements to a product design, based on their experience in serving a particular market. Purchasers who have long-term relationships with suppliers can often have their designers seek the advice of suppliers, with the understanding that the suppliers technology must be protected. Also, it is important that the supplier have a reasonable opportunity for gaining business from this activity. 358

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Product co-development Using suppliers in the co-development of a product or service provides for a sharing of development costs. This normally implies that there is a formal agreement regarding future business that may result from the development. This agreement can take many forms. For example, the organization can pay the supplier for the development costs, pay a royalty on each item sold, or guarantee a certain amount of future business. Co-development spreads the risk to more than one organization. It also implies that the rewards will be shared. Often this is the only way that a supplier will share technology. Cycle time Total cycle time can be reduced by the early development of relationships with suppliers. They can assist with the elimination of redundancies in product development, manufacturing, and distribution processes. Once the product and process are in place, the cycle required to provide the ultimate customer with the desired product can be continuously improved.

J)

2)

CONFIDENTIALITY The basis for early supplier involvement is trust between the parties involved. Part of this trust is built on the confidentiality of the information shared between the organizations. Confidential information may take a variety of forms, such as bids, supplier proposals, pricing, drawings, designs, strategies, wage and salary information, software programs, or scientific formulas. The purchasing professional should ensure that information about one supplier is never given to another supplier unless laws and regulations require that the information be made public as in the case of public procurement. The other participants in the purchasing process may not be aware of the need for confidentiality. Therefore, it is purchasings responsibility to ensure that proper controls are established to protect information. One way to protect confidential information is to put it in writing and label it Confidential. Another tool is the non-disclosure agreement that clearly defines acceptable and unacceptable use of the information.

3)

PARAMETERS FOR DISCLOSURE When a purchaser and supplier are developing a new product or service it is important to create an agreement in advance specifying when and under what conditions the information developed (bids, supplier proposals, pricing, drawings, designs, strategies, software programs, scientific formulas, etc.) may be released to others. A) Product development model Many organizations are concerned with protecting their intellectual property. The safest way to avoid problems is to not allow access to trade secrets or other proprietary information. Intellectual property agreements can take many forms, ranging from complete ownership by the purchasing organization to complete ownership by the supplier.

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Module 3 Production plan It is common for organizations to share production plans with suppliers. The supplier should regard the production plan as confidential. It is appropriate to use a confidentiality or non-disclosure agreement that includes a section describing the purchasers commitment to the schedule. For example, an organization commits to 100 percent of the first four weeks of the schedule, plus or minus 10 percent for the second four weeks, and plus or minus 25 percent for the third four-week period

4)

LEGAL IMPLICATIONS When using non-disclosure agreements, proprietary information must be carefully defined. If it is too broad, the supplier or purchaser may not want to sign the agreement, and it may be hard to enforce. If it is too narrow, the purchaser or supplier risks exposing and losing important data. Try to be specific. Consider software, customer lists, pricing information, target markets, business plans, and other material not usually shared with competitors. The definition usually will state that publicly available or generic information is not proprietary. The purchaser might want to include a dispute resolution clause, in the event problems arise about what data is actually proprietary (see also Task 117). The non-disclosure agreement should also define how information may be used. How many copies of the documents can be made? Who gets to see and use the software? The contract should also require the return of the data if the venture is not successful or the relationship ends. A well-drafted, mutual non-disclosure agreement should prevent each party from disclosing the other partys confidential information to third parties. It should also limit the use of the other partys confidential information to the authorized purposes that are set forth in the non-disclosure agreement. This latter provision is designed to ensure that neither partys confidential information will be used in a manner that was not anticipated by such party. A non-disclosure agreement will often provide that the recipient will treat the confidential information with the same level of care that it uses to protect its own confidential information. This language can be dangerous because the recipient may not be taking adequate steps to protect its own information. The agreement should obligate the recipient to use at least reasonable care to protect the other partys confidential information.

BIBLIOGRAPHY Grass, L.A. Confidential Information and the Treatment of Suppliers, NAPM Insights, October 1993, pp. 6-7.

360

TASK 315: Develop and maintain market awareness through merchandise shows, trade periodicals, and other resources to secure new product and pricing information.
1) RATIONALE FOR MARKET AWARENESS Competition puts enormous pressure on organizations to innovate, improve quality, reduce costs, and find new sources of materials and technology. Because of its constant presence in the supply market, purchasing can provide information about market trends, competitor actions, and changes. In essence, purchasing has the opportunity to be the organizations eyes and ears in the market. A) New product development/introductions The early participation of key suppliers in the development of new products or services, or modifications to existing products or services, can reduce the risk of product or service failures. The exclusion of purchasing may lead to problems in the later stages of product development. If purchasing is brought into the decisionmaking process too late, it may be difficult to get the team to work with the key supplier. Some reasons for purchasings involvement in new product introduction include: Actively soliciting suggestions from suppliers on process, product, and service improvements. Analyzing a proposed product design for mass production. Evaluating material specifications needed to achieve the performance that the designer desires. Controlling costs of materials to match a budget. Assessing quality and functionality needed to meet required standards. Analyzing the supply base to determine which suppliers are capable of producing the part with the required specifications. Determining opportunities where the organization can leverage its volume and acquire the raw material for the supplier. Sourcing of prototypes. Negotiating firm pricing, service requirements, and an overall relationship. Firm pricing includes prototype pieces, tooling, setup charges, and production requirements. Evaluating markets - Is it a buyers or sellers market? - Are raw materials in adequate supply? - Are the suppliers competitive, with availability of resources? - What are the entry barriers to get into this market? - Are large capital investments required for the design phase? - What does the market require concerning agreements? Can these be challenged? - Is the current level of competition likely to continue? 361

Task 315

Module 3 Purchasing can also evaluate where the product is in its life cycle, to ascertain its suitability for use.

B)

Alternate source development One way to keep abreast of the market is to regularly evaluate new sources of supply. New suppliers may bring new production methods, product designs, and technologies to the market for consideration or use by the purchasing organization. Evaluation of supply forecasts and market capacity Many organizations invest significant time and effort forecasting sales, but forecasts of raw materials, and component availability and cost, may be just as important. Without the ability to increase production or service capacity at the same rate as sales increase, an organization risks late deliveries and irate customers. Forecasts of supply availability should be made just as diligently as forecasts for demand. Development of supplier profiles Supplier profiles are useful in identifying suppliers that are willing to share information and resources. A profile includes information on factors such as organization, history, supply management, current technology, inventory control, facilities, equipment, financial data, delivery, scheduling, process improvements, and quality. Technological updates Understanding how technology is being incorporated into products and applied to manufacturing, how it influences transactions and processes between and within organizations, and how it enhances relationships between final customers and the organization making or supplying an item, is critical to the longterm success of purchasing organizations. Because much of the information is available from suppliers, purchasers must continually develop relationships and strategies to ensure they are receiving the information they need to support their organization. Other sources of information include trade shows; trade publications; and technology shows, such as NORTHCON and COMDEX.

C)

D)

E)

2)

PROCESSES FOR COLLECTING, PRIORITIZING, FILTERING, AND MANAGING THE DATA Implicit in the data management process is purchasing communicating with other parts of the organization to identify the market intelligence and information required. Purchasing is then in a position to determine how to prioritize efforts; assign responsibilities for data collection; and build the systems required to filter data, generate reports, and communicate significant information within the organization. The process for collecting data about suppliers and the marketplace includes the following steps: Planning and direction Set objectives for data collection, such as identifying changes in trends, regulations, supplier strengths and weaknesses, and innovative products and services. Collection of information Sources of information can either be primary or secondary. Primary information comes directly from the source such as a companys annual report. 362

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With secondary sources, the original information has been filtered, analyzed, and edited, such as a stock analysts report. There are many publicly available sources of information. A) Federal government agencies All publicly traded companies are required to submit quarterly (10-Q) and annual (10-K) financial reports to the Security and Exchange Commission (www.sec.gov). These reports, which can be accessed using the Internet, include standard financial statements, an analysis by management, a description of the industry, and a discussion of the industrys future from managements perspective. Companies must also submit reports and filings to other government agencies, such as the Federal Communications Commission, and the U.S. Food and Drug Administration. Many of these reports are available through the Internet, or can be obtained through a Freedom of Information Act request submitted to the government agency. B) State and local government agencies Most states require every company to register with the state government every year (usually with the secretary of state). Depending on the state, much of this information is available to the public. Additional information that may be available includes environmental impact studies. In addition, most counties and local municipalities routinely collect information about companies, and may be excellent sources of information for reviewing property records, building permits, maps, aerial photographs, surveys, and complaints about a firms products or services. These records, permits, and filings are part of the public record and can be viewed. On-line databases With the expansion of the Internet, access to on-line databases has become easy and economical. Although most of these databases are fee based, their fees are very reasonable when compared to the detailed level of information provided. Some of the most frequently used databases include Dialog, Datastar, and Lexis-Nexis. Human intelligence One important source of information is human intelligence or humint. Humint includes any information learned from other people. This area is often overlooked by many in the intelligence gathering community because of its labor-intensive nature. Human intelligence provides the most beneficial information available for purchasing professionals, especially when dealing with local suppliers. Following are some of the best ways to gather information using human intelligence. Ask for the information One of the best ways to find out information about suppliers is to ask other customers. Customers are often key sources of information on product compatibility, support services, and customer responsiveness. Another valuable source is the supplier. There is nothing illegal about calling the company to ask for a brochure, its pricing on specific products, or what support services they provide.

C)

D)

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Module 3 Salespeople Purchasing professionals often look at visits from salespeople as being a nuisance instead of an opportunity to learn more about the supplier and marketplace. Salespeople love to talk about their products and their companys capabilities; and they like to demonstrate how their products are superior to their competitors. Use these opportunities to ask probing questions about their operations. Plant Visits Purchasers and their technical counterparts frequently have an opportunity to visit a suppliers facility. The visits provide a great opportunity to learn through personal observations some critical elements of information that may not be available from other sources (see also Task 111). Trade shows Trade shows and merchandise shows provide the purchaser with the opportunity to visit several suppliers under a single roof. At trade shows, salespeople are encouraged to talk about their new products and services to whoever visits their booth. Many of the barriers found in other situations have been removed. In order to take advantage of trade show information gathering, the purchaser must plan which booths to visit, what printed material to collect, and what questions to ask. Economic information There are a number of sources of information about the economy, specific commodities, and industries. Sources of information include trade publications, ISMs Report On Business , and government economic data, including the Consumer Price Index, Producer Price Indexes, interest rates, and utilization levels. Other things the purchaser can do include: - Be aware of recent events that may affect the market. - Look at published indices to get an idea of where prices are going. - Discuss with the supplier general market outlook. - Determine the levels of inventory the suppliers carry and their capacity. - Find out who the suppliers other customers are and if those customers are preparing any new product offerings.

Data has no value until it is turned into information and then into intelligence. Information is factual, but provides no basis for action, while intelligence is information that has been filtered, analyzed, and formatted to answer key questions. 3) DISSEMINATION OF INFORMATION THROUGHOUT THE ORGANIZATION With the information it receives from daily contact with suppliers and the market in general, purchasing has the opportunity to provide a valuable service to the organization. Information should be shared with internal customers and managers on a scheduled basis. The information sharing process is likely to range from informal to formal, depending on the relative importance of the data and the party to whom it is being communicated. Depending on the nature of the information, the purchaser can disseminate information using a variety of methods, including bulletin boards, organizational or departmental newsletters, press releases, interoffice memos, e-mail, and Intranets. 364

Part D: Forecasting and Strategies BIBLIOGRAPHY

Task 315

Buddress, L. and A. Raedels. Use of the Report On Business as a Forecasting Tool, Proceedings of the 1999 NAPM International Purchasing Conference, NAPM, Tempe, AZ, 1999, pp. 385-389. Clayborn, S.L. Competitive Intelligence: Where Spies Go After the Cold War, Proceedings of the 1999 NAPM International Purchasing Conference, NAPM, Tempe, AZ, 1999, pp. 39-44. Nageotte, M. Building an Effective Forecast, Purchasing Today , February 1997, pp. 43-45. Nelles, J. Making Two Ends Meet, Purchasing Today , September 1999, pp. 10-11. Sisk, L.A. At the Drawing Board, Purchasing Today , May 1999, pp. 63-68.

365

TASK 316: Provide data on current and future market conditions to management, sales management, and/or user departments.
1) PURPOSES OF FORECASTING If the economy never changed it would not be necessary for purchasing and supply managers to forecast. But because it does and because a primary responsibility of purchasing is to protect organizations from supply constrictions, it becomes necessary to forecast, to try to predict future trends and events. There are many different kinds of forecasts. Fact-based forecasts use historical information, such as price or production data, to project future trends. Opinion-based forecasts use expert judgment to estimate future events, such as the impact of technology on a particular industry in the next ten years. Another type of forecast, called a change index, is finding increasing use, and is the format of the ISM Report On Business . To purchasing and supply managers, the ability to forecast required quantities, material availability, and prices represents a competitive and strategic advantage. With the realities of global markets, come the necessity to study and forecast commodity and industry changes, based on worldwide commodity or industry studies. A) Quantity Forecasts of requirements for purchased goods and services are based on sales or usage projections, including the cyclical and/or seasonal characteristics for each need. Any quantity forecast is influenced not only by the timing of the requirement, but also by forecasts of availability, price, and rate of technological change. Industry capacity and availability Determination of short- and long-term availability is based on commodity studies that examine global supply and demand, including sources of supply, reserves, and the impact of technological change on the manufacturing or service process, uses, and demand. Cost or price There are many factors beyond simple supply and demand that determine price. Among these are the influences of governmental action and laws such as OSHA; hazardous commodity regulations; and transportation and other supply chain activities. Perceptions of supply shortages, such as those that might be caused by the threat of war or strike, may also change prices. In any forecasting exercise potential influences on supply or demand in the market and quantitative projections of their impact must be considered. Technology Technological change has been occurring at an increasing rate and appears likely to continue. The impact of changing technology, such as price reductions and product obsolescence, must be forecast in order to determine the best types of purchasing strategies for items likely to be affected.

B)

C)

D)

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Task 316 E)

Module 3 Planning There are many facets of organizational planning that are highly dependent on the flow of accurate information about the supply markets. Decisions to build or expand capacity, ability to fulfill sales projections, investment choices between new or existing technology, and whether or not to enter certain markets are just a few examples. Assuring supply Supply assurance is important to all organizations but becomes more critical when Just-In-Time (JIT) supply arrangements are made, and when supply bases are reduced to one or a few suppliers for each significant product or service. Forecasting supply conditions in critical purchase markets is key to the ability to continuously ensure supply of needed items.

F)

2)

GENERAL ISSUES IN ECONOMICS A) Industries, organizations, and markets The economy of the United States is made up of a large number of industries. At different times, different industries lead the economy. At the turn of the 20th century, the railroad, steel, and oil industries drove the economy. After World War II, the key industries were automobiles, machine tools, housing, and retailing. However, the economy does not stay stagnant. Today, the major industries include computers and semi-conductors, health and medical, communications and telecommunications, and instrumentation. Another major sector of the economy is government at all levels federal, state, and local. In a free-market economy, price is basically determined by supply and demand. In a centralized economy, price is determined administratively. Even in a free-enterprise capitalistic economy, however, prices sometime bear little relationship to supply and demand. A price can be influenced by market structure or set by regulation, as under the price controls of the 1970s. Elasticity of supply and demand indicates how the total revenue is affected by a change in price. Elasticity is of interest to organizations because it gives insight into the effects of price changes on supply and demand. The elasticity of demand is determined by what happens to total revenue if the price is lowered. If total revenue increases, the demand is elastic; if total revenue is unchanged, demand is unitary elastic; and if total revenue declines, demand is inelastic. The elasticity of supply is determined by what happens to total quantity supplied if the price is lowered. If total supply increases, the supply is elastic; if total supply is unchanged, supply is unitary elastic; and if total supply declines, demand is inelastic. The purchasing professional needs to consider these factors as the availability of goods fluctuates, and as organizations and plants adjust to new levels of demand. The total demand for a product is represented by the sum of the wants of all purchasers. Purchasers are not all alike. Some have more money to spend. Some have greater needs. When all of the individual demands at each price are added together, the result is

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referred to as the market demand curve. This demand curve shifts as the amount of money available to purchasers changes. As successive new units of the product are produced, the extra utility added by the last unit tends to decrease. This is known as the law of diminishing marginal utility. Utility can be thought of as satisfaction, or how important or valuable a unit of the product is to the decision maker. The total supply of a product is represented by the sum of the supply curves of all the independent producers of the item. The aggregate is the industrys supply curve. The slope of this curve reflects the cost to produce the good. The marginal cost at any output level is the extra cost of producing one extra unit. The marginal cost curve is a rising curve because of the law of diminishing returns. If the supplier obtains diminishing returns from a factor of production, the supplier will also have increasing marginal cost. Most organizations are interested in maximizing profit in the long run, and will continue to produce only if prices at least cover expenses. They will produce little if prices are low, and much if prices are high. At a market price at which the organization recovers only its variable costs, it will be on the verge of shutting down. At higher prices the organization will be obtaining revenue to help cover its fixed costs, and at still higher prices it will be making a profit. The ideal competitive market condition in an industry is one in which the willingness of purchasers to pay and the actual minimized marginal costs of the producers, are in reasonable balance. There is no such thing as perfect competition. Likewise, there is probably no complete monopoly. Most market situations fall somewhere in-between (see Task 213 for a discussion of the different types of competition). Organizations operate in a condition of imperfect competition in which each supplier has some control over its prices. There are a limited number of rivals in each market, and products can usually be differentiated in some way. The term oligopoly means few suppliers. This refers to two types of conditions: When there are few suppliers of similar or identical products. When there are only a few suppliers of similar but differentiated products.

The first condition is illustrated by the synthetic fiber industry, in which there are only a few manufacturers of nylon filament, a fairly homogenous product. The second condition is illustrated by the automobile industry, in which relatively few auto companies all market somewhat differentiated products. In reality, the most prevalent market condition is imperfect competition, with many producers and many real or perceived differences in products. B) Global markets The U.S. economy is part of the world economy. Trends and developments throughout the industrialized nations are of great importance. The scope and

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Module 3 composition of international trade is continually changing. Sources, prices, and conditions of sale and payment shift continuously. Many nations hold economic advantages in certain commodity areas. Saudi Arabia, for example, has much oil; Canada has timber; Zimbabwe has chrome. Others hold advantages in labor supply, location, or climate. An absolute advantage in international trade is said to exist when one of the trading countries can produce a unit of the good involved with less resources than the other, or when only one country has the resources, such as South Africa with natural industrial diamonds. More important is the concept of comparative advantage, upon which world trade depends. A nation has a comparative advantage when its efficiency relative to that of other nations producing the same good is higher. On this basis, a country will specialize in exporting the products for which it holds a comparative advantage. The natural flow of world trade, reflecting whatever advantages exist, is modified by a great many factors. Embargoes and quotas can stop or slow the flow of goods, tariffs can wash out price differences, and government subsidies can create an artificial comparative advantage where one does not naturally exist. In some cases this leads to exporting goods at prices below their production costs. This practice, called dumping, is increasingly common in todays international trade.

C)

Business cycles and trends The level of national income and production fluctuates. Conditions rarely remain static. Earnings, consumption levels, savings, production, employment, and profits are constantly changing. No two business cycles are the same in either intensity or duration. A recession leads to a trough and a lower turning point. Expansion (recovery) leads to a peak and an upper turning point. Overlaid on this pattern are long-term economic trends and seasonal variations. Many things contribute to the cyclical pattern. Political disturbances, wars, population migrations, natural disasters, harvesting conditions, and governmental actions in monetary and fiscal policy affect the economy. Business cycle forecasting models rely upon leading indicators, such as average hours worked per week, stock prices, construction contract awards, and new orders. Some models provide fair estimates of upcoming changes in the output of the domestic economy, usually measured by Gross Domestic Product (GDP). Purchasing and inventory management decisions can be made using this information. 1.0 Price elasticity Economic fluctuations may provide changes in prices resulting from changes in demand levels. When this occurs, prices are said to be elastic. Should there be very little fluctuation or none at all, it is said to be inelastic. Different products and materials behave differently.

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Transportation trends Through the late 1940s to the 1970s, the transportation industry in the United States was relatively stable. Rates were uniform and changed in small and predictable amounts each year. Over the period from the late 1970s to 1994, transportation was economically deregulated in the United States. As a result, the price of many transportation services decreased as entry to the industry was opened, and pricing became subject to market forces. The purchase of transportation is now handled more like the purchase of other services, due to deregulation. Economic indicators Purchasers should have an understanding of the major economic indicators. 1.0 Money supply The term money supply refers to the total of a nations money available for spending. This consists of currency and various bank deposits held by private businesses and individuals. There are three commonly used measures of the money supply. The first is called M-1, which consists of currency plus demand deposits. The second measure, M-2, consists of M-1 plus time deposit balances (savings accounts). The third measure, M-3, consists of M-2 plus time deposits (such as certificates of deposit) held at commercial banks and savings banks. Economists keep track of M-1, M-2, and M-3, as well as other measures of the money supply, to better understand what is happening in the economy. Interest rates In general, interest rates refer to the prices paid for borrowing money. Interest rates fluctuate according to a number of factors including the lenders willingness to postpone use of the money, the lenders willingness to assume the risk management, the possibility that economic changes will have reduced the purchasing power of the funds by the time they are repaid, and the administrative costs of processing a loan (see the Federal Reserve at www. bog.frb.fed.us/releases for current data on interest rates and money supply). Interest rates also depend on the market for a particular loan that is, the demand for a loan by the borrowers, and the supply of funds available for such lending. 3.0 Inflation An economic factor of great relevance to purchasing managers is inflation. Inflation is a loss of purchasing power due to price increases for needed items. Anticipated price increases encourage purchasing managers to place orders promptly, a practice that tends to exacerbate inflation. Purchasing becomes more complex during inflationary periods because reorder quantity calculations need to be modified to reflect potential price increases. Level of employment Instead of describing the level of employment, the level of unemployment, expressed as a percent of the labor force that is unemployed, is used. The size of the labor force keeps changing as new members are added and others retire or change careers. Typically, about 4 percent of the

E)

2.0

4.0

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Module 3 labor force will be unemployed. When we say full employment we really mean about 96 percent employment. In accordance with the Employment Act of 1946, the government is supposed to do all it can to help ensure full employment. Through its fiscal policy, the government shapes taxation and public spending to dampen swings of the business cycle and to maintain high employment. Fiscal policy decisions include public works programs, unemployment compensation, job retraining, and variations in tax rates that might encourage organizations and individuals to spend, thus creating jobs. Monetary policy also plays a role by shaping consumption and savings. The two together represent the governments power to influence the economy. 5.0 Trade and exchange rates What a buying organization will owe another organization based in a foreign country is a function of the international exchange rates that exist at time of payment. Historically, exchange rates were determined under the gold standard, with each national currency converted into a specified amount of gold. When the gold standard was abandoned the trading nations adopted a system of fixed exchange rates. Today, foreign exchange rates float between parameters established by the central banks. Exchange rates respond to the market and to economic activity. While each country wants its currency to be strong relative to that of its trading partners, it does not want it to be too strong. For example, too strong a U.S. dollar makes it more difficult to sell U.S. products abroad, because it takes more foreign currency to pay for U.S. products. In addition, too strong a dollar reduces domestic investment because the dollar goes further in overseas investment (see also Task 107). Balance of trade and payments The phrase balance of trade refers to the difference between the value of a countrys exports and the value of its imports of goods and services. The balance for the United States is favorable if more merchandise is exported than imported. Balance of payments is a summary statement of a countrys transactions with the rest of the world during a year. It consists of the balance of trade plus the Capital Account, which measures the inflow and outflow of investments and loans, and the Official Reserve accounts that document the changes in government reserve accounts. The United States has been in an unfavorable trade and payments position since 1950. 7.0 Gross Domestic Product (GDP) GDP is a measure of a nations domestic output, which is the total value of all finished goods and services produced within a country within a given time period (usually one calendar year). It is a very general measure of economic activity. These are final goods and services, including only the value added at each process or distribution step. Consequently, they are purchases by households and government, not of 372

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industry. There are various components within GDP measuring activities that seek to adjust for depreciation, taxes, and savings rates. F) Governmental policies The government is in a unique position to influence economic activity through various means solely at its disposal that, in turn, influence the economic behavior of individuals and organizations. Economic behavior assumes that when goods are relatively inexpensive more of them will be sold than when the opposite is true. This simple relationship can be adjusted, however, through various means. 1.0 Fiscal policy Government can affect economic activity by adjusting spending as well as taxation. For example, economic activity can be increased by initiating a road building program, assuming that taxes are not increased at the same time. Monetary policy Another method used by government to control economic activity is its ability to adjust the amount of money in circulation. The quantity of money relative to the demand for its use drives interest rates higher or lower. This mechanism is handled by the Federal Reserve, which buys government securities to add liquidity and sells bonds to reduce it. Budget deficits affect monetary policy as well. The governments need for borrowed money, and the rates of interest that result, directly compete with industrys need for capital to finance new plants and equipment. The deficits reduce the economys growth potential and its competitiveness in markets both at home and abroad. 3.0 Tax rates After many years of relatively high federal tax rates, rates were reduced during the 1980s, effectively making resources that had been going to government available to the private sector. From this came relatively long periods of economic growth in the 1980s and 1990s, interrupted only by a brief recession in 1990-91 after the Gulf War. Small tax rate increases were enacted in the early 1990s, but appeared to have a minor effect on the economy. Budget deficits For most of the last 40 years, U.S. federal spending has steadily increased. This upward momentum in program growth far exceeded the growth in tax revenues. Tax increases both legislated increases, and automatic increases that occur as income growth moves taxpayers into higher tax brackets have been imposed to finance this program growth. But even these increases, which many economists believe have been a fundamental cause of economic stagnation, have been insufficient to finance the large spending growth that has occurred. As a result, the country experienced unprecedented peacetime budget deficits. In the 1990s, as the national defense budget has been reduced and economic growth has continued, federal spending has increased more slowly than tax revenues. As a result, in 1997-98, the United States experienced its first budget surplus in many years. 373

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Task 316 G)

Module 3 Net National Income It is useful for the purchaser to understand how the various economic measures are calculated, in order to understand what the government reports mean for the purchasers supply and demand markets. The relationship of the various measures of economic activity can be summarized as follows: Gross Domestic Product - Plus factor income from the rest of the world - Minus factor payments to the rest of the world Equals: Gross National Product - Minus consumption of fixed capital Equals: Net National Product - Minus indirect business taxes - Minus subsidies less surpluses of government enterprises Equals: National Income - Minus corporate profits with inventory valuation and capital consumption adjustments - Minus net interest - Minus contributions for social insurance - Minus wage accruals less disbursements - Plus personal interest income - Plus personal dividend income - Plus government transfer payments to persons - Plus business transfer payments to persons Equals: Personal Income 1.0 Personal income Receipts by individuals, such as wages and salaries for services rendered, and from government in the form of transfer payments (e.g., social security benefits) make up personal income. Corporate income Corporate income includes receipts by businesses from individuals and governments for products and services, plus net investments in businesses, plus depreciation of plant and equipment.

2.0

In addition to the above, other factors that influence economics include: H) Political stability/instability A country or region of the world can be affected economically because of its political stability or instability. While it is beyond the scope of this study guide to address matters of a geopolitical nature, the political situation in another country is often a major consideration in doing business with that country. An unstable political situation might lead to plant, transportation, or port closings, all of which may influence the availability or price of a product. In addition, the country may join a cartel, creating a situation where market forces no longer determine price. For these reasons, a purchaser needs to demonstrate caution when relying on international suppliers. 374

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Global industrial migration The U.S. economy is changing. Differences in country labor, inflation, interest, and currency rates have caused shifts in manufacturing throughout the world. Increasingly, organizations are moving to overseas sites to tap local markets for low production costs and to establish sales outlets to emerging economies. Import/export issues 1.0 Free trade vs. protectionism The term free trade refers to the uninhibited flow of goods and services across national boundaries. There are no tariffs, no quotas, and no embargoes on trade. The term fair trade usually implies protectionism, meaning selective and graduated tariffs and carefully negotiated quotas on selected products (for example, quotas on the number of canvas shoes imported into the United States from Korea). Protectionist measures are also instituted for government buying. For example, Public Law No. 97-377, which was enacted in December 1982 and applies to the Department of Defense, states: There shall not be acquired supplies consisting in whole or in part of any food, clothing, cotton, wool, woven silk and woven silk blends, spun silk yarn for cartridge cloth, synthetic fabric, or coated synthetic fabric, which have not been grown or produced in the United States or its possessions; or specialty metals, including stainless steel flatware which have not been melted in steel manufacturing facilities located within the United States or its possessions; or hand or measuring tools which have not been produced in the United States or its possessions. Most economists agree that protectionism is not in a countrys long-range interest, and not in the interests of a healthy world economy. This has been the impetus for the emergence of the European Economic Community (EC), North American Free Trade Agreement (NAFTA), and other relationships affecting trade throughout the world. 1.1 Trade Deficit or Surplus A deficit results when a country imports more than it exports. A surplus results when a country exports more than it imports. The United States has been in a trade deficit situation for many years.

J)

2.0

Countertrade Some companies import goods from a certain country so the sales group from their organization can make a sale in that country. This is useful when the other countrys currency is not easily converted in the world market, or when the country does not possess the currency to pay for such purchases. In such cases, the purchase of raw materials provides the resource for the other country to consummate the sale.

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Module 3 Barter Barter occurs when one organization swaps its goods and takes those of another as payment. Such arrangements may take place because of a lack of trading currency, but the difficulty lies in matching purchasers and sellers (see also Task 107). Offset In contrast, offset usually occurs with government involvement, especially when government purchases are at stake. Offset is a form of countertrade similar to counterpurchase, in which a supplier selling to a foreign company agrees to purchase a certain quantity of materials from the county it supplies. The primary difference is that the supplier can fulfill its obligation by purchasing from any company in the country it supplies. This term is primarily used in the sale of military hardware. For example, military purchases may be most common where a nation agrees to purchase new weapons from the industry of organization X, provided other industries in the selling country purchase a like amount of product. The outcome is that the balance of payments for the buying nation is not adversely affected by the military purchase.

2.2

K)

Environmental In recent years, environmental concerns have been legislated into controls and standards for industrial and consumer environmental emissions, and into disposal of industrial and household wastes, particularly hazardous wastes. Some groups believe that economic growth is to blame for increasing amounts of emissions and wastes, and that economic growth should be limited or stopped. Others believe that, for economic well being, growth must continue and that controls and incentives should be used to control the generation of emissions and wastes, and to ensure safe disposal of those that are generated. Thus far, growth has proceeded with controls, although there are continuing debates over what amounts of emissions and wastes are safe, and over safe means of disposal. Other environmental concerns include land use, particularly of wetlands; and control of commercial operations on public lands, such as national forests. Laws, regulations, and other decisions made to address environmental matters can affect productivity, the availability of natural and other resources, and the cost to produce products.

3)

ECONOMIC CONCEPTS AND TERMS USED IN FORECASTING A) Price Indices A comparison of prices in one year to a base year yields a price index. While there are many significant economic indices, those for Producer Prices, Consumer Prices, and the GDP, or Implicit Price Deflator, are among the best known in the United States. 1.0 Producer Price Index There are three Producer Price Indices (PPIs) that are reported each month by the Bureau of Labor Statistics of the U.S. Department of Labor. These data are published around the middle of the month for the previous month. The indices are for: Finished goods (goods that do not undergo any further processing). 376

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Intermediate goods (goods that have undergone partial processing, such as electricity, gasoline, steel, fabricated metals, and automotive parts). Crude (raw) materials (products entering the market for the first time that have not been manufactured and are not sold directly to producers, such as foodstuffs, coal, natural gas, and crude petroleum).

Prices used in these indices represent the actual producer transaction prices, and are seasonally adjusted. Current data is available at http://stats.bls.gov/ ppihome.htm. 2.0 Consumer Price Index The Consumer Price Index (CPI) is a monthly measure of the percentage change in the price of goods and services consumed by urban families and individuals compared to a base year. This index gauges the overall rate of change for a fixed basket of household goods and services. The Bureau of Labor Statistics of the U.S. Department of Labor generates this index, which is published toward the end of the month for the previous month. The indices are for: All items less food and energy Services

Approximately every 10 years, the basket is revised to reflect changes in consumer tastes and purchases. Food, beverages, housing, education, medical care, transportation, apparel, and entertainment are among the items measured by this index. The CPI is a measure of urban population purchases (families and individuals) only, and excludes rural household purchases, as well as those of military personnel and people in institutional settings such as prisons, homes for the aged, and long-term hospital care. Like the PPI, the CPI is seasonally adjusted. Current data is available at http://stats.bls.gov/cpihome.htm. 3.0 Implicit Price Deflator The implicit price deflator (GDP deflator) is an index used by the U.S. Department of Commerce. It compares the average level of prices in one year to those of a base year (1992). The factor is used to eliminate price changes in computing a nations real changes in output. This index includes the effect of changes in the distribution of goods and services bought in the marketplace on overall price. The Implicit Price Deflator is calculated by dividing current-dollar (or nominal) GDP by constant-dollar GDP (real GDP, which is deflated for price increases since the base year).

B)

Interest rates Interest is the term for the cost of borrowing money. An interest rate is the annual percentage of the principal that the borrower must pay for the use of borrowed funds. Interest rates vary depending on repayment risk, duration of loan, and inflation expectations. Among the most well-known measures of short-, medium-, and long-term interest rates are the following: U.S. Treasury three-month bills, U.S. Treasury notes and bonds with maturities between three and 10 years, high-grade municipal 377

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Module 3 bonds, corporate AAA bonds, Federal Reserve discount rate, prime rate charged by commercial banks, and new home mortgage rates. See the Federal Reserve Board at www.bog.frb.fed.us/releases for current data on interest rates and money supply.

C)

Economic indicators The Bureau of Economic Analysis (BEA) of the U.S. Department of Commerce groups key indicators of economic trends by their general tendency to turn or change direction before, during, or after the general economys cycles. Leading indicators change direction before the turning point of the general economy, lagging indicators follow the economy, and coincident indicators turn with the economy. The BEA forms these groups of indicators into composite indices. The data is available at www.conference-board.org. 1.0 Leading Components of the leading index include average weekly hours of production workers, manufacturers new orders for consumer goods, manufacturers new orders for non-defense capital goods, supplier performance, average weekly new claims for unemployment, the Index of Consumer Expectations, the stock prices of 500 common stocks, housing starts, interest rate spread, and the amount of money in circulation. All these indicators are thought to represent the future expectation of business in general toward product demand, labor, and financial markets. Lagging Components of the lagging index include the CPI for services, the average bank prime interest rate, the volume of outstanding business loans, the ratio of consumer installment credit to personal income, the index of manufacturing labor cost per unit of output, manufacturing inventory/sales ratio, and the average unemployment duration. These indicators are thought to reflect the costs of business operation and consumer consumption. As such, they reflect the results of past activities, and lag behind general economic changes. Coincident Components of the coincident index are the Industrial Production Index, manufacturing and trade sales, non-agricultural employment, and personal income net of transfer payments.

2.0

3.0

D)

Inflation/deflation Inflation is an increase in the economys average level of prices. The rate of inflation is the percentage rate of increase in the average price level. Deflation is a decrease in the average level of prices. As measured by the rate of change in the GDP deflator, the United States has not experienced deflation since the 1930s, but has had a persistent inflationary trend ranging from 3 to 9 percent per year since the 1940s, with an average of about 2.5 percent in the 1990s. Capacity utilization Each month the Federal Reserve Board calculates the proportion of plant and equipment used in the manufacturing, mining, and electric and gas utilities industries. This index represents the ratio of the Industrial Production Index to plant and equipment capacity. These figures are seasonally adjusted. This is an

E)

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inferential statistic, derived from year-end surveys made by several governmental and private organizations. See the Federal Reserve Board at www.bog.frb.fed.us/releases for current data on capacity utilization. F) Economic indexing An index is a comparison between a figure from a base period and a figure from another later period. This method summarizes and examines changes in the direction and level of economic activity. Index numbers relate such things as annual industrial production, industrial prices, and consumer prices to those of base years. An index typically starts with a base period or year defined as 100. The base year is often selected as a period when the economy is relatively stable, without high inflation, recession, or high unemployment. All other comparison years or periods are represented as percentage differences from that base year or period. For example, if 1989 was the base year (100) for a particular statistic, and the 1991 index number for that activity was 105, then the economic activity in 1991 would be 5 percent greater than the base period. The formula for calculating percent changes between two periods is: [(current period value prior period value)/prior period value] x 100 For example, if 1997 had an index number of 130, then comparing 1997 to 1991, the results would be: [(130-105)/105] x 100 = 23.8 Thus, 1997 is 23.8 percent higher than 1991, in terms of 1989 (base year) units. 4) SOURCES OF DATA USED IN FORECASTING The generation of fact-based or quantitative forecasts begins with research and the accumulation of data. Many sources provide useful information, including governmental data and forecasts, private organization or public organization forecasts, commercial forecasts (made available to subscribers), and internal organization data and forecasts. A) ISM Report On Business (Manufacturing and Non-Manufacturing) These are comprised of two polls of approximately 350 companies in 20 manufacturing industries and 17 non-manufacturing industries from around the country. Unlike other business system indicators, the ISM Report On Business does not measure the level of activity, but the change in activity level. The purchasing managers from these organizations are asked to report changes from the previous month for several activities. The main indicators for which change is reported are production, new orders, supplier performance, inventories, employment, and commodity prices. Purchasing managers report whether each activity was higher/better than, the same as, or less/worse than the previous month. For each of these indicators, a diffusion index is formed by adding 379

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Module 3 all of the higher/better responses together with half of the same responses, to develop the indicator. For the manufacturing results, ISM seasonally adjusts the total to arrive at the final index number. From five of the manufacturing indexes, ISM PMI is computed. Changes in this index have historically had a close relationship to changes in GDP. Because the first government estimate of GDP for a quarter is not available until one month after the end of the quarter, the first months PMI for the quarter gives an early indication of that quarters GDP three months before the first government number is available. The ISM Report On Business is one of the most widely watched and highly regarded of all leading economic indicators. The Report has two specific advantages. First, turns in diffusion (change) indices have the property of leading turns in the actual activities, when changes are measured by one quarter of a business cycle. Second, unlike governmental data, which are often several months old when released, the ISM data describes changes in the previous months activity. The data are typically no more than a week to 10 days old. For these reasons, the ISM Report On Business is extremely valuable as a forecasting tool.

B)

Government publications (international and domestic) Federal, state, and local governmental agencies gather and publish a remarkable variety of information on a broad range of business and economic topics. In most metropolitan areas, there are libraries designated as federal depositories that contain information disseminated by the federal government. A document librarian is essential when researching government documents. The U.S. Government Printing Office is a source for many popular federal publications. The GPO Web site, www.access.gpo.gov/su_docs, provides access to a wealth of electronic documents, and links to other federal agency Web sites. The U.S. Department of Commerce and state commerce departments offer many types of statistical information useful to forecasters. These include: 1.0 Survey of Current Business Published monthly by the Bureau of Economic Analysis of the U.S. Department of Commerce, this provides estimates and analysis of U.S. economic activity. The Survey also reviews current economic developments, and quarterly national income and product accounts. It is available at www.bea.doc.gov/bea/pubs.htm. Federal Reserve Bulletin Prepared by the Federal Reserve Board, this monthly publication includes such information as flow of funds measures, interest rates, savings, wages, and prices. It is available at www.bog.frb.fed.us/ releases. Other governmental sources The Economic Report of the President and the Statistical Abstract of the U.S. are only two of the many sources of data available from the federal government. These are also available through the GPO Web site at www.access.gpo.gov/su_docs.

2.0

3.0

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The United Nations publishes annual information relevant to purchasing and materials management forecasting needs, including International Trade Statistics, World Economic Survey, and Statistics of World Trade in Steel. C) Private publications Many associations such as the Institute for Supply Management (ISM) and the American Production and Inventory Control Society (APICS) publish surveys or analyses of economic conditions for their members. In addition, many industry associations and other special interest groups also generate such information. Other business forecasts can be found in The Wall Street Journal and Business Week. Commercial forecasts Many organizations develop and market economic forecasts for sale to subscribers. Among these are banks and industry groups. Customized forecasts are available from many of these organizations. Regional surveys Many of the local affiliates of ISM including Arizona, Austin, Boston, Buffalo, Chicago, Cincinnati, Cleveland, Detroit, Milwaukee, Oregon, Rock River Valley, South Bend, Southwestern Michigan, Toledo, and Washington publish their own business surveys. These surveys, which are similar in methodology to the ISM Report On Business , reflect local or regional situations that may be significantly different from national conditions. Data is available at www. ism.ws. Internal historical data Many organizations develop organization-specific forecasts from internal historical data. For example forecasts of sales for individual products and families of products can be determined using internal records. Forecasts of standard costs, leadtimes, seasonality of demand, employment levels, and financial data are additional types of internal historical information that can be gathered and used. Industry sources Industry publications and associations that specialize in particular industries, such as Electronic Buyers News, Chemical Week, American Metal Market, and The American Iron and Steel Institute, are just a few examples. Internet Most economic data is available on the Internet at various industry, association, and government Web sites. Much of this is available free of charge, but some require a subscription or membership.

D)

E)

F)

G)

H)

5)

FORECASTING METHODOLOGIES/TECHNIQUES In any comprehensive forecasting program, many different methods of forecasting are applied. Several of the most important of these methods are discussed below: A) Short-term vs. long-term forecasting Long-term and short-term forecasts are often made. A short-term (usually up to one year) forecast is used as an aid in developing

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Module 3 and executing short-term purchase plans, and operational or tactical activity. Longterm forecasts facilitate the evolution and development of strategic plans, and typically include in-depth commodity and industry studies.

B)

Macro vs. micro forecasting Macro forecasts project broad scale activities, such as a nations gross national product or an industrys growth. Micro forecasts are organization-specific, or limited to small segments of larger issues. Macro and micro forecasts usually are linked. A organization may forecast prices paid for a specific, locally-purchased product (micro), but that forecast will be dependent on the status of that supply industry both nationally and globally (macro). An organizations projection for the next years inventory investment is based on sales estimates, which, in turn, are based on general economic condition forecasts.

C)

Delphi method Many times purchasing and materials managers need forecasts of activities or issues where no factual data exist. A procedure for developing such opinion-based forecasts is the Delphi method. First used by the Rand Corporation in 1963, this procedure begins with the identification of a panel of experts in the field of interest. Rather than bring these people together, they are deliberately kept apart and are unknown to each other. This is done because group dynamics and discussion may distort and reduce creativity. These experts are posed a series of questions regarding the topic. Each expert then prepares a written response to each question, along with supporting arguments. Each participant receives anonymous copies of all other responses. The experts are then invited to revise or defend their responses. The revisions are then submitted to the researcher, who repeats the process perhaps as many as three or four times, until a consensus develops. Correlation/regression analysis Measures of correlation are used to describe the degree of relationship between two variables (or data series). The correlation coefficient indicates whether the relationship is positive (both increase together) or negative (one increases while the other decreases). With the use of a regression equation, the scores on one variable based on the other variable can be predicted. Correlation and regression analysis is particularly useful in forecasting. Time-series analysis Time-series refers to statistical procedures to analyze data that accumulate over regular time intervals. Time-series analysis for costs, prices, inventories, interest rates, and employment is important to business, because it can be used to extract information regarding variations that might be time-related. Components of time-series include long-term trend, seasonal variations, cyclical variations, and random error. To accurately forecast based on time-series data, reasons for variation must be examined. Is the observed data fluctuation an indication of seasonal variation (e.g., lawn furniture), long-term general business or economic variation, or an indicator of a long-term trend (e.g., the result of a sustainable increase in demand)? Or is it just the result of random sampling or other error?

D)

E)

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The answer may include several of these factors. Data may be smoothed and seasonally adjusted to remove these influences, with the objective of exposing the long-term underlying trend. F) Central tendency In any data set, the statistics of interest may lie in the measures of central tendency, because these statistics allow generalized interpretation. Measures of central tendency include the mean, mode, and median. The mean is the average of all of the values in the set. The mode is the most frequently appearing value in the set. The median is the midpoint when the set is arranged from lowest to highest value. Variability Central tendency only shows part of the picture. Measures of variability or dispersion (the degree to which scores differ from each other) are also important. The smaller the measure of variability, the more tightly the numbers cluster around the central point. Measures of variability include range, variance, and standard deviation. The range of a set of numbers is the largest number minus the smallest. The variance equals the squared sum of the differences of the individual values of a set from the mean, divided by the number of values in the set. The standard deviation is the square root of the variance. H) Analysis of cyclical data A cyclical component of data is the residual variation fluctuating around the long-term trend, due to changes in the economic or business system. Seasonal variations are those that occur annually on a repetitive basis. Economic and seasonal cycles can often make detection of long-term trends difficult. For this reason, data are often seasonally adjusted, meaning that the cyclical component of the data is removed. For example, a purchaser may want to remove from sales records of lawn furniture that element of increased sales attributed to sunny weather in spring and summer, in order to see if the increase in spring and summer sales is greater than, the same as, or less than the traditional seasonal change. The objective is to uncover the long range, underlying trend in the data. Is the lawn furniture sales increase due entirely to the fact that it is summer, or is some of the increase attributable to a sustainable long-term increase in demand? Smoothing the application of moving averages to time-series data dampens variations to make trends more apparent. Exponential smoothing weights the observations being averaged to increase the significance of more recent experience. I) Trend analysis A trend is the long-term component that underlies change in a series of data. Factors that produce trends or trend changes include population changes, productivity changes, technology changes, supply/demand changes, and price changes.

G)

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Task 316 6) FACTORS THAT CAN AFFECT FORECASTS

Module 3

The numerical output of any forecasting tool is accurate only as long as conditions remain unchanged. Factors that can affect the accuracy of forecasts include war and threats of war, strikes and threats of strikes, and natural factors such as disasters, discoveries, and depletions. Other issues for consideration include changes in technology, government, law, and in the population or consumer taste. Each of these and other commodity-specific factors must be considered and tracked for each of an organizations critical raw materials or components. A) Fluctuating leadtimes Fluctuation in leadtimes may result in material shortages or in the necessity to carry larger inventories to protect the organization from delivery uncertainty. Both of these increase costs, so neither is acceptable in todays globally competitive economy. Factors causing leadtime fluctuation range from financial and production problems, to demand increases, to constrictions in a supply chain. Many of these can be measured and forecast. In planning material acquisitions, the purchasing or supply manager must carefully assess the probability of occurrence and causes of leadtime fluctuation. Changing labor conditions Any organization that purchases materials or services from companies or supply chains that contain organized labor need to be aware of upcoming labor agreement expirations, and the accompanying potential for supply disruption. Not only can labor negotiations affect a supplier, they may disturb output from an entire industry. Strikes, or threats of strikes, can result in dramatic market changes. Advance warning of such potential supply constrictions allows a purchasing or supply manager to take protective action. A surplus or shortage of specific labor skills may also inhibit or enhance the ability of an organization to supply its customers. For example, a lack of skilled machinists or electronic technicians may restrict output of products requiring those skills. Availability of specific requisite labor skills should be observed and forecast in the same way as availability of other necessary inputs. Strikes, threats of strike, and shortages of properly trained skilled labor are elements of potential change to historical projections that the purchasing or supply manager must track and forecast for all critical purchased materials and components. C) Changes in money markets Early theories of international trade assumed that a countrys factors of production (land, labor, and capital) were fixed and immobile. In todays economy, funds are transferred worldwide around the clock. Money markets in financial centers all over the world facilitate currency exchange and lending. Central banks operate in concert to regulate exchange rate limits and interest rate differentials. Domestically, the Federal Reserve Board (the U.S. central bank) has the delicate job of balancing the availability of money in the national economy. Making funds more readily available has the benefit of driving interest rates down, but risks growth in

B)

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the rate of inflation. Restricting money supply counteracts inflation, but results in higher interest rates that limit or restrict business expansion and affect unemployment. At the micro or organizational level, an increase in interest rates obviously affects an organizations borrowing rate and its cost of doing business. It may cause a project to be crowded out, to become economically unattractive to the organization. In an economic sense, reductions in investment lead to reductions in income and employment. D) Political factors Changes in government often portend changes in the business climate. Even in the United States relatively stable political system, a change in the party in power may bring about change in emphasis on anti-trust law enforcement, environmental focus, economic goals regarding money supply, inflation, and acceptable levels of unemployment. In other countries, political change, or even the threat of political change, may pose significant risk to a multinational organization. Supplies or prices of raw materials or components purchased from politically unstable countries may change precipitously. Forecasts and long-term purchase plans should always include political risk assessment (the U.S. Department of State, international banks, and other multinational organizations publish country risk assessments that are useful to purchasing and supply managers). Even if purchases are not made from an international supplier, an examination of the countries of origin of purchased materials is likely to reveal a significant import dependence. For this reason, purchasing and materials managers should examine all strategic or critical materials to remain aware of political risk to supply continuity. E) Technological shifts In an environment of rapidly changing or developing technology, shifts from an established technology to a new one can significantly affect forecasts. For example, the rapid development and adoption of the Internet as a means of locating sources, communicating with suppliers, and conducting business transactions has caught many businesses unprepared. This shift in technology has been so rapid that many established organizations paid little attention to it at first, giving new companies opportunities to enter the market and take market share. Those companies that have lost market share as a result of this phenomenon are well aware of the impact of technological shifts on forecasts. While such shifts are difficult to foresee, and their impact even more difficult to predict, forecasters must be vigilant for such developments and include their possibility in forecasts as alternate scenarios, whenever appropriate. Climatic conditions In the longer term, weather can play a critical role when considering the amount of sunlight and moisture necessary for materials originating with agricultural products. In the shorter term, it can adversely affect the ability to extract minerals and transport goods. At its extreme, weather can idle suppliers plants due

F)

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Module 3 to flooding or wind damage, as well as interrupting their supply of power, water, and gas utilities.

G)

Changes in global trade Shifts can affect the relative supply and demand for goods, but also of importance are the sources precipitating these shifts. Changes in customs duties, trade embargoes, and import quotas can change availability, but political instability may limit supply, especially when civil unrest occurs. Purchasers also need to be aware of government subsidies that artificially lower the price of goods and the impact of developing nations acquiring higher levels of technological capability.

BIBLIOGRAPHY Beck, N. A Tool Kit for the New Economy, NAPM Insights, April 1995, pp. 67-69. Frumkin, N. Guide to Economic Indicators, 2nd ed., M.E. Sharpe, Armonk, NY, 1994. Frumkin, N. Tracking Americas Economy, 3rd ed., M.E. Sharpe, Armonk, NY, 1998. Kauffman, R. Indicator Qualities of the NAPM Report On Business , The Journal of Supply Chain Management, (35:2), Spring 1999, pp. 26-37. Murphree, J. Some Say New Some Say Old, Purchasing Today , June 1998, pp. 48-51. NAPM Report On Business in Purchasing Today . NAPM Report On Business Information Kit, NAPM, Tempe, AZ. Niemira, M.P. A Practitioners Guide to Forecasting, The Purchasing Handbook, McGraw-Hill, New York, NY, 2000, pp. 607-639. Ore, N. The Value of the ROB, Purchasing Today , April 1999, pp. 26-30. Rogers, R.M. Handbook of Key Economic Indicators, Irwin, Burr Ridge, IL, 1994. "Using the NAPM Report On Business to Forecast Purchase Trends, CD-ROM, NAPM, Tempe, AZ, 1996.

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TASK 401: Develop strategic plans and objectives (short and long term).
1) ISSUES IN STRATEGIC PLANNING Strategic planning is the process of developing plans to achieve the organizations mission. Purchasings responsibility in strategic planning is to develop its goals, strategies, and plans to support the organizations strategic plan. A) Purchasing support for organizational strategy Strategic planning is the setting of long-term direction for the organization. An organizational or business strategy, once implemented, requires the support of the procurement function. Purchasing plays a key role. In the acquisition process, the requisitioning authority, engineering, quality, purchasing, planning, and finance/legal organizations may all be involved. Purchasing manages the process with the supplier community. Early involvement by purchasing and the supplier, as appropriate, is essential to ensure the most effective use of resources. Purchasing must understand the business plans and objectives of the organization. Then, using that knowledge, it must develop a procurement strategy that best supports the organizational objectives. Purchasing must also identify the sourcing strategies and tactics that can be used to reduce total cost, enhance revenue, or achieve competitive advantage for each targeted purchase category. B) Planning process and objectives Given that purchasing has the leadership role in managing the procurement process, it must establish a network of internal and external organizations for products and services purchased. This includes suppliers, as well as all internal customers that support the purchasing and supply management process. Purchasing becomes the communicator during the procurement process. Thus, a first step in the purchasing process is to ensure that all organizational elements understand their roles and responsibilities. Second, each must understand the organizational objectives. Finally, each must understand the plan from an operating point of view. The supply chain will be more successful if trust is established throughout the chain. In developing a purchasing strategy, this may be the most important element. Many redundant procurement activities can be eliminated once trust between the organizations activities is established. For example, development of long-term supply relationships reduces the non-value-added work, because terms and conditions, written offers/counter offers, expediting, inspection, late payments, and so forth can be reduced or eliminated. When both supplier and customer trust each other, their respective organizations can establish communication at all levels. Such communication will ensure the free flow of information and ideas necessary to support strategic plans and objectives. 389

Task 401 C)

Module 4 Planning timeframes Generally, short-range strategic plans involve timeframes of one to two years, while long-range strategic plans cover five to 10 years. Operational plans can be instituted over periods of 30, 60, or 90 days, or quarterly or annually. Developing commodity plans Prior to making a commodity supply plan, the purchaser should consider such elements as forecasting requirements for the commodity over certain time periods; the source(s) of the commodity; the type of market for the commodity (e.g., Is it traded on an exchange? Can it be purchased from a manufacturer or through a distributor?); the form in which it is purchased (e.g., raw, refined, converted); the total supply availability; the geopolitical control of the commodity; and the costs of acquisition. When developing commodity plans, purchasing also needs to consider issues pertaining to source selection; logistical considerations (such as location, customers, tariffs, free trade zones, the use of agents and brokers, transportation); communications issues (such as the use of EDI); and financial elements (such as exchange rates and payment modes) (see Task 313 for more information on the development of supply plans).

D)

E)

Developing contingency plans In the event that the commodity or service is not available in the desired quantity, quality, or cost, what are the alternatives? How can they be managed to satisfy the internal customer? Typically, contingency planning has a tactical nature. However, some of the supply issues associated with material-flow disruption show that risk is strategic in nature, because any disruption tends to seriously reduce the competitive capability of the company experiencing the disruption. Strategic conditions implying large strategic risks and high importance of contingency planning include: Extensive supplier power. Many purchasers for supplier products. Extensive customer influence on purchaser. Few, or no, substitute products available. Large strategic importance given to aftermarket customer service.

Once it is deemed important to pursue an active strategic contingency planning program for all, or selected, suppliers, the issues come down to methods. Although most methods are traditionally viewed as tactical, their use should be evaluated in determining strategic costs and benefits, as well as tactical benefits. The overall approach involves evaluating each product, or family of products, based on the strategic risk, and developing a method, or package of methods, that are the most effective in reducing risk at the lowest total cost:

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Part A: Management and Organization F) Inventory Backup suppliers Multiple suppliers Backup capacity in supplier organizations Close linkages with selected suppliers Vertical integration

Task 401

Decisionmaking A number of considerations are involved in the decisionmaking processes that are part of the strategic plan. Important questions include: What resources (e.g., people/financial/physical/technical) are required for implementing the strategic plan? Who has the authority to review/authorize the plan? Who will decide how the plan is to be implemented? Will the decisions be made using team input? What decisions will be made by management alone? Will there be customer or supplier input? What will be the timeframe for the plan? What will be the qualifications of those implementing the plan? Are there any models or prototypes for the plan that could be implemented? How will success be measured? By whom? How often?

G)

Profit planning Profit planning begins with the strategic and operational plans. Procurement can have an impact on these plans and on the financial results, because how effectively purchasing does its job will affect profitability. Purchasings input can include current and future material prices, supplier input into the design process, and supplier selection, which affects quality and delivery. Periodic review All strategic plans should include feedback loops for managing the various elements of the plan. Organizational assignments and resources allocations should be reviewed, as well as progress toward reaching milestones and goals. Advanced acquisition planning Advanced acquisition planning can occur when the purchasing manager is included in the development of the business plan. Specific factors that a purchaser should consider when planning include whether or not the item is a new or existing product, the dynamics of the market for the item, the competition among suppliers of the item, the general availability of the item, the possibility of implementing a JIT process for purchasing the item, the costs of inventory, the readiness of possible suppliers to produce the needed item, and projected leadtime for purchasing the item. In summary, there is no substitute for information, and the better informed procurement is from the beginning, the more effective the purchaser will be. A purchaser who is organized can earn a place on the team and become an effective contributor to the strategy of the organization.

H)

I)

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Task 401 2) SUPPLIER STRATEGIES

Module 4

In order to achieve the organizations goals, purchasing must select and develop suppliers consistent with the organizations strategy. Development of supplier strategies involves three major steps. To ensure that the best strategy is used, the following steps should be implemented: Identify the industry, commodity, and organizational infrastructure characteristics that may affect the supplier strategy. - Industry For example, competition, consolidation, supplier capacity, ratio of the organization purchase as percent of supplier sales, and potential new suppliers. - Commodity For example, available substitutes, switching costs, product complexity, and stage-in-life cycle. - Organization For example, the potential to standardize, potential for leveraging, and supplier manufacturing flexibility. Review the potential supplier strategies, which include: - Partnership/alliance - Long-term contract - Standardization - Quality improvement - Overhead cost reduction - Consolidation of requirements - Competitive bidding - Price rollback - Supplier reduction - Cross commodity leverage - Internal price benchmarking - New supplier development - Substitute Match the supplier strategy to the industry, commodity, and organization. One approach to selecting supplier strategies is to develop a criticality grid, with the vertical axis representing the importance of the commodity on the organizations performance and the horizontal axis representing the procurement risk. - Non-critical components These items have little effect on the organizations competitiveness and profitability. The primary goal is to minimize the procurement costs of these items. - Leverage components These items are relatively low risk to obtain, yet have a major effect on the organizations competitiveness. The dominant strategy is to leverage the organizations volume to get lower prices. - Bottleneck components These commodities are of relatively low importance to the organization, but the supply situation has high risk due to factors such as patent protection or lack of substitute products. - Strategic components These high risk-of-supply and high-importance-to-competitiveness items require supply strategies that reduce costs and ensure continuity of supply. 392

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Task 401

Criticality of Commodity Low High

Leverage Components

Strategic Components

Non-critical Components

Bottleneck Components

Low Procurement Risk

High

The resulting four quadrants can be matched with the strategies given above. Leverage X X X X X X X X X X Bottleneck X X Non-critical X X X X X X X X X

Supply Strategy Strategic Partnership/alliance X Long-term contract X Standardization X Quality improvement X Overhead cost reduction X Consolidation of requirements Competitive bidding Price rollback Supplier reduction Cross commodity leverage Internal price benchmarking New supplier development Substitute 3) COMMODITY STRATEGIES

X X X X

Blind reliance on numerical benchmarks, such as purchase price variance and landed cost, threatens to keep organizations from acquiring distinctive competitive advantage in todays supply-constrained marketplace. As more and more organizations are discovering, positioning the purchasing process into a segmenting of different commodity strategies, commodity tactics, and commodity management approaches is the only way to effectively link commodity strategies with overall organizational goals, product-marketing strategies, and competitive efforts. This differentiation process is often referred to as commodity segmentation. The commodity segmentation technique provides a mechanism for discriminating between the various items and services that are purchased by an organization. The goal is to develop specific strategies to meet the needs of the organization with respect to separate and logical categories of items. Commodity segmentation is an excellent marketing tool for convincing 393

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senior management of the critical role that purchasing plays in support of corporate-level strategies and organizational profitability. 4) DEPARTMENTAL STRATEGIES Strategies implemented by the purchasing and supply management department will encompass and be affected by supplier strategies, internal customer strategies, and the strategic goals and objectives of the purchasers employer. Generally, departmental strategies can be thought of as those implemented by the purchasing and supply management organization, and those for which the department is responsible. Lower total cost can be achieved by using appropriate internal departmental strategies, in concert with appropriate supplier strategies. Some common departmental strategies are: Supplier programs - Near/on site production - Pull system of replenishment (kanban signals) - Electronic data interchange/advance ship notice - Supplier-managed replenishment (JIT II) - Early supplier involvement in product/service design - Supplier performance evaluation/compliance Supply base rationalization Evaluating the current supply base for a purchased category to determine if it should be consolidated or increased. - Why decrease? Too many suppliers to effectively manage; buy is spread across broad supply base, resulting in lack of leverage, attention to quality, and service; large supply base inhibits effective development of alliances. - Why increase? Risk of too few suppliers for strategic items; current supply base does not have enough capacity. Fact-based negotiation A process that results in a well-researched, data-based set of facts and prepared arguments to aid the client in negotiations with suppliers to supply a purchase category (see Tasks 201-202 for more information on negotiation). The resulting fact-based brief includes: - Competitive market information about the purchase category. - Supplier information and capabilities. - Suggested negotiation strategies and tactics. Bundling This is the consolidation of cross-category spending into fewer (or single) suppliers. - Benefits Enhances leverage with fewer (or single) suppliers, simplifies the supply network, and reduces the costs of managing multiple suppliers. - Disadvantages Risk of stockouts because of consolidating requirements with a single source, and expertise across categories may be mixed.

394

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Task 401

Hedging Hedging is managing the cost of purchased categories (generally for raw material commodities traded in organized markets) to minimize the risk of volatile/erratic prices (see Task 312). Standardization Standardization is the process of agreeing on a common specification. Standardization reduces the number of substitute/similar material/SKU inputs to simplify the materials management process, reduces inventory investment, and increases supplier leverage (see Task 308). Specification change Broadening, relaxing, or tightening purchased category specifications to optimize the right degree of quality, reliability, etc. Specifications may be too tight or too loose for required form, fit, or function for the market targeted for the final product. Logistical improvements Examples of logistical improvements include: - Frequent shipments of small lot sizes arriving in fixed, narrow-time windows. - Shipments arrive as sequenced mixed truckloads to match assembly order (blue wheels to match blue cars, etc.). - Fixed delivery and back-haul routes. - Supplier ships from JIT production versus JIT warehouse. - On-site logistics coordinator (JIT II). - Transportation mode analysis (air versus truck versus rail). - Effective use of third-party logistics providers. - Cross-docking capability of suppliers. Cross-docking is a distribution system in which freight moves in and out of a distribution center without ever being stored there.

BIBLIOGRAPHY Chapman, S.N. Lets Get Strategic, Purchasing Today , June, 1996, pp. 28-31. Dobler, D.W. and D.N. Burt. Purchasing and Supply Management: Text and Cases, 6th ed., McGraw-Hill, New York, NY, 1996, pp. 623-643. Douchkoff, W.L. Developing a Supply Management Strategy, Proceedings of the 1995 NAPM International Purchasing Conference, NAPM, Tempe, AZ, 1995, pp. 64-69. Elliott-Shircore, T.I. and P. Steele. Procurement Positioning Overview, Purchasing and Supply Management, Official Journal of the Institute of Purchasing and Supply, December 1985. Leenders, M.R. and H. Fearon. Purchasing and Materials Management, 10th ed., Irwin, Homewood, IL, 1993, pp. 627-655. Monczka, R., R. Trent, and R. Handfield. Purchasing and Supply Chain Management, South-Western College Publishing, Cincinnati, OH, 1989, pp. 179-209. Steele, P. and B. Court. Profitable Purchasing Strategies A Managers Guide for Improving Organizational Competitiveness Through the Skills of Purchasing, McGraw-Hill Book Company, London, 1996.

395

TASK 402: Develop goals and objectives of a purchasing and supply department, aligned to organizational goals.
The purchasing department is uniquely positioned in an organization to ensure that value exists in the goods and services required to achieve the organizations mission. The success of the organization may be determined, or dramatically enhanced, by purchasings ability to maximize value through an effective and efficient purchasing and supply management process. To ensure the organizations value is maximized, purchasings goals and objectives must be consistent with, and supportive of, the organizations mission and objectives. 1) TYPICAL ORGANIZATION VISION, MISSION, AND GOALS STATEMENTS Henry Mintzberg said, Many of the great strategies are simply great visions. And great visions can be a lot more inspirational and effective than the most carefully constructed plan. Vision statement Written in the present tense, the vision statement broadly outlines the organizations future direction, and serves as a guiding concept for what the organization will do and become. The vision answers the question, What results do we want to achieve? Objective The organizations targets for achievement must be met in order to fulfill the organizations vision. Objectives are specific and measurable levels of achievement. Goals Goals define the desired future of the organization and the direction it will take.

Goal statements are critical to the overall success of the purchasing department. If an organization does not set goals, the organization cannot expect to reach them. A vision statement cannot be created in a few hours. Several sample mission/vision statements are: We have developed partnerships with customers and with vendors that have permitted us to achieve the highest standard of logistics and communications service. We have focused on Electronic Data Interchange (EDI) to produce seamless transactions with our partners. We have statistically measured our performance, and that of our vendors, to systematically increase efficiencies. The efficiencies, which we have created and maintained through our technology, have created our value to our customers. (Harbor International, Inc.) To meet our customer and technology requirements, Sequent makes a significant investment in its suppliers' products a rate that is expected to increase as Sequent continues to grow. Our suppliers are a strategic and essential link in Sequents value chain to drive technology, industry-leading designs, and cost/performance leadership. (John McAdam, President and Chief Operating Officer, Sequent)

397

Task 402

Module 4 The Procurement Divisions Vision and Mission reflect the organizations strategic direction: - Vision: Provide world class leadership in external operations" - Mission: We ensure the success of our customers mission by providing strategic acquisition and material management guidance while maintaining public trust (Department of General Services, Procurement Division, State of California)

2)

FUNDAMENTAL OBJECTIVE OF THE PURCHASING DEPARTMENT: TO PROVIDE THE HIGHEST VALUE AT OPTIMUM COST TO THE ORGANIZATION Fundamentally, the overall objective of purchasing and supply management is the acquisition of materials and services of the right quality, in the right quantity, at the right price, at the right time, and from the right source. From a management viewpoint, the key objectives are: To buy at the lowest price, consistent with required quality and service. To attain a high inventory turnover, thereby diminishing excess storage, carrying costs, and inventory losses as a result of deterioration, obsolescence, and pilferage. To maintain continuity of supply, preventing interruption of the flow of materials and services to internal customers. To maintain the specified material quality level and a consistency of quality that permits efficient and effective operations. To develop reliable alternative sources of supply to promote a competitive atmosphere in performance and pricing. To minimize the overall cost of acquisition by improving the efficiency of operations and procedures. To hire, develop, motivate, and train personnel; and to provide a reservoir of talent. To develop and maintain good supplier relationships, in order to create a supplier desire to furnish the organization with new ideas, products, and better prices and service. To achieve a high degree of cooperation and coordination with user departments. To maintain good records and controls that provide an audit trail, and ensure efficiency and honesty.

Additional objectives that support other functions in the organization are: To search for effective new products/services that are relevant to the organizations operations, which can be called to the attention of internal customers. To suggest to internal customers materials or components/services that may improve the organizations products, services, or operations. To introduce standardization in requirements to simplify specifications, and reduce the costs of materials and the types of inventory. To furnish data for forecasting, or to assist in forecasting, the availability of materials and trends in prices. To participate in make or buy and other outsourcing decisions. 398

Part A: Management and Organization

Task 402

To serve sales personnel by bringing to their attention effective methods and techniques used by sales forces of suppliers.

3)

STRATEGIC GOAL OF THE PURCHASING DEPARTMENT: TO LEAD/MANAGE SUPPLIER RELATIONSHIPS FOR GOODS, SERVICES, AND MATERIALS IN SUPPORT OF THE ORGANIZATIONS OVERALL MISSION/VISION The strategic goal of purchasing is to develop and monitor supply sources and relationships for goods and services in support of the organizations overall strategic goals. An effective strategic goal provides the purchasing organization with a mission that it can further define for its own purposes, and use to help suppliers and its internal customers understand the reason for its existence. The challenge is to break this down into specific elements that result in successfully managing the acquisition of goods and services for the organization, while minimizing the resources required and adding value in support of the entire organization.

4)

ISSUES RELATED TO THE ESTABLISHMENT OF OBJECTIVES A) Priority of objectives Not all objectives should receive the same priority, so it is necessary to first pursue those that have the greatest impact on the operation of the organization. These priorities should be established and communicated throughout the organization to ensure that the objectives and the assigned priorities are valid. Integration of objectives Purchasing objectives must be aligned with, and work in conjunction with, those of the rest of the organization. The integration of objectives ensures success of the vision, mission, and goals of the organization. It is imperative that the purchasing department understands its relationship to the organization it serves. Typically, the greater the value of the inputs purchased as a percentage of the outputs sold, the greater significance the accomplishment of objectives will have for the organization. Goal alignment The goals of every function and process of an organization must be in alignment with those of the overall organization. Goals are specific statements about what is intended to be accomplished. It is important that the organization takes time to ensure congruity of goals at the outset to avoid later conflicts. Measurability of objectives Objectives need to be divided into groups (e.g., cost savings and product improvement) that can be quantified and measured. Quantifying the existing situation, and then comparing the situation at some point in the future against historical data or against appropriate external benchmarks, is one way to do this. The key to effective measurement is the selection of elements to measure that focus attention and resources on how, and when, purchasing can add the maximum value to the organization.

B)

C)

D)

BIBLIOGRAPHY Dobler, D.W. and D.N. Burt. Purchasing and Supply Management: Text and Cases, 6th ed., McGraw-Hill, New York, NY, 1996, pp. 41-60. 399

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Leenders, M.R. and H.E. Fearon. Purchasing and Materials Management, 10th ed., Irwin, Homewood, IL, 1993, pp. 28-31. Monczka, R., R. Trent, and R. Handfield. Purchasing and Supply Chain Management, SouthWestern College Publishing, Cincinnati, OH, 1998, pp. 94-133.

400

TASK 403: Plan/develop/provide operating policies, guidelines, and procedures.

Managements responsibilities include controlling the organizations activities and resources. Most management controls are financial, and form the basis for monitoring action and progress. The organizations and the functional units strategies, objectives, policies, and procedures are management tools to improve communication, understanding, and performance. A clear understanding of policies and procedures enhances effective coordination and communication relative to purchasing and supply activities, especially when activities cross functional responsibilities. 1) NATURE OF MANAGEMENT CONTROL Management control is the ability to influence events and keep them on the desired course. Management controls can be conveniently divided into three parts: before- the-fact controls, during-the-fact controls, and after-the-fact controls. A) Before-the-fact controls Before-the-fact controls are measurable and are based on business plans, forecasts, budgets, or established policies and procedures that represent the formulation of tactical activities for a specified period. Such plans establish a benchmark against which actual performance can be measured. 1.0 Budgets One of the more obvious ways to establish management control is through the organizations budget. Available funds are allocated to high priority activities and/or projects. Plans The business plan incorporates the budget process into additional assessments of other areas, such as market conditions, market share, customer requirements, competitive analysis, staffing requirements, technological advances, and other managerial concerns that affect the organizations strategies and objectives. 2.1 Disaster planning is an example of contingency planning. Such plans help facilitate the use of resources in the event of strikes, earthquakes, hurricanes, and major plant fires.

2.0

3.0

Forecasts Forecasts generally relate to the demand for finished goods or services, but also can involve internal capacity and external availability of materials and services. Forecasts for a specific product or service, where tiers of suppliers work together to form a supply chain, will have the output from one supplier become the input for another, as the product, component, or service moves toward the final customer. The final customers requirement for products and services availability drives the entire supply chain (see Tasks 312 and 313 for a detailed discussion of forecasting). Policies/procedures manual The policy section establishes guidelines for achieving an organizations objectives and contains the functions major policies,

4.0

401

Task 403

Module 4 for easy reference by users. The procedure section outlines in detail the specific actions to be taken to accomplish a given task. Procedures typically define information and document flow, and/or individual responsibilities.

B)

During-the-fact controls During-the-fact controls relate to quality and timing issues (scheduled due date or activity completion dates). Monitoring and measuring the tasks while they occur, or before they are finalized, allows the process to be adjusted to stay within the designated parameters of quality and schedules. 1.0 Quality Control Quality control is the quality assurance activity that measures quality performance and compares it with specification requirements as a basis for controlling output quality levels. It is the review and measurement of processes, products, or services to determine if each meets or exceeds stated requirements. Scheduling Scheduling as a during-the-fact control is concerned with the delivery of goods and services, production schedules, and so forth.

2.0 C)

After-the-fact controls After-the-fact controls are reviews to measure what actually happened, so actual performance can be compared with planned benchmarks. 1.0 Audits Audits are conducted to determine if the work performed meets the original intent. Generally, a sample of transactions is taken by the auditor and compared to established benchmarks. The auditors findings are usually reported to management. Management is responsible for drawing conclusions and implementing the appropriate corrective action. Periodic reports The periodic report is another information source that can be used to compare actual performance with the plan. The timeframe for periodic reviews should be established during each planning stage, and the quantitative information should be summarized at intervals that will facilitate the review process. Purchasing can use the report process to communicate with internal customers, suppliers, and senior management. The effective use of reports and their positive impact on how purchasing is viewed cannot be overemphasized. Procedures review Procedure reviews are initiated to ascertain if those charged with following established procedures are doing so, and if the procedures are achieving the anticipated results.

2.0

3.0

2)

WORKLOAD DISTRIBUTION How purchasing responsibilities are assigned to purchasing personnel varies from organization to organization, based on the organizations particular needs, the size and capability of the purchasing function, and the nature of the product and service purchased. The methods chosen to assign responsibilities will affect the effectiveness and productivity of the purchasing and

402

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Task 403

supply department. Distribution of work can be accomplished in any of the following ways, singularly or in combination: A) Commodity, component, or service orientation Assignments can be made to purchasers or teams, based on the various commodities or components that the organization requires. The purchaser or team can specialize in a group of similar commodities or (usually in the case of large organizations) in a single commodity, when it is a significant enough part of the product cost to justify the assignment and when the purchaser has a strong product orientation. User department orientation When purchasing responsibilities are assigned by department orientation, the purchaser or team handles requests from certain internal customer departments assigned to the purchaser. Such an assignment focuses the purchaser or team toward servicing the department and handling all of its needs, as opposed to the commodity purchaser who knows a great deal about particular commodities/service but does not necessarily know a lot about individual departmental needs. Special project Responsibilities may be assigned according to a special project or a new product line. The purchaser or team may be assigned to provide the products and services to support the needs of a specific project. Volume To balance the buying workload in a department having similar levels of responsibility, some departments make assignments based on dollar volume or other similar criteria. In rotation Under this process, the responsibility is assigned to the next purchaser on the roster. It is a means of developing expertise and tapping as wide a range of skills as possible throughout the purchasing organization. Type of contract This method of assignment of duties is useful if a specific type of contracting involves products or services where there is a high degree of complexity, and a need for specialization or experience. Staff expertise The assignment of responsibility is made consistent with the skills and capabilities of the individuals employed. Supplier The responsibility is assigned according to suppliers or groups of suppliers. This is often the genesis of the supplier manager concept. Purchasing councils and lead buying Decentralization of buying, particularly in large organizations, has given rise to purchasing councils or lead-buying groups. When a council is used, all purchasers of an item get together and decide how procurement and supply management strategies can be used to maximize value. The lead-buying unit with the specific expertise will buy for others in the organization.

B)

C)

D)

E)

F)

G) H) I)

403

Task 403 3) PROCEDURES FOR CONTROLLING PURCHASE REQUISITIONS

Module 4

Management of information to ensure easy access and the ability to respond to internal customers' and suppliers' questions is an important function for purchasing. Basic procedures for controlling purchase requisitions are summarized below. A) Logging To maintain traceability, departments keep a register of the requests they receive. A computerized (or manual) log may include the requisition number, date, number of line items, description, assigned purchaser, and status. Technology has ensured that this information can be collected quickly and summarized in a variety of ways for use by management and the purchaser. 1.0 Manual control An assigned individual maintains the log and issues purchase request numbers, as needed. Some organizations control the issuance of purchase requisition numbers by using preprinted purchase requisitions with pre-assigned numbers. Computerized controls Normally, the application software will assign the purchase requisition control number and other internal customer-defined data elements.

2.0

B)

Location information When an organization employs a number of purchasers, the use of the log and the control number can help locate a particular requisition promptly to meet the information needs of the internal customer or supplier. Status information Some systems are designed to provide requisition status. Depending on organizational requirements, this may include whether they are in the quote, proposal, purchase order, or contract stage.

C)

4)

RELATIONSHIPS BETWEEN OBJECTIVES, POLICIES, PROCEDURES, DESK ROUTINES, AND FORMS The planning process hierarchy starts with an understanding of the organizations mission, vision, and overall strategic plans and initiatives. The functional unit develops its plans and objectives to support the organizations plans and objectives. The next step is to create the policies that will guide all action, communication, and coordination toward achievement of the functional units objectives. Procedures, or the step-by-step actions and activities, are then developed to guide the operation toward fulfilling the objectives. Finally, desk guides/routines and forms are used to implement the procedures to support accomplishment of the work.

5)

ORGANIZATION POLICIES THAT AFFECT PURCHASING/SUPPLY Purchasing must be sensitive to overall organizational policy. A complete understanding of the organizations mission, vision, strategies, and goals is necessary. This includes implementation of policy not always found in the purchasing manual, but in the organization policy manual, or 404

Part A: Management and Organization

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in policies from related functional areas, such as finance, legal, safety, operations, quality assurance, and human resources. Examples include expense reimbursements, hiring policies, discipline policies, and accounts payable procedures. 6) CENTRALIZATION VERSUS DECENTRALIZATION A multi-division or multi-site organization must decide to what extent purchasing activity should be centralized at the organizational level. Every organization treats this problem differently. Some centralize the activity almost completely, doing the buying for all sites at a central location. Others decentralize the function entirely, giving each site full authority to conduct all of its purchasing activities. Other organizations operate somewhere between these two extremes. Each approach offers advantages and disadvantages. Centralization is often used for one, or all, of the following reasons: High cost Purchases are centralized when they are a very high percentage of a products cost or the organizations budget. Centralized items It is common to centralize the purchase of items that are used by most of the operating units. Need for tight controls When there is a need for tight control over purchases, management may choose to place the authority and responsibility with one central group. This central group assumes the responsibility for developing purchasing policy and control measures for the product or service in question. Advantages of centralization Centralization has the following advantages: Communication with suppliers A central buying group becomes the representative for the organization with its suppliers. It is easier for both purchaser and supplier to make known their objectives and work together efficiently. Buying leverage Centralized purchasing permits the consolidation of requirements for all operating units, and increases the likelihood of obtaining improved prices and/or services. Suppliers generally are able to reduce their sales expenses because they only have to call on one location to reach the entire organization. Greater knowledge Centralization generally affords more purchaser specialization. Specialized knowledge permits purchasers to more effectively deal with suppliers and obtain greater value, because they know more about what they buy. Job satisfaction The centralized department may increase job satisfaction because purchasers are able to make a more significant and measurable contribution to the organization. More time to manage Planning, organization, professional development, and personnel issues require time. It is easier to allocate resources to these areas if the centralized department is adequately staffed. Lower operating costs While this may be arguable simply because the cost of a decentralized organization is difficult to assess, there is a consolidation 405

A)

Task 403

Module 4 of effort in a centralized organization in terms of purchase orders, requisitions, telephone and written communications, sales interviews, and the coordination and scheduling of meetings. These consolidated efforts and resulting synergy usually lead to lower operating costs. Advantages of decentralization Decentralization has the following advantages: Communication with internal customers The closer purchasers are to their internal customers, the more likely purchasers are to understand internal customer needs and to respond accordingly. Broader responsibilities The decentralized purchaser usually is given a wider range of responsibilities. In some cases, such responsibilities may include work outside the scope of a typical purchaser. Decisionmaking authority The decentralized purchaser often has greater decisionmaking authority because of a flatter organizational structure. Better purchase timing In some organization, the timing of requirements Counterbalances the objective of maximizing buying clout. This is particularly true in multi-plant manufacturing, where plants do not use similar raw materials or where they are widespread geographically. Fast-track organizations/project management R&D, construction, new products, and high-tech organizations often decentralize buying at the functional level. Those charged with the ultimate success of a product or project are given complete control of all resources, including purchasing.

B)

7)

REENGINEERING PROCESSES Reengineering became popular during the early 1990s as organizations sought ways to reduce costs, reduce cycle times, become more marketplace responsive, and improve overall competitiveness. Efforts to reengineer purchasing typically focus on key activities or processes, such as: A) B) C) D) E) Ordering cycle Reductions in order cycle times reduce product leadtimes, thereby reducing new product introduction leadtimes and inventories. Direct user releases Reengineering the order release process often leads to eliminating purchasings involvement and having the internal customers issue the order releases. Inventory Inventory control processes can be reengineered to eliminate unnecessary activities, as well as reducing replenishment leadtimes and inventory levels. Invoice payment Speeding up the invoice payment process improves supplier relations, as well as reducing the costs of a non-value activity. In-plant stores Reengineering the way in-plant stores are managed may lead to the use of supplier-managed inventory or consignment inventory systems.

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Part A: Management and Organization F)

Task 403

Other processes with an impact on purchasing performance or costs Other processes to consider reengineering include new product development and introduction, engineering changes, and supplier selection and certification.

8)

APPLICABLE INDUSTRY STANDARDS Purchasing and supply management may establish policies, procedures, or guidelines specifying that industry standards be used for product or service specifications whenever possible. Depending on the organizations maturity, industry affiliation, and nature of product or service purchased, the purchaser or team determines which product or service standard(s) apply to the purchase (see Task 308).

BIBLIOGRAPHY Baker, J.R., R.S. Kuehne, and L. Buddress. Policy and Procedure Manual for Purchasing and Material Control, Prentice-Hall, Englewood Cliffs, NJ, 1992. Ellram, L.M. and L.M. Birou. Purchasing for Bottom Line Impact: Improving the Organization through Strategic Procurement, Irwin, Burr Ridge, IL, 1995. Fearon, H.E., D.W. Dobler, and K.H. Killen (Eds.). The Purchasing Handbook, 5th ed., McGrawHill, New York, NY, 1993. Fearon, H.E. and M.R. Leenders. Purchasings Organizational Role and Responsibilities, Center for Advanced Purchasing Studies, Tempe, AZ, 1995. Gentry, J.J. and D.W. Dobler. Glossary of Key Purchasing Terms, 2nd ed., NAPM, Tempe, AZ, 1995. Killen, K.H. and J.W. Kamauff. Managing Purchasing: Making the Supply Team Work, Irwin, Burr Ridge, IL, 1995. Harris, G. (Ed.). Purchasing Policies, Business Laws, Inc., Chesterland, OH, 1988. Monczka, R.M. and R.J. Trent. Purchasing and Sourcing Strategies: Trends and Implications, Center for Advanced Purchasing Studies, Tempe, AZ, 1995.

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TASK 404: Prepare periodic reports of department activities for senior management and other areas of the organization.
1) IDENTIFICATION OF RELEVANT PURCHASE ACTIVITIES, PERFORMANCE, AND OTHER INFORMATION TO REPORT Procurements focus must shift from cost savings to value creation, taking into account product quality, total life-cycle costs, and profitability. For example, instead of simply supporting new product development, strategic sourcing must lead that effort through the identification of new materials, technologies, production techniques, and competitor activities. The main challenge is finding measurable items to report. The manager must look at the organizations strategic objectives and define measurable, reportable factors that reflect those objectives. For example, is the organization trying to get involved in electronic commerce and the latest technology? If so, then track the number of suppliers the organization is linked with, or the number of dollars spent via electronic commerce. The manager can demonstrate how these technology links have reduced cost or improved efficiency. Also, what goods or services are important to the organizations operations? Are any of these elements especially volatile, such as paper? If so, periodic status reports or when something happens updates will be meaningful to upper management, if tied to the organizations business or operational plan. When presenting information to upper management, try not to inundate them. Instead, take a few key measures to show the purchasing departments progress toward the organizations goals. For example: Expenses An organizations external spending for goods and services is significant both in terms of sales revenue and all other expenses. In most organizations, the procurement spend is between 25 percent and 66 percent of revenue and is significantly higher than the payroll expense, which has received tremendous attention due to downsizing. The opportunity to reduce expenses is significantly greater in procurement than in any other area of business or government. Assets Organizations have major investments, primarily in inventories, such as raw materials, finished goods, and spare parts, that can be managed much better than they have been in the past. Better control results in a stronger balance sheet, an improved return on assets, and reduced expenses associated with carrying costs. This has been the primary driver behind cycle-time reduction and Just-In-Time replenishment strategies. Productivity The procurement process, customer-need-identified to customer-needsatisfied, is complicated and time consuming because it involves so many business functions, (e.g., engineering, planning, procurement, quality control, and inventory control). This type of process creates a tremendous opportunity for productivity improvement. Productivity gains and associated cost reductions can easily exceed 25 percent. Additional benefits, such as increased responsiveness to customers and reduced cycle

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Module 4 time, are a bonus. Another productivity measure is earnings-per-share. Restating the purchasing groups objectives in earnings-per-share (EPS) puts purchasings goals into a framework that is much more easily understood and appreciated by executives.

2)

EFFECTIVE PRESENTATION TECHNIQUES Effective communication skills are identified by employers as the top requirement for new employees. The oral and written presentation skills of employees can have a huge impact on how well or how poorly information is transmitted, received, and understood. Employers are concerned that many people lack rudimentary reading, writing, and speaking skills. The avalanche of information available because of technological advances actually increases the demands placed on individuals in terms of communication skills. Information can be presented either orally or in writing. Either approach can be formal or informal, depending on the circumstances and purpose of the communication. If oral communication is chosen, then the speaker must decide if the presentation should be formal or informal. A formal presentation may include visual aids, such as PowerPoint slides, transparencies, video, or slides. The level of formality may affect the attire of the speaker and audience, the language used, and the structure of the presentation itself, such as when and how questions are handled. An informal presentation may take place at the office or workstation of either the sender or receiver of information, or at a neutral spot. The language, mood, and structure of the conversation may be more informal, and involve more give and take between speaker and listener(s). Whether it is e-mail, face-to-face presentations, or written reports, it is important that the presenter tailor the method of presentation to the culture of the organization and the preferences of top management. A) Written If written communication is chosen, the writer must decide if a formal or informal approach is required, and the format of the message. Written communications include writing a report, sending an e-mail message, or writing a letter or memo. In preparing a written report, the manager must consider who will be reading the report, as well as its purpose and context. Identification of the audience will determine what information will be included, and the information that can be assumed to be known by the reader. The purpose of the report could be to provide analysis, present an action plan, or present a position paper. The context may include whether to use a formal written report, memo, or e-mail. The written document must be well organized, clear, concise, and correct. The organization of the document will depend upon its purpose and company style. A common report structure is an executive summary, followed by an analysis and conclusions. An alternate structure is problem statement, analysis, recommendations, and implementation plan.

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Clarity is determined by precision and simplicity. The writer should avoid the use of jargon and big words to impress the reader. Conciseness does not mean brevity. Conciseness means avoiding padding sentences, minimizing the use of phrases and clauses, and avoiding the use of passive verbs. Correctness involves spelling, punctuation, grammar, and the appearance of the document. A sloppy report conveys the message that the content may be sloppy also.

B)

Oral Some things to guide the purchaser when making an oral presentation are: The presentation should be heavily sprinkled with action verbs and positive business words, and must exhibit enthusiasm and confidence. The speaker must master the use of effective eye contact. Match the tone, speed, and tempo of the spoken or written word to that of the decision maker(s). Also, people like to hear their name used in conversation and in writing. Thus, frequent use of names creates a positive relationship between the speaker and the decision maker. Posture must show a person with confidence in his or her credentials and ability. Body movements and positioning of the purchasing staff member should mirror that of the decision maker, without being noticeable. This builds rapport. The speaker should dress to fit in. Appropriate dress builds rapport with the senior manager. People like to be with people who remind them of themselves. People trust those who mirror how they see themselves. If the senior manager wears dark colored suits, then that should be the mode of dress for any meeting with that person. The speaker should consider the best time of day and location in which to meet with a decision maker, and determine how much time will be needed for the presentation. Prepare an agenda and follow it beginning and ending on time. The language of power calls for precise, concrete, and memorable wording. It eliminates the need to ask for permission, apologize, or ask for approval. It speaks to change, and adds value to the visions and tactics of the executives to whom it is addressed. The language of statistics, dollars, percentages, value creation, and the impact on the bottomline, with plenty of proof and back-up, will capture attention. Effective presentations and/or proposals speak the lingo of senior management, not the lingo of the purchasing department. Silence is a powerful tool and should be used before a critical comment, between phrases, when new points are introduced, and between strong parallels.

See Task 217 for additional information on effective presentations.

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Module 4 E-mail E-mail offers a great way to disseminate information quickly. When presenting information to upper management using e-mail, the manager should keep the document compact. Each paragraph should only deal with one topic. The memos organization should be logical and based on the final objectives of the organization. When sending information to overseas divisions, make sure that everyones software is compatible. E-mail makes regular communication easier and faster, but not necessarily better. Many people are inundated with e-mail messages on a daily basis. Learning to sort these incoming messages according to some system of categorization, such as ABC analysis, is critical from a time management standpoint. Also, many people are poor writers who lack the ability to put even the simplest piece of information into a concise, clearly written message. Some blame the informality and impersonal nature of e-mail for these problems. Others look to training personnel to teach employees basic writing skills and online etiquette. E-mail has the key advantages of speed and immediate availability, ensuring it a place in organizational communication. The key is to identify when e-mail is an appropriate means of communication.

D)

Internet Recently, purchasing departments have begun to use Web pages to facilitate communication both internally and externally. A Web page is a file of information directly accessible on the World Wide Web or on an organizations intranet. Purchasing is discovering the benefits of Web visibility. Web pages allow access to information by both current and potential suppliers anytime, from anywhere. A Web page can save a purchaser time by not having to answer frequently asked questions (FAQs). It promotes consistency because everyone gets the same response. The downside to the use of a Web page is the time it takes to maintain and update the information. It may also reduce person-to-person contact. A search of the Internet reveals that the public sector is an important player in the use of purchasing department Web pages. Potential applications include: Publishing of bid requests. Identifying potential suppliers. Providing answers to frequently asked questions. Providing copies of forms. Data collection.

E)

Intranet An intranet is an Internet-based internal Web site (see also Tasks 203-205). There are many applications for the purchasing and supply function. Purchasing and supply departments have developed intranet sites to do everything from gathering and disseminating information, to linking up with external resources via the Internet, to accessing online supplier catalogs. One application of the intranet is the posting of purchasings performance measures so management and internal customers can monitor purchasings performance and provide input into those measures.

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Part A: Management and Organization 3) DATA MANAGEMENT TECHNIQUES

Task 404

Making better business decisions quickly is key to succeeding in todays marketplace. Organizations wanting to improve their decisionmaking abilities are seeking better ways to use the data from their information systems. This can be a complex task due to the various systems in which the data are stored and the sheer size of the data available. In response, many organizations are choosing to build data warehouse systems to store data from varied sources. Purchasing and supply management can optimize its information requirements by tapping into the organizations data warehouse. A data warehouse provides a means to store data from a number of different systems in a way that provides a quick and easy single point of access for the organizations decision makers. It is important to differentiate between a data warehouse and an organizations online transaction processing (OLTP) system (enterprise resource planning systems used to process real time transactions). An OLTP system is designed around transactions (generating invoices, processing orders) while a data warehouse system is designed around subjects (orders filled per month, customer demographics). A data warehouse is often integrated with online analytical processing (OLAP) tools that provide increased usability and query performance for end users accessing the data warehouse. The first step in designing and creating a data warehouse is to identify the needs and specific expectations of each department in the organization. The quality of the interaction between the information services (IS) department and the purchasing and supply department at this initial stage of development determines the quality of the data warehouse design. The IS department then obtains the resources and constructs an empty data warehouse. Next, historical data stored on the older systems are used to initially fill the new database. The data are cleaned, summarized, and reformatted to fit the data warehouse structure, and inserted into the data warehouse. On a continuous basis, data collected by the operations of the OLTP system are transferred to the data warehouse. Data mining is increasingly switching from queries on OLTP systems to the more appropriate data warehouse data stores. As real time data are obtained from the OLTP systems, it is often processed just once and stored as summarized data in addition to (or instead of) its raw data form. The actual design of the data warehouse is often very different from the OLTP data structure. The differences in structure result in a system that is efficient and easy to use. The design of a data warehouse allows for increased performance of complex queries. The use of summarized historical data, and a database structure designed for speedy query results, make a data warehouse extremely valuable when querying historical data. Obtaining the same results from an OLTP system is much more time consuming. OLAP tools, when integrated with the data warehouse, provide easy data navigation to endusers. These tools can be used to design user-friendly interfaces that hide the sometimes cryptic query language used to access data. Some data warehouse systems are beginning to implement a natural language query system. These systems enable the end user to type in

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queries using everyday English. The system then translates the request into the data warehouses querying language and the query is processed. 4) CUSTOMER NEEDS Purchasers continually strive to meet the objectives of the procurement function, such as: Managing supplies so that the organization has what it needs when it needs it. Buying that is focused on the best interests of the organization. Purchasing at the lowest total cost. Continual upgrading of skills through education, and encouraging others in the field to do the same.

Equally important is the commitment to bringing the newest ideas and concepts into the organization. Purchasing departments have greater access to the latest product ideas and concepts, due to their relationships with suppliers and access to trade shows and trade publications. Each provides procurement personnel with the opportunity to make a powerful impact on the bottomline of their organizations, and also to provide that important competitive edge to help the organization outshine the competition. This important objective often proves to be the biggest challenge. This is not because the ideas, facts, and results are not available, but because the difficulty lies in: A) Getting the attention of the important decision makers. Getting them to listen and understand. Getting their buy-in. The language of top management Purchasing staff not only must prepare proposals based on well-documented facts and proven results, but must also present this information effectively. This communication must be at the correct time; must be in the tempo, speed, format, and language that will get the attention of the decision makers; and must meet the objectives and goals of the organization and the decision maker. This calls for research, planning, and preparation. It is not enough to know the material; it is critical how the material is presented. This may be where purchasing professionals fall short. If purchasing personnel want to make an impact and have senior management implement their suggestions then it is necessary to learn the language of top management. Being successful in having ideas and suggestions accepted by top management requires research, a knowledge of human relations and behavior, an understanding of the organization and its goals and objectives, effective communication skills, and a thorough knowledge of the idea or concept. Anyone who intends to suggest new ideas, concepts, and/or methods must thoroughly research the subject. It is critical to become the expert on the topic. Purchasing staff must have a clear understanding of the documented mission, objectives, and goals of the organization. This also includes any unspoken or hidden goals and objectives. 414

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Important questions the manager must answer are, Who are these decision makers? What are their objectives and goals for the organization? Just as critical to research are their personal career objectives and goals, along with their psychological needs. It is important to remember the term WIFM whats in it for me. People are motivated positively or negatively by how events affect them. Through what channels can these decision makers be reached? Who in the organization has a close working relationship with the decision maker and could help get a proposal accepted? How can this person/persons be approached for help? Is there a committee or a networking event within the organization or outside the organization that would provide an opportunity to get to know the senior manager or a trusted confidant? Who would be open to the proposal and able to help navigate the obstacles to acceptance? What are the communication styles of the decision makers? Procurement personnel need to be aware of the tempo, speed, level of detail, preferred method of communication (verbal, written, or kinesthetic), and choice of graphs and charts. This information may be gathered through the help of the senior managers executive assistant and any inter-organization memos written by the decision maker. It is important to check the personality type of the senior manager/managers. Are they to the point, number crunchers, aggressive go-getters, gruff, warm and friendly, achievers, affiliators, or influencers? Communication should fit the personality of the person who will be asked to decide on any suggestion or proposal. It is critical to use language and terminology that mirrors the persons way of thinking. Procurement buzzwords and terminology require translation into the decision-makers language. The politics of the organization must be considered. The presenter must know who should be included in the process, who could thwart the request, and who could help gain acceptance of the proposal. Suggestions must be phrased to match the personality and communication patterns of any of these sources of positive or negative support. Preparation also requires an awareness of all of the obstacles and objections to the project, and a prepared rebuttal to each one of these concerns. This shows someone who has thought through a proposal and is capable of implementing and managing a project to completion.

Some additional tips for successful communication with senior management include: Meet the goals and objectives of senior management. Be aware of roadblocks and difficult questions, and be prepared to respond quickly to such challenges. Be knowledgeable, organized, and authentic. These are necessary attributes for the acceptance of purchasings ideas and suggestions by senior management. Without knowledge of the audience, purchasing personnel may lose the opportunity to affect the organization. 415

Task 404

Module 4 Equally important is persistence. Battles are won because of persistence. If the purchaser has done sufficient research, and both the purchaser and his/her boss strongly believe in the project, then it is a matter of reviewing the above steps and formatting the information to be most effective.

B)

Investor viewpoint Investors are those who have an ownership interest in the organization through either debt or equity. Taking the investors viewpoint means reporting purchasings performance in terms of return on investment, future expectations, direction, control, and predictability. Investors are most interested in the success or failure of these efforts as they may affect future sales and profit results. Bring solutions, not problems approach The bring solutions, not problems approach operates under the philosophy of empowering employees and pushing decisionmaking to the lowest possible level. The individual is expected to take the initiative to solve problems and bring solutions to his or her superior. However, there is the danger of creating an organization in which people let issues become problems to be solved because this creates an opportunity to engage in a problem-solving effort that will be highly visible. Executive overview and supporting detail Another communication approach is to provide an executive overview or summary with supporting detail. This overview or summary should include the key point or central message along with supporting evidence. Before preparing the summary the purchaser should ask the questions: Why is this important? What is expected? How will it be measured or how will progress be tracked?

C)

D)

BIBLIOGRAPHY Clark, D. Dust Off the Data in Your Warehouse, Purchasing Today , July 1999, pp. 19-20. Gettinger, M. The Language of Senior Management A Whole New Way of Communicating, Proceedings of the 1999 NAPM International Purchasing Conference, NAPM, Tempe, AZ, 1999, pp. 121-125. Jousan, C.M. Giving Effective Presentations, NAPM Insights, October 1994, p. 7. Karoway, C. The Power of Influence: Do We Have It? Purchasing Today , January 1998, pp. 32-35. Raedels, A. and L. Buddress. Developing Your Own Purchasing Home Page on the Internet, Proceedings of the 1998 NAPM International Purchasing Conference, NAPM, Tempe, AZ, 1998, pp. 118-122. Raedels, A. and L. Buddress. What is Purchasing Success and How Do We Know If We Did It? Proceedings of the 1999 NAPM International Purchasing Conference, NAPM, Tempe, AZ, 1999, pp. 404-407. Wining, L.C. Straight to the Top, Purchasing Today , February 1997, p. 8. 416

TASK 405: Analyze and resolve issues raised in purchasing and supply audit reports.
How well is the purchasing department really doing? How well are its processes really working? Is the organization consistently following procedures? How do you know? The answers to these questions are normally acquired through an audit in which objective evidence is gathered. An audit is more than a compilation of opinions. It is a structured process to ascertain whether or not an organization, process, or product meets an agreed upon standard. Reasons for undergoing an audit include: Prevention of mistakes and problems. Gauging system and process efficiency and effectiveness. How do the policies work in practice? Repetitive or contradictory practices are easily identified through an audit. The purchasing process may meet every organization policy, rule, and procedure, and still may be seriously flawed. A regulatory or industry requirement.

In planning for the audit, the manager will need to determine the appropriate standard, audit type, and what will be done with results. Determine the standard By definition, auditing is gauging compliance to a given standard. Without a standard, a review exercise is not auditing, but rather investigating. Sample standards include organizational policies, organizational procedures, contract requirements, regulatory requirements, and ISO requirements. If no standard exists, try the ANSI/ISO/ASQ Q9001 standards. They can be obtained for a fee by calling the American Society for Quality at 800/248-1946, or visiting their Web site at www.asq.org. Select audit type Just as there are many different standards to compare purchasing and supply practices to, there are many different audit types. - Internal An audit conducted by auditors who are employed by the organization being audited, but who have no vested interest in audit results of the area being audited. If a purchasing and supply department is being audited, an internal audit might be conducted by a team from another department. Advantages of an internal audit include ease of scheduling, flexibility, and the auditors already have an understanding of the organization. Disadvantages include difficulty in finding qualified auditors with technical or audit expertise; and the audit report may not be taken seriously, depending on reputation of auditors. - External This type of audit is performed when an organization hires an outside auditor to audit the organization. An external auditor will probably conduct a preliminary interview to determine audit scope and probably request a current organization chart, copies of purchasing procedures, normal operating hours, and any special travel or safety requirements. Depending on the scope of the audit, it is common for the auditor to request a list of key suppliers or internal customers. Keep in mind, as with most professional services, there is a wide variation in the cost and quality of auditors. Check the auditors references and look for ASQ Certified Quality Auditor or RAB ISO 9000 auditor credentials when audits are conducted in these areas. Advantages of external audits include the auditors are normally

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better trained, the audit report is more likely to be taken seriously, and the auditor has no vested interest in the outcome and therefore can be more objective. Consequently, a more credible audit report may result. Disadvantages include cost because the auditor may not be familiar with the organization or industry, and escorts are normally required in an organization with proprietary and security concerns. - Self-inspection Self-inspection is the process of using an auditor who has a vested interest in the audit, hence the term inspection versus audit. A purchasing and supply department can be audited by individuals from that department. Self-inspection can be a valuable tool; however, it can be biased. Most people put on the rose-colored glasses when it comes to their own programs. Depending on the culture of the work unit, the manager may be better served by using an internal or external auditor. Advantages of self-inspection include lower cost, flexibility, use of department personnel, and less intrusion. Disadvantages include credibility of the final report and lack of auditing knowledge and training. Sometimes the standard or scope of the audit will dictate what type of audit is performed. For example, an official ISO audit is conducted by external third-party auditors. This normally happens when an organization is first certified, and then reoccurs on a schedule of once every six to nine months. However, the ISO standards require that an organization have an internal auditing and corrective action program. In the case of ISO audits, more than one type will be used. With all these options available for performing an audit, which method best fits the organizations needs? Choosing the right audit type is subjective, but normally involves a judgment of the importance of the function being audited (the audit scope) and how much leadtime is available. What will be done with the results? Once the processes and steps to be examined during the audit are determined, decide the objectives, in terms of personnel, of the audit. Depending on the scope, different individuals will take part or be affected by the results of the audit. The following questions should be answered: - Who should see the audit report? Management only? The individuals being audited? Personnel outside of purchasing? - Who has the authority to make system changes for the scope of the audit? - What will be done with the audit findings? Make improvements? Incorporate as an element of employee reviews? Use the findings to guide training? - Will the audit report be tracked and an action plan developed, or will it be filed away? Based on the answers to these questions, an audit report distribution list is developed and the group of employees who will attend the opening and closing meetings is selected. This should be done before the audit begins. The audit: What to expect By this time, the audit plan, the scope, distribution, and date should be known. Surprise audits are a thing of the past, with the exception of some regulatory audits. As part of the audit plan, escort requirements, if necessary, and a preliminary list of requested staff needed for interviews, will be provided. With external audits, escorts are commonly used for systems audits (of any kind) in which the auditor may not be readily familiar with the people or process involved. The purpose of the escort is to point the auditor in the right direction when, for example, the auditor would like to talk to the receiving supervisor.

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The next milestone is the opening meeting. The lead auditor (who may be the only auditor) will hold the opening meeting and discuss the scope of the audit with key personnel being audited. This meeting is normally brief and is more or less an introduction. It is critical that those managers or other personnel who have the ability to influence process changes attend the opening and closing meetings. On the other end of the process is the closing meeting. The same people who attended the opening meeting should attend the closing meeting. Draft audit report findings will be shared at the closing meeting. External auditors will not usually offer solutions on how to remedy audit findings. Some auditors leave written draft copies of the audit report and some do not. All auditors should highlight audit findings in the closing meeting. The amount of time needed for this process will vary. Audit time will be somewhat dictated by the audit scope, but an audit team of two or three auditors can conduct a company-wide ISO 9000 audit in two days. Audit costs will be another factor to consider when planning an audit. The biggest audit cost, by far, is the time taken by personnel to answer questions or auditor requests for data. Time cost must be a factor during the scope definition phase. 1) MEASUREMENT OF CHANGE INITIATIVES One function of an audit is to document the effects of changes in purchasing processes, policies, procedures, or organization (see Task 210 for a discussion on the management of the change process). The final step in that process is to periodically review outcomes using the measurement criteria defined in the process. Thus, the purchasing audit may be used to evaluate the outcomes of previous changes. 2) VALIDATION OF CURRENT POLICIES, PROCEDURES, WORK INSTRUCTIONS, AND FORMS The purpose of an audit could be as narrow as verifying that complete purchase orders are filed correctly, or as broad as an ISO 9000 systems audit. The purpose of the audit will also determine the resources required for the audit. Some other possible purposes include: Are proper dollar limits being adhered to? Are the appropriate personnel conducting given transactions? Are suppliers' references and performance records being checked? Are purchasers responding in a timely fashion to internal customer inquiries? How often does the item received match the one ordered (with the standard being the contract or PO)? Are items that have not been received followed up on? Are competition requirements being met? For larger projects, how good is the forecast? How close was the actual price to the budgeted number? 419

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Module 4 Is the organization using prompt payment discounts if it is the organizations policy? Are other departments using purchasing cards in accordance with policies? Are the best transportation methods consistently being used? How do contract administrators gauge that contract requirements are being met? Are they accurately keeping payment records? Is receiving conducting incoming inspections for key components? Is purchasing using technology appropriately? Is purchasing providing internal customers with appropriate information regarding new products, services, and suppliers?

As many purchasing systems or procedures involve some form of automation, it is natural that the technology be included in an audit as well. This can occur in two ways. First, do the electronic systems function properly? If, when inventories reach a particular level, the system is supposed to trigger a reorder, does it generate it properly? Analyzing and correcting this information might involve information technology personnel. Second, automated systems may be functioning just as they have been programmed and as intended, but are those intentions the best answer? Should there be a check in place to match receiving with an invoice? If the answer is yes, then that new process can be implemented into the automated system; but examining the processes is the same, whether or not the organization has a computerized system. 3) CONFLICT RESOLUTION SKILLS One result of an audit can be the identification of conflict between functions, suppliers, or individuals. Conflict occurs when one or both parties' goals and objectives are not being achieved or show a reasonable expectation of not being achieved. Conflict is not necessarily bad. Out of conflict can come awareness of a problem, improved solutions, productivity improvement, organizational change, and personal development. Conflict resolution begins by acknowledging that serious problems exist. The conflict resolution model presented below assumes that conflicts are real. It was developed to teach how to resolve issues that cause conflict. It does not assume that either side in a conflict is inherently bad, wrong, or evil. It is a nonjudgmental model that simply assumes that both sides are stuck and that they need to find a way to get unstuck. The conflict resolution model simply asks the question: how can the conflict be resolved in the most effective way? Effective conflict resolution is a seven-step process. The following is a checklist for use in the development of a conflict resolution strategy: Resolve internal conflicts Often one part of us wants to forgive, and another part wants to keep blaming and fighting with the other person. Forgive the other person. Listen to what the other person needs or wants. Set priorities Often, what is wanted in a difficult situation and what is really needed are two different things. Discuss the situation calmly Never get angry or resort to name calling. 420

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Come to a mutually agreeable solution. Follow up Remember to set a follow-up meeting to assess how things are going.

Again, conflict resolution is a learning model. It focuses on teaching professionals practical techniques they can use to resolve the conflicts they experience in the workplace (see also Task 117 for a discussion of other conflict resolution techniques). 4) NON-DEFENSIVE PROBLEMSOLVING Problemsolving in todays environment involves searching for the root cause without attempting to lay blame on an individual. If problemsolving can be focused on searching for the root cause, then non-defensive problemsolving can occur. Many mistakes can be traced to lack of training, improper tooling, wrong methods, defective materials, or inadequate materials. 5) CORRECTIVE ACTION PROCESS The audit report presents findings (conclusions) based on observations. Audit reports are representations of fact. There should be no mention of blame, and the focus of the report should be on the audit standard. The number of findings varies with each audit. There should not be any surprises from the draft audit report presented in the closing meeting. Even in award-winning organizations, there are normally some areas in need of improvement. Internal auditors and regulatory auditors normally require a plan that outlines what steps are going to be taken to address audit findings. The corrective action required will vary depending on the magnitude and root cause of the problem. In general, the process will include establishing timeframes for improvement, prioritizing the steps in the improvement plan, and conducting cost/benefit analysis to determine the appropriate level of resources to allocate to the corrective action plan implementation. A) Establishment of timeframes Once a problem area is identified, it is necessary to establish timeframes for corrective action. This may take the form of a final due date, along with milestones and timeframes leading up to full implementation of the corrective action. The manager must be clear about the purpose of the corrective action. In some cases, the first step may be to take the time to determine the root cause of the problem and then develop an action plan for dealing with the root cause. In other cases, interim measures may be taken to deal with symptoms of the real problem, while a plan is developed for identifying the root cause. Prioritization Whatever the process, prioritizing the steps in the implementation plan is critical. This process should include an understanding of the resources needed for the action and their availability. Cost/benefit analysis Corrective action must be cost effective, given the expected benefits if the action is undertaken. A comparison of resources (people, time, equipment, money, etc.) and availability to the expected value (quantified in some way) should be 421

B)

C)

Task 405

Module 4 performed. An ability to quantify the value of the benefits achieved is paramount. In most process improvements, this benefit is in the form of saving time. One of the most commonly used methods of quantifying savings is through activity-based cost analysis.

BIBLIOGRAPHY Lloyd, R.L. Why and How You Ought to Audit, Purchasing Today , May 1999, pp. 54-58. Smith, M. and R. Zelman. New Models for Diversity and Conflict Resolution, Purchasing Today , September 1998, p. 10.

422

TASK 406: Develop/utilize criteria for evaluating purchasing and supply department performance.
One of the major functions of management is to evaluate and control the performance of an activity. The purchasing and supply department is certainly no exception. The department leadership evaluates overall performance of individuals, the department, and suppliers, in conjunction with each person in purchasing, internal customers, and suppliers. Creating meaningful measurements, collecting data, and communicating results is often difficult because there is no one set or collection of metrics that work. However, it is the responsibility of purchasing and supply management to set, report, achieve, evaluate, and revise the departments (and individual) performance measures in order to improve its strategic position within the organization, and to enhance its relationship with internal customers and the organizations relationships with suppliers. According to work done by CAPS Research, broad categories of performance measures include: customer service, cycle times, quality levels, information technology, financial performance, organizational structure, flexibility, asset management, supplier management, workforce assessment, and impact on capital efficiency. 1) ORGANIZATIONAL EXPECTATIONS OF PURCHASING A) Congruence with organizational objectives Most purchasing departments are measured on price paid, on-time delivery, and incoming quality levels. These may not be consistent with the organizations objectives. Purchasings objectives need to be consistent with the organizations mission statement, strategy, and objectives. The decisions that purchasing makes must contribute to creating competitive advantage for the organization. Congruence with supplier and customer objectives As a service function to the organization, purchasing needs to advance the organizations ability to meet supplier and internal customer needs. Therefore, the measures used to evaluate purchasing need to reflect purchasings contribution to the organizations ability to meet the customers needs.

B)

2)

REASONS FOR DEPARTMENTAL (MACRO-LEVEL) PERFORMANCE APPRAISAL A) To determine departmental effectiveness in meeting organizational needs To evaluate the overall effectiveness of the purchasing operation, the purchaser must understand the mission of the total organization and the specific objectives of the purchasing operation to obtain maximum value, prescribed quality, and continuity of supply. Once the organizational mission is understood, the purchaser can relate this information to the ability to perform tasks that, when combined, ultimately meet goals. The purchaser can then establish benchmarks to measure the impact of the departmental efforts. Much

423

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Module 4 emphasis is placed on cost/benefit analysis. The purchasing department is expected to carry its weight in the organization. Fortunately, cost reduction, value analysis, and minimization of liabilities and administrative costs, make justification of purchasings added value and contribution to profit possible to document.

B)

To determine the effectiveness of department management The factors that the purchasing manager may wish to measure include the capabilities of personnel, the soundness of the organizational structure, the scope of each job, the departmental plans, and policies and procedures. Such factors influence the potential level of a departments performance and are useful indicators of performance. Measuring improvement/deterioration Measurement is crucial to improving performance. Without measures, there are no indications of whether changes in processes are improving performance. Measurement also provides early warning signals of deterioration of performance. This allows managers and purchasers to take corrective action. Providing incentives for improvement The act of measurement provides a builtin incentive. Individuals respond to the criteria by which they are measured. Wellestablished and accepted performance criteria generally provide an objective means of measurement of continuous improvement. To determine resources needed for improvement Given the past performance by the purchasing department and the goals for the future, the purchasing manager can develop estimates for future resource requirements, such as training, technology, and staff. To determine if value is added to the process Many activities have been done for years simply because they were never examined for improvement. Today most areas of the organization are subject to analysis to reduce or eliminate activities that no longer add value to the internal customer or the supplier. The question of value should never be far from the mind of the purchaser when evaluating effectiveness and efficiency.

C)

D)

E)

F)

3)

STEPS IN DEPARTMENT-LEVEL EVALUATION A) Identify department objectives When a manager develops a system to evaluate the performance of any department, the logical starting point is an analysis of the objectives of the department. Once this has been done, the organizational structure and the responsibilities assigned to each work group should be examined to determine the impact each operating activity has on the attainment of each departmental objective. This procedure normally identifies the critical activities in the operation where evaluation and subsequent control are most important. When an analysis of departmental objectives is made in a purchasing department, it reveals one unfortunate fact. Most of the critical points at which evaluation and

424

Part A: Management and Organization

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control should be performed lie in a single function buying. A wide range of extremely variable activities is placed under the jurisdiction of each purchaser. Moreover, examination of the basic responsibilities of each purchaser reveals that performance in most areas is quite difficult to express quantitatively. Thus, the very nature of the purchasing function makes it somewhat difficult to establish workable performance standards. Because of this difficulty, many organizations have adopted a broad approach to the evaluation and control of purchasing activities. Organizations attempt to establish performance targets (standards) for the measurable secondary factors that contribute to attainment of primary buying objectives. Recognizing that a single factor alone may not provide an accurate indication of creative buying performance, most organizations develop a crosscheck by measuring several factors that relate to the same primary objective. For example, buying performance relative to the price objective can be checked from two standpoints: (1) actual prices paid can be compared with target prices, and (2) targets for cost savings resulting from negotiation and from value analysis can be established and actual savings compared with these targets. Thus, two measurements provide a crosscheck on attainment of the same primary objective price. A similar approach can be used in evaluating buying performance relative to each of the other basic objectives of the department. B) Identify criteria for success The criteria for success are a direct result of the organizations mission, strategies, and objectives. Purchasing must identify how it can contribute to the organizations objectives, and then develop measures that will move purchasing in a direction that will reinforce those objectives. For example, if the organizations objective is to be the low-cost producer, purchasings criterion will be to find low-cost suppliers. Identify appraisal factors It is obvious that a number of different performance factors can be measured to provide a basis for appraising purchasing proficiency. These factors differ in importance among different organizations, depending upon the nature of the business and the materials or services purchased. Most organizations do not use all of the measures listed for this objective. Each selects those measures most useful and cost-effective in its own specific situation. Typical appraisals consider one or more of the following: 1.0 Contributions to profitability/success of core activity Contribution to profitability is a primary concern in a business. Total value and maximization of resource utilization are a primary concern of business, government agencies, and institutions. Each purchasing and supply management department is responsible for identifying how it influences and affects the core activity (or activities) of the organization it supports. Timeliness of actions A purchasing departments primary responsibility is to support operations. Three measurements indicate how effectively this responsibility is fulfilled. 425

C)

2.0

Task 406 Percentage of overdue orders Percentage of stockouts caused by late deliveries Number of production stoppages caused by late deliveries

Module 4

This data can be categorized by material classification, supplier, or purchaser, depending on the need and purpose of evaluation. 3.0 Materials/service costs Several techniques provide a crosscheck on the reasonableness of prices paid for materials: Standard or target prices can be established for major materials. Prices actually paid can then be charted against the target figures to display any significant differences. Another basis of comparison would be a materials budget, using standard price data. An organization can develop its own average price paid indices for major classes of materials. The trends of such price indices are valuable guides in assessing effectiveness of performance. If developed on a comparable basis, these indices can also be charted against various national commodity price indices published by the Bureau of Labor Statistics and the U.S. Department of Commerce. This comparison reveals cases where an organizations costs are rising at a greater rate than market prices. Periodic cost-savings figures can be individually charted for savings arising from such activities as negotiation, value analysis, design and material changes, supplier suggestions, change of supplier, packaging improvements, and transportation cost-reduction projects. If an organization engages in forward buying activities, gains and losses can be periodically reported to determine forecasting effectiveness. A report of the percentage of purchase orders that are issued without firm prices provides another basis for evaluating and controlling costs.

All of the preceding measurements can be classified and subclassified in various ways to pinpoint responsibility for the problems they reveal. 4.0 Material/service quality Once material specifications have been established, the most direct measure of quality performance is the percentage or number of delivered materials that are rejected by the inspection and operations departments. To monitor the improvement of quality specifications, the purchasing manager can also review the value analysis reports dealing with design changes and material substitutions. The same concepts apply to service purchases. Supplier reliability Measurements that can be used to indicate the reliability of major suppliers include:

5.0

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Part A: Management and Organization 6.0

Task 406

Percentage of late deliveries and percentage of rejected items, further analyzed and classified by supplier and purchaser. Percentage of orders on which incorrect materials were shipped. Percentage of orders on which incorrect quantities of materials were shipped. Percentage of orders on which split shipments were made. Quality and reliability of transportation service offered by various carriers.

Supplier development Suppliers affect a significant part of product or service cost, and their failure to perform must be considered in the search for maximum value. Generally, the more reliable the supplier, the lower the total cost of the suppliers product or service to the organization (see Task 112 for a discussion of measuring supplier performance). Order quantity and inventory investment Purchasings failure to buy the right quantity (i.e., that which keeps the operation functioning, yet minimizes the amount tied up in inventory investment) jeopardizes the cost structure or misuses resources that may be better used elsewhere. Several useful measurements in evaluating how well purchasing uses funds are: A chart showing target and actual inventory levels in the aggregate and by major material classifications. This chart is most useful when supplemented with a chart showing inventory turnover rates for the same material classifications. When analyzed together, these charts point out imbalances between inventory carrying costs and material acquisition costs. A report of dead stock materials carried in stores, resulting from overbuying or less-than-planned use. The number of stockouts and production stoppages attributed to underbuying. A list of supplier stocking arrangements that have been negotiated, along with an estimate of resulting inventory savings.

7.0

8.0

Customer satisfaction Feedback from internal customer departments (whether obtained informally or through more structured questionnaires and surveys) are a good source of data on the functioning of a purchasing department, and how well it is serving the needs of its internal customers and adding value to the organization. 8.1 External customers External customers include suppliers and sales representatives. The purchasing department should identify measures and benchmarks for external customer satisfaction and include them as part of the appraisal process.

427

Task 406 8.2

Module 4 Internal customers Examples of internal customers include engineering, maintenance, production, quality, and sales. Selected service dimensions to measure include reliability, responsiveness, assurance, empathy, and tangibility. As service organizations, purchasing departments need to understand the requirements of its internal customers, if purchasing is to remain a vital asset to the organization.

9.0

Creativity Value creation has become an important factor in the success of organizations. An important element of value creation is the ability of purchasing to encourage and reinforce creativity by the internal customers and suppliers. While often difficult to quantify, the degree to which purchasing can positively influence creativity can be an important measure of purchasing effectiveness.

D)

Internal audits/self-governance/self-assessment A purchasing audit is a comprehensive, systematic, independent, and periodic examination of an organizations purchasing environment, objectives, strategies, and activities. It is used to identify strengths and weaknesses, and to develop a plan of action to improve purchasing performance. Often, audits are conducted by outside consultants to ensure the necessary objectivity and independence of judgment. They are, however, also conducted internally. A drawback to internal audits may be hesitancy on the part of the auditors to be critical of performance, even when it is justified. Process benchmarking Process benchmarking refers to the search for organizations that perform the best in a particular area and the examination of their processes for the purpose of emulating them. In other words, process benchmarking provides an answer to the question: How are we doing compared to leading-edge organizations? The answer to this question should lead an organization toward the development of best practices for its own internal operations. Before initiating process benchmarking, an organization should carefully consider: Is the organization willing to make a major change? Is the expected improvement worth the expenditure? Are the expected results important to the organization? Does the process affect a critical success factor? Have all investigations related to this process been completed? Have all other alternatives been explored? Has the organization begun measuring the current process? Does the organization know the major cost components and service factors of its process? Is the organization willing to wait for a benchmarking study to be completed before implementing any changes? Is the organization willing to reveal information about its own processes to outside organizations? 428

E)

Part A: Management and Organization

Task 406

Process benchmarking may actually involve the division of the functions of an organization into several modules analyzed as independent processes. Such a study may find, for example, that one organization has the best order processing, another has the best inventory control, etc. F) Exercising management control in response to results Evaluation should be an ongoing process and catalyst for improvement in the purchasing function, and a means of validating performance to meet managements expectations. Once the results of a performance appraisal are obtained, management must be sincere in its efforts to correct the problems identified through the appraisal. Otherwise, the entire performance appraisal process serves no useful purpose (see also Task 416).

4)

CONCEPTS OF THE PURCHASING DEPARTMENT A) Purchasing as a profit center Some organizations have split internal functions into business units that must compete for, and sell their services, to other groups of the organization, and in some cases other companies. There can be many variations of how this concept is applied. For example, a department may actually charge other departments for its services. The extreme of this concept would be to move procurement into its own corporation that must compete for the organizations purchasing business. A profit center must meet three conditions: Value is added. Capital is employed productively. Costs are incurred.

Purchasing can purchase material and services from suppliers, add value to them in the form of distribution, and sell the goods and services to the remainder of the organization. The objective is to encourage the purchasing manager to find ways to improve service to the organization while reducing costs. For the profit center concept to work: Procurement must absorb the costs of all supply failures. Transfer prices are relatively rigid. If supplier prices rise, purchasing must absorb the increase. Likewise, if prices decline, purchasing keeps the increased profits. Price changes are market determined.

The benefits of using profit centers include: Defining purchasings responsibility more sharply. Emphasizing profit, not cost. Encouraging risk taking. Allowing purchasing to spend money to make money. 429

Task 406

Module 4 A potential downside of the profit center concept is that managers will be tempted to take short-term actions to increase profit that may reduce long-term competitiveness. As a profit center, purchasings characteristics would typically include: Developing plans for one to three years. The need for high-level negotiation skills is recognized. Contract creation and contract management are improved, resulting in yearon-year cost/productivity benefits. Rigorous multi-year forecasting is in place. Evidence of a comprehensive cost management program is in place, encompassing a structured cost-containment and structured cost-reduction program. Measurement of all actual costs is introduced and used in the business. Cost objectives are targeted, planned, and achieved. All purchasers focus on suppliers cost and value, not price. All purchasers are capable of purchase price and cost analysis.

B)

Purchasing as a cost center If purchasing is viewed as a cost center, its objective is to achieve its goals with the minimum expenditure of labor and operational costs. As a cost center, purchasing is only responsible for the costs it controls. The activities may not differ significantly; but, as opposed to a profit center, a cost center: Emphasizes cost, not profit. Does not encourage risk taking. Generally does not allow purchasing to spend money to make money.

5)

EVALUATION OF EXTERNAL PURCHASING External purchasing functions should be evaluated in the same manner as any service provider. They should provide the required goods and services at the lowest possible cost, with zero defects, when required. Examples of external purchasing organizations are cooperatives, consortiums, and third-party logistics organizations. The performance of external purchasing organizations may be included as a component of the departmental evaluation.

BIBLIOGRAPHY Harding, M. Purchasing Performance Measurements on the Leading Edge, NAPM InfoEdge, (2:5), January 1997. Michels, W.L. and R. Johnson. Primitive or Advanced Purchasing: How Does Your Company Stack Up? Proceedings of the 1997 NAPM International Purchasing Conference, NAPM, Tempe, AZ, 1997, pp. 323-327. OReilly, P.E. Service Companies Allow Customer Surveys to Measure the Effectiveness of Purchasing Departments, Proceedings of the 1996 NAPM International Purchasing Conference, NAPM, Tempe, AZ, 1996, pp. 410-413. Pye, C. Measure Right, Measure Now! Purchasing Today , January 2000, pp. 33-40. 430

TASK 407: Prepare and/or administer a purchasing department/supply management budget.

1) PURPOSES FOR A BUDGET A budget is a financial plan that covers a specified period (usually one year). It identifies financial resources allocated to products, services, departments, and/or divisions of an organization. Budgets are also tools for allocating funds to accomplish the objectives of the organization. A budget is a financial plan that indicates planned future actions and the funding levels required for their completion. To be effective, budgets must contain some means by which management can determine whether planned operations are being accomplished. As such, there are two elements common to all budgets. First, there is a set of specific goals that relate to future operations. Establishing goals is equivalent to defining the standards by which the organization is to measure its performance. Second, provision is made for a periodic comparison of actual results and established goals. This represents the control feature of budgeting activity, and is usually accomplished through the development and use of budget performance reports. With few exceptions, most budgets are developed in terms of cost. In fact, one of the major duties of the purchasing manager is the review and evaluation of a suppliers actual or anticipated cost data. The evaluation phase itself involves the judicious application of experience, knowledge, and judgment to the cost data of the supplier. The purpose of this evaluation is to project reasonable estimates of contract costs. These estimates then become the basis for negotiations between purchaser and supplier, and are used for arriving at contract prices satisfactory to both parties. A) Control of expenditures A primary function of budgets is to provide control of expenditures through the allocation of financial resources. By using flexible budgeting techniques, the purchasing manager can control expenses relative to the level of business activity. Pre-approved funding In some organizations, a budget indicates pre-authorization of expenditures for projects, products, services, or other expenses. The purchaser is authorized to spend up to the budgeted amount without gaining additional approvals. Monitoring of expenditures As expenditures are made, they can be compared against the planned expenditures shown in the budget. Consequently, budgets become a management tool useful for the evaluation of expected, versus actual, results. Development of standard costs Standard costs are used in estimating budgets for materials and labor. Given a forecast of revenue, the standard costs are used to estimate material and labor requirements. Such costs can then be allocated across budget centers, departments, or subsidiaries, as appropriate (see also Task 104).

B)

C)

D)

431

Task 407 2) TYPICAL ELEMENTS SUBJECT TO BUDGETARY CONTROL

Module 4

Major areas that are subject to budgetary control in a purchasing department include: A) Inventory The primary purpose of a materials budget is to identify the quantity and cost of the materials necessary to produce the predetermined number of units of finished goods or to provide services. A properly prepared direct-materials budget provides management with a tool that: Permits the purchasing department to set up a purchasing schedule that ensures delivery of materials when they are needed. Leads to the determination of minimum and maximum levels of raw materials and finished parts that must be on hand. Establishes a basis from which the treasurer or finance department can determine or estimate the financial requirements of the purchasing department.

Although generally based on estimated prices and planned schedules, direct materials budgets: Permit planned maximum leadtime. Lead to an enhanced selection of sources. Reduce transportation costs. Provide a basis for planning workloads. Help in forward buying.

In addition, the direct materials budget may improve purchase negotiations by reducing the pressure of time constraints. Other budget line items may be established to account for inventory items that are consumed within the organization, but are not directly attributable to each product or service. B) Wages and salaries Wages and salaries include not only the direct costs of the purchasing personnel, but benefits, such as retirement contributions, health benefits, and insurance benefits. Travel Travel budgets cover expenses related to visiting current and potential supplier facilities. Expenses include transportation, food, and lodging. It may also include travel for training and other activities of those in the purchasing department. Occupancy/energy Occupancy and energy costs are the overhead costs associated with the space occupied by purchasing. Communications Communication expenses include telephone charges, fax costs, EDI costs, Internet access, and postage.

C)

D) E)

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Part A: Management and Organization F)

Task 407

Books and supplies This item includes subscriptions to information such as Dun & Bradstreet and Thomas Register, as well as books and CD-ROMs for the purchasing library, and magazine and journal subscriptions. Training Funds for attendance at educational activities, such as seminars and classes; professional organization memberships; and training libraries.

G)

3)

STEPS IN BUDGETING A) Review goals and objectives The first step in the budget process is the review and concurrence on the organizational goals and objectives. This is important, because the budget will demonstrate, in financial terms, how these goals and objectives are to be met. Define needed resources (e.g., personnel, equipment, furnishings, training) The next step is defining the needed resources in the budget process. It is necessary to begin with general forecasts in terms of economic trends, purchase prices, sales, and profit. This will provide more realistic estimates for revenues and expenditures. While forecasts may be provided by top management, finance, or marketing, it is generally agreed that the actual budget requests are best developed at the level where implementation takes place. This is usually at the department level or lower. This approach tends to work best because those responsible for implementation can best identify their own needs, and they will be more motivated if they have input into the decisionmaking process. The major categories of resources used in purchasing include personnel, equipment, furnishings, and training. Personnel expenses include salaries and benefits for the existing staff and proposed additions to staff as well as recruiting expenses, such as travel, advertisements, and relocation expenses. Equipment expenses include replacement of computer hardware and software; maintenance of existing equipment including computers, fax machines, and other hardware or software. Furnishings include tables, desks, chairs, and other office furnishings. Training expenses include travel to seminars, seminar expenses, and other training materials, including books, magazines, journals, and CDROMs. C) Estimate the dollar value of resources Clearly, the dollar value of needed resources must be estimated accurately for budgets to be valid. The best starting point for this step is to estimate values by closely analyzing the previous years actual expenditures. This information can then be used to extrapolate resource figures for the new budget year. Develop standard material purchase costs Standard material purchase costs can be developed from historical data and/or from an analysis of supply market conditions for the coming budget period. These costs serve as targets against which to buy for a forthcoming period. 433

B)

D)

Task 407 E)

Module 4 Present the budget/obtain the appropriation This step is handled differently by each organization. It is quite common for a committee to be set up to review and consolidate all budgets and make recommendations, but there are many other approaches. After the budget has been presented and any changes made, appropriations are set to cover the approved expenses during the budgetary period. Variance analysis The final step in the budget process is the control of expenditures during the budgetary year. The budget is the most widely used tool in organizations to provide financial control. This control activity, called variance analysis, occurs through the matching of appropriations and expenditures, and also through tracking expenditure trends against budget estimates. Variances are analyzed and reasons for the deviations from the budget are identified. Corrective actions are then taken, as necessary.

F)

4)

TYPES OF BUDGETS A) Zero-based budgets Zero-based budgeting is a process that does not use past experience to determine future needs. All budget items are fully justified in detail, and are viewed as new requests, as opposed to continuations of current programs. The assumption is that the budget is prepared from scratch, i.e., zero-based. The zero-based budget is helpful in questioning the traditional way things have been done because all programs, including those that have been in effect for years, are justified, prioritized, and subject to scrutiny and approval. In reality, few organizations use a pure zero-based budget. Those that do use the concept generally employ it for selected segments of the operation, and use the traditional historical/extension concept for developing the budget for the rest of the operation. B) Cash-flow budget A cash-flow budget links expenditures and cash requirements during the budgetary period. In other words, funds are made available as expenditures are required. In this type of budget, cash outlays are forecast over periods of time (such as weeks or months). This type of budget is useful when tight cash controls are necessary. Line-item budget A line-item budget is formatted to show individual expenses during the budgetary period without tying those expenses into broad programs or goals. A typical line-item budget would include such categories as salaries, office supplies, travel, equipment, telephone expenses, and postage. Each of these categories contains further detail of what these expenses are. For example, the travel section would show exactly what travel is to be taken and the estimated cost of each trip. Line-item budgets are generally incremental, meaning that, to a large extent, they are based on the previous budget period. Program/project budgets Program budgets are also known as Program Planning Budgeting Systems (PPBS). This type of budget is often used by not-for-profit and governmental entities. Program budgets tie the organizations goals and objectives to 434

C)

D)

Part A: Management and Organization

Task 407

the programs or sections responsible for meeting those objectives. To further the relationship between goals and funds spent, this type of budget normally uses productivity measurements and cost-benefit analysis. Program budgets have the advantage of offering management the ability to evaluate and make decisions on the need for various programs. E) Capital budget This is the budget for buildings, equipment, and other long-term assets that are used for the operation of the organization. The primary purpose of capital expenditures budgeting is to provide a formal summary of future plans for acquiring facilities and/or equipment. This area of budgeting is particularly critical because of the magnitude of funds involved and the length of time required for capital recovery. In addition, the capital expenditures budget can be used as a basis from which purchasing can determine the best possible source for a given addition. Capital expenditures budgeting involves both short- and long-range expenditures. Shortrange expenditures must be included in a budget for the current year, and must be evaluated in terms of their economic worth. Long-range expenditures will not usually be implemented during the current budget period; hence, their inclusion in the budget can be in somewhat general terms. F) Flexible budgets Flexible budgets are those that change depending on changing conditions, such as an increase or decrease in output. One type of flexible budget is known as the variable budget, which is a set of budgets that account for different conditions. Often, flexible budgets have a formula that is used to determine the needed budget amount based on the output. The obvious advantage of flexible budgets is that they allow a quick response to changing conditions. Purchasing price variance Purchasing price variance (PPV) is the difference between the standard price and the actual price paid during a budget period (see also Task 104). Open-to-buy budget The open-to-buy (OTB) budget, often used in the retail sector, is similar to a cash flow budget. Open-to-buy budgets link cash requirements and expenditures during a budgeting period with funds availability during the budgeting period. In retail, marketing strategies are often divided into separate programs that are measured by return on investment. The open-to-buy budget allocates funds based on the planned investment by budgeting period. Those funds are then used for inventory replenishment. When a requisitioner makes a request to buy, it may be limited by the availability of funds for that program and budgeting period. Limited funds may also affect the purchasers ability to obtain volume discounts.

G) H)

BIBLIOGRAPHY Budget in the Right Stuff, Purchasing Today , February 1999, p. 12. Yates, R.A. Open to Buy: Managing Cash and Inventories, Purchasing Today , July 1998, p. 42.

435

TASK 408: Design, modify, and/or manage operational forms (paper and/or electronic).
Much of the activity performed by purchasing is documented using a variety of forms, such as requisitions, purchase orders, requests for proposals, contracts, and material returns. The purchaser needs to ensure that the forms contain the proper information, that the relevant forms are used, and that the information can be achieved quickly and accurately. 1) REASONS FOR FORMS A) B) C) Communication The communication of information is the primary reason that forms are used. This includes information in the form of words and data. Operational control Operational control is another important reason for using forms. Forms are used for such things as controlling transactions, funds, and schedules. Records Another reason for using forms is to create a record of activities. These records are needed to research information, prove that actions occurred, and to provide audit trails. Consistency of approach Forms allow tasks to be accomplished in a consistent way. This is useful for a number of reasons. First, forms ensure that all pertinent information is included. Second, forms allow for greater efficiency (when compared to preparing needed information from scratch) because the same sequence and placement of information takes place each time the form is used. Third, the individuals receiving or reviewing forms are able to glean information more easily than if it was transmitted in many different formats and styles. Legal requirements The information on forms may need to be retained for legal reasons, such as federal and state tax requirements, and for other government agencies. The requirements will change depending on the agency involved. Purchasing decisions, correspondence with suppliers, and other data generated by the purchasing process may also be required for legal reasons.

D)

E)

2)

TYPES OF FORMS AND COMMUNICATION FORMATS USED BY PURCHASING A) Purchase requisition The purchase requisition is most commonly used to request that purchasing buy certain items. Departments forward this form to purchasing, indicating the goods or services needed, where and when they want the goods or services delivered, and who will pay for the goods or services. Depending on the organization, approval authority information is also a part of the purchase requisition form. Simply put, this is the form that authorizes purchasing to purchase the goods or services. The form can be paper or electronic.

437

Task 408 B)

Module 4 Traveling requisition Traveling requisitions are basically the same as purchase requisitions except they are used for repetitive purchases. The same form is used for many buys. This form is often on card stock (or electronic), with information that does not change (such as the description of the item to be purchased and accounting information). This form provides requisitioners with the advantage of reducing preparation time, because they normally only have to enter the items that do change (e.g., quantity). Other advantages of this form include less preparation time and a history of previous purchases for the item available on the form. While many items are adapted to the use of traveling requisitions, they are commonly used for items , such as storeroom materials. With the increased computerization of the requisition process, traveling requisitions are seldom used. Bill of materials The bill of materials is another form that can be used as a purchase requisition. It is developed initially by the design engineer for use in manufacturing and production planning. The bill of materials lists all of the parts needed to manufacture a particular product. Purchasing is then informed of the total amount of the product to be produced, and determines how many of each of the individual parts to buy. A second application of the bill of materials is for projects. The purchaser is given a list of materials and services needed for a project and instructed to purchase from the list, as needed, for the project.

C)

D)

Purchase order/contract Purchase orders are written contractual documents prepared by the purchaser to describe all terms and conditions of a purchase. For this reason, the PO is a very important form for purchasing. Common elements of information on most purchase orders include: the supplier, price, quantity, product description, shipping and billing information, delivery date(s), payment terms, terms and conditions, and date of order. Receiving documents Receiving documents (also known as receivers or receiving reports) are used to indicate that a shipment of goods has arrived. They serve the purpose of notifying departments such as purchasing, production control, inspection, and accounts payable of the shipment. They also let the appropriate individuals know when there is a problem with the shipment. Often, the receiving document is one of the designated copies of the purchase order, or part of an electronic system. Inspection documents Inspection documents differ from receiving documents in that they are used to record whether the goods conform to the organizations requirements. These forms typically specify the type of inspection used (e.g., 100 percent inspection) and the results of that inspection (e.g., 20 percent defective). There is no centralized inspection activity in many non-manufacturing organizations, and inspection becomes the responsibility of the receiving organization. In such cases, the receiving report and the inspection document are the same.

E)

F)

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Part A: Management and Organization G)

Task 408

Change orders Change orders are forms used to modify or cancel purchase orders or contracts that have been issued. Some organizations use special change order forms, while others use their standard purchase order form with Change Order printed or stamped on it. Because the purchase order is the written evidence of a contract, it is appropriate that all changes to the purchase order also be in writing. Material return form This form is used to notify suppliers and in-house departments, such as purchasing and inventory control, that goods must be returned. The reasons for returning these items may include overshipments, rejections, or damaged goods. Nonconformance form This form is used to document why material is unacceptable to the purchasing organization. This information is used for communication between the buyer and the supplier. Statement of work A statement of work (SOW) is used in the purchase of services to define exactly what work is being contracted (see Task 106). Check request form This form is used to request accounts payable to issue a check to a specified party. Evaluation forms (e.g., supplier evaluation) Supplier evaluation forms are used for recording the relevant information regarding a suppliers performance (see Task 112, Exhibit 1, for a sample supplier evaluation form). Capital equipment justification form The capital equipment justification form usually requires the following information: Project description. Projected project expenditures. Projected benefits. Discounted cash flow analysis of projected expenditures and benefits.

H)

I)

J) K) L)

M)

N)

Other Other forms include nondisclosure agreements, bid analysis, requests for quotation, and shipping logs.

3)

ELEMENTS OF FORM DESIGN/MANAGEMENT The proper design of forms must consider the media in which the form is stored, how the information is organized, and the equipment that will be used to store and access the form. Todays rapidly changing technology may result in the need to maintain technologically obsolete systems to access old information, or require the archiving of old information using the latest technology. A) Available media Available media for forms include many possibilities, ranging from standard paper, to punch cards, to electronic forms. The appropriate media

439

Task 408

Module 4 depend on such factors as the use of the form, its cost, its ultimate disposition, and the image the organization wishes to project.

B)

Organization of information The way information is organized on a form is extremely important to its successful use. One of the key elements to consider is that the information should be kept to the necessary minimum. Superfluous information detracts from finding needed information. Make it easy for the user to enter information on the form. This is most often accomplished with check marks next to appropriate responses, as opposed to a fill in the blanks format. Keep the information in a sequence that makes sense. There is usually a logical order of information and this should be followed on the form. Instructions If at all possible, instructions for the use of a form should be on the form itself; otherwise, they should be with the form. The instructions need to be concise and clear. Forms control Forms control is important in any organization. In larger organizations, this function is often centralized. In smaller organizations, it is often performed by each department for that particular departments forms. Forms control involves the key elements of design, user determination, standardization, and appropriate stock levels. An important element of form control is the periodic review of all forms, to ensure uniformity and to reduce the risk of obsolescence. Retention periods Standard questions to ask to determine how long to retain forms include: How long will the information be needed? What are the legally required periods, if any, for retaining the information on the forms? What is the cost of storage?

C)

D)

E)

Often, retention periods are determined as a result of compromises between cost, convenience, and need (see also Task 120). F) Privacy Act/public information implications The Privacy Act places restrictions on access to some types of information. It is important to understand this when designing forms and systems. In governmental purchasing, most (if not all) purchasing forms are a matter of public record and are subject to public view. Legal advice is often necessary when dealing with Privacy Act/public information implications of forms. Cost implications The amount of money required to print forms is only a fraction of the total cost of the form. There are many other cost areas related to forms. One of these is the time needed to fill out the form. There are costs due to storage and time needed to distribute the form (including copies). Another cost relates to the speed of information access, particularly if the form is poorly designed. There are also costs

G)

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resulting from errors in design or form completion. These errors and resulting costs can be substantial if the organization does not take the creation and use of this important communication tool seriously. H) Printed vs. electronic generated There can be a large difference in the cost of operating a group that is supported electronically rather than one using a traditional paper-based approach to forms. A key difference is the time and effort involved in accessing a file and sending the information to those who need it. Electronic information can be retrieved for sorting and analysis more efficiently than in paper-based systems. Compatibility with equipment The form should be designed with appropriate spaces and size, consistent with the equipment with which it will be used. If the form will be filled out by hand, the spaces for the user to respond must give adequate room for handwritten answers. If a typewriter is to be used, the line spacing must reflect normal typewriter line spacing. If it is used with a printer, it may need to have edges for tractor feed. Periodic review All forms should be reviewed at least annually to verify the information requirements are current, the form is still relevant, and the form is easy to understand. Computer generated forms Probably the most commonly used computer generated form in purchasing is the purchase order. A purchase order data file can be used to efficiently process purchase orders, and to provide numerous reporting and status activities. Almost any form can lend itself to computer applications. Many computergenerated forms are used in a paperless system, where the form itself is only viewed and used on a computer monitor. Advanced shipping notice This is a document that is either faxed, sent by EDI, or emailed from a supplier confirming the correct shipping of specific items and their quantities. This gives advance confirmation and planning abilities to production personnel. Other While the above-described forms are those most commonly used in purchasing, there are other forms as well. These include forms used for bid analysis, requests for quotation, price records, supplier ratings, tracer requests, surplus equipment forms, and quality performance records.

I)

J)

K)

L)

M)

BIBLIOGRAPHY Baker, R., J.L. Buddress, and R.S. Kuehne. Purchasing and Materials Control, 2nd ed., Prentice-Hall, Englewood Cliffs, NJ, 1992.

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TASK 409: Supervise and lead purchasing/supply staff.

1) ISSUES IN ORGANIZATIONAL MANAGEMENT AND ADMINISTRATION A) Delegation of authority and responsibility In principle, delegation involves the assignment of tasks, the granting of authority to make commitments to perform these tasks, and holding people responsible for the final results. Ideally, these three elements should increase and decrease together. Any change in one should be accompanied by a corresponding change in the other. Effective management of an organization not only requires a recognition of this principle, but also a recognition of the degree to which it should be practiced (i.e., the degree to which management should delegate tasks and the authority to perform them). Delegation involves the following phases: The assignment of tasks In every enterprise employing two or more people, there is a division of labor, or a grouping of activities. In order to translate the division or grouping of labor into jobs for people, there must be specific job assignments. Employees not only need to be told what task they are to perform, but also the goals to which these tasks are to contribute. This is the initial phase of delegation. The granting of authority It is pointless to assign employees a task, such as purchasing production materials, without also giving them authority to obligate the organization to pay for them. By the same token, the person with the task of supervising must have authority to direct the activities of subordinates to requisition supplies, and to determine how the equipment entrusted to the department will be used. The presence of responsibility The third phase of delegation is implicit in the preceding two. When tasks are assigned and authority to discharge them given, the recipients are not free to comply with them or ignore them at their choice. They have a corporate responsibility to fulfill their assignments to the best of their abilities. In like manner, the executive who assigns duties and grants authority to subordinates is still ultimately responsible for their proper fulfillment. 1.0 Responsibility has both immediate and ultimate connotations Subordinates have an immediate responsibility for the performance of their assignments. Those who delegate assignments have the ultimate responsibility to see that subordinates perform them in accordance with the operating standards and objectives of the organization. Although ultimate responsibility cannot be delegated, immediate responsibility is present in every act of delegation. Parity of authority and responsibility The nature of responsibility makes it imperative that managers who delegate match the responsibility they have conferred on subordinates with equal authority. This

2.0

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Module 4 concept is called the parity of authority and responsibility. While the principle of equal authority and responsibility does not directly affect the arrangement of operating groups within an organization, it does influence the degree of delegation, which in turn influences the way activities are grouped and the need for staff. There can be little delegation of authority by managers who believe their subordinates are incapable of assuming responsibility. Because individuals can be held strictly responsible only for actions over which they have control, the willingness to accept responsibility at least sets the outside limits on the authority that can be entrusted to them. This balance between authority and responsibility is especially important for persons responsible for negotiation and for making decisions regarding warranties, leadtime, order splitting, credit terms, or exceptions to policy. The director or manager of a purchasing department may be willing for buyers to make some decisions, but not others. Confusion often develops as a result of the responsibilities implied by a positions title, such as senior buyer, and managements intention that certain buying decisions be made by a manager rather than a senior buyer. An effective solution for this problem is good communication, which can be facilitated through a clear chain of command.

B)

Chain of command The responsibility of a subordinate to a superior, whether it is between a senior purchaser and a manager, or assistant purchaser and a purchaser, is essentially a personal relationship. Responsibility not only carries with it an obligation to accomplish desired results, but also to account to a superior for the degree of success achieved in the pursuit of these results. It follows that manager-purchaser, purchaser-assistant purchaser, or purchaser-expediter relationships can be more clear, and communication can be more direct, if the structure of the purchasing department is designed so that each subordinate has only one superior to whom he or she is responsible. This one-on-one, superior-subordinate relationship reveals the structure of delegation, and is most evident in the traditional line and staff form of organization. Span of control/span of information dissemination The number of people a manager supervises is called span of control. For example, if a purchasing department has 25 buyers, all of whom report directly to the department manager or director, the executive has a span of control of 25. There are no formal criteria by which a reasonable span of supervision or control can be easily determined. How many persons one manager should supervise is largely a matter of individual capacity. Things such as the complexity of the supervisory situation, the demands on the manager, and the capabilities of subordinates are important factors to consider.

C)

D)

Line and staff relationships When events such as a departmental reorganization, the addition of new positions or job titles, or a change in a departments mission occur, it is important to be able to distinguish line from staff positions. The most 444

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basic distinction is that line personnel are directly involved in the production of goods and services. They have the prerogative of deciding what should be done and issuing appropriate instructions down the chain of command. Line managers act on their own authority, within whatever limitations are imposed upon them by their own immediate superiors. The function of staff, by contrast, is advisory in nature. There is no connotation of authority beyond that which one member of a staff may have with respect to another member of the same staff. Staff officers support the line, and perform such tasks as purchasing, advising about matters of human resources, or providing financial analysis. The recommendation of a staff member goes to the line managers for whom they work, who can accept or reject the recommendations. Staff personnel have expertise in their area, and should endeavor to analyze situations to provide the best possible advice to the line. 1.0 Flat organizations A flat organization is a term that indicates that one supervisor has a large number of people reporting to him or her. In organizational structures, this means fewer middle management personnel.

E)

Management by objectives (MBO) MBO is often misused, leading to a results-atall-costs mentality, increased competition within the organization, and pushing workers to accept inappropriate goals. If properly implemented, MBO can: Produce specific, realistic objectives toward which each individual works. This typically results in more effective job performance and more extensive professional development for each individual. Allow all individuals to become involved in the establishment of their objectives. When properly done, this results in the development of more meaningful objectives for each individual, and produces a stronger commitment by the individual to attempt to achieve the objectives.

The basic steps to conduct an MBO program as the basis for performance planning and evaluation activities are: Definition of responsibilities and preparation of the job description Each individual should review, modify, and update his or her own job description. After the initial effort, this procedure typically involves give and take discussions with the supervisor, until a mutually acceptable description is achieved. Establishment of individual objectives After the job description is agreed upon, the individual is asked to plan how he or she will accomplish the results necessary to fulfill the job responsibilities. This requires the establishment of specific objectives within a specific time schedule. The planning period typically runs for six months or for one year. Agreement on objectives The individual then discusses the tentative plan with the supervisor. During the discussions, the role of the supervisor should 445

Task 409

Module 4 be that of questioner, developer, and counselor. During the entire process, it is important that the individual takes ownership for the resulting objectives, and concurrently comes to complete agreement with the supervisor about the objectives established. Establishment of evaluation criteria The individual and supervisor must jointly determine in precise, quantifiable terms exactly what checkpoints and criteria will be used in evaluating progress toward achievement of the objectives. Typical criteria include project due dates and formats, cost/profit figures, and comparison of performance with historical trends or other performance levels within the organization. Comparison of performance with the plan Worker and supervisor jointly review the performance and compare it with the plan (or standard). Performance must be evaluated as objectively as possible in light of objectives and expectations established in the planning process. From the results of this planning and evaluative process, subsequent plans can be developed to move toward further achievements, in terms of both departmental and individual progress.

Problems with the use of MBO: Organizations must meet certain targets MBO goals are supposed to be presented to the worker in a way that can be accepted or rejected. Workers rapidly discover that there is less give in the system. If they disagree with a goal, the manager quickly tells the worker why the worker must still strive to achieve the goal. In most situations, participative goal setting becomes topdown, and the entire process loses credibility. Evaluative criteria are to be clear, specific, and quantitative This does not take into account the changing nature of jobs, where goals might shift dramatically, as well as the knowledge that effective performance management requires the evaluation of behaviors. Goal setting theory suggests that highest productivity occurs when challenging goals are set Workers prefer to not set challenging goals because they are harder to achieve. Because MBO rewards workers only when they achieve their goals, workers may attempt to negotiate simple goals that do not motivate them to achieve the highest levels of performance.

For these reasons, MBO, although widely used, can cause significant inefficiencies in organizations. Its lack of flexibility, along with the command and control nature of its application, suggest that it should not be used except by those who can truly ensure that it will meet the organizations goals. F) Continuous improvement This Kaizen approach to management means constantly seeking and implementing methods and processes that lower cost, enhance service response, and contribute to overall profit. The concepts of total quality management (see also Task 207), Just-In-Time (see also Task 304), and reengineering (see also Task 403) focus on finding ways to reduce non-value-added activities in processes. 446

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Rightsizing/workload Rightsizing the purchasing department is the process of shaping and controlling its growth to improve its effectiveness and efficiency. In order to do this, purchasers must show the benefits of the department in order to help prevent unjustified cuts. The key is making the purchasing service tangible and evident by reporting cost savings and value creation. Identification of low-priority or low-value work allows consolidation of resources, and puts the focus on higher-leveraged activity. Speed and simplicity are pivotal elements. Rightsizing does not always involve moving work out of the organization. It simplifies the process and reduces the length of time to perform a function, thereby reducing its cost. 1.0 Outsourcing of purchasing One of the consequences of rightsizing the purchasing workload has been outsourcing. This means having suppliers acquire items previously purchased by the organization (for example, use of integrated suppliers) or using outside purchasing organizations such as cooperatives or consortia (see also Task 301). Staff productivity By identifying and eliminating low-priority or lowvalue work in the purchasing department, the productivity of the purchasing staff will increase. Purchasing will be able to spend more time in value-added activities, such as product development, early supplier involvement, and supplier development.

2.0

H)

Process reengineering Process reengineering is the rethinking and radical redesign of processes to create dramatic improvements in performance. By focusing on processes that cross functional boundaries, potential improvements resulting from the interactions between functions can be identified and unnecessary activities eliminated. Quality improvement Quality is the responsibility of everyone in the organization. Many organizations have created cross-functional groups for improving quality using input from the various job areas of the persons represented on the team (see also Task 207). Diversity in the workplace Todays workforce represents a diverse set of people, groups, cultures, beliefs, and experiences. This creates a number of issues for the manager to deal with, such as cross-cultural communication, differences in expectations, and varying work ethics. The successful manager must learn how to leverage these differences to benefit the organization. Incentive programs Incentive programs are designed to share the benefits of cost reduction and other financial improvements with those who help bring them about. However, improperly designed programs can lead to counterproductive behavior. Matrix organizations For organizations that work on a project basis, the matrix organization overlays a project manager across the normal functional areas of the organization. A member of the project team reports to both a functional manager and a project manager. The benefits of this structure include: 447

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Module 4 The functional departments provide the technical expertise and physical resources needed. The presence of workers in their functional areas allows them to keep upto-date in their area as well as increases the chances for cross-fertilization of ideas. When the project is finished, the workers are reassigned to new projects, reducing hiring and firing costs.

The project (or matrix) managers responsibility is to integrate the resources available by working with the functional managers. The main drawback of this organizational style is the potential conflict created when a worker has two bosses. 2) THEORIES OF MANAGEMENT Over the years a number of theories of how to manage and motivate employees have been proposed. No one theory seems to be universally applicable. Each approach has its strengths and weaknesses. The purpose of this section is to review some of the more common theories so that the purchasing manager can adopt and adapt the relevant principles. A) Universal theories These theories are based on the premise that managerial skills are transferable to any organization. Thus an excellent manager can be put in charge of a department in any organization, no matter what technology is involved. The theory developed by Henri Fayol is based on the following propositions: B) Management is universal; all managers perform the same basic functions. A set of flexible and adaptable principles exist that all managers can follow. The functions of management are planning, organizing, commanding, coordinating, and control.

Operational theories In studying the elements of work and job design in factories and foundries, Fredrick Taylor observed that the output of individual workers increased as a job was made more specialized. Removal of the elements of planning and control, as well as some peripheral operational elements, permitted the individual to become more proficient at the core job activities and to become more productive. Subsequently, the concepts of functional job specialization and detailed job supervision became well accepted as a basic management technique. The problem with these theories lies in the fact that they have been applied to all jobs manufacturing, service, and knowledge jobs taking most decisionmaking away from workers. Behavioral theories Behaviorists believed that people and relationships should be the focus of management theory. The focus of these theories was meeting the social needs of the worker as a means of increasing productivity. Optimal productivity was obtained by having the right balance of working conditions combined with the right motivational influences.

C)

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Systems theories Perhaps the simplest way to analyze an organization is to view it as a system of related, interlocking parts. Typically, systems theory views the organization as a unitary whole. Each subsystem is separated from the others by what is known as a semi-permeable boundary, through which certain energy can flow in selected situations. The organizational system exists within an environmental supra-system, also separated from the organization by a semi-permeable boundary. The organization is typically thought of as being composed of the following subsystems: Psychosocial This identifies the people, and the groups to which they belong. Psychosocial includes skills and abilities, individual backgrounds, motivation, team processes, and reward systems. All team and individual aspects of organizational culture are part of the psychosocial subsystem. Structural This identifies such things as reporting relationships, power systems, and organizational control. The structural system describes most formal policies and procedures in the company. Technical (technological) How are organizational tasks accomplished? The technical subsystem is immense. It encompasses both machinery and individual and organization skills. Goals and Values Goals and values help identify what is important to the organization. Goals suggest the organizations future targets, while values identify the underlying premises that guides all member actions. Leadership This is the key. Organizational leaders tie all the subsystems together.

Systems theory simply provides the analytical tools that contingency theory uses. E) Contingency theories Contingency theory uses systems theory to make prescriptive statements about what the organization should do. In other words, contingency theory tells managers that if they analyze their situation well, then they are in a position to determine what their actions should be. Contingency theory helps managers look at one organization subsystem and describe what to do elsewhere. The following might be one set of contingency statements: If the technology is complex, then workers (psychosocial subsystem) must be highly skilled. If workers are highly skilled, they will demand some control (structural subsystem) over their activities. If the organizations structure allows worker decisionmaking, then its leaders must learn to move from a command-and-control style, to a counsel-andcoach style.

The effective manager will first understand how to analyze all aspects of the organization, using systems theory, and then apply that knowledge with contingency theory. While the ineffective manager might be seen as wishy-washy, the effective manager, when stating it all depends, will understand the relationship between the appropriate variables. 449

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Module 4 Styles The views managers hold about how employees can be motivated, and about people in general, heavily influence the management styles they develop and practice. An individuals management style can be either subordinate (employee) centered or supervisor (production) oriented. Few managers use a style that focuses completely on one orientation or the other. In daily operations, most managers employ a mix of the two orientations, depending upon their beliefs concerning the nature and motivation of their subordinates. Additionally, as the type of job and situational environment change, a perceptive manager will vary the management mix to suit the circumstances. 1.0 Subordinate-centered McGregors Theory Y is a subordinate-centered management style. Theory Y assumes that: Work is a natural activity. Most people tend to accept and to seek responsibility. Creativity and imagination are possessed by most workers, but are not fully used. Workers normally take pride in what they do and consequently want to do a good job.

Managers who follow a subordinate-centered management style tend to have a more participative management style that involves employees in planning, problemsolving, and change implementation. They allow workers to do their jobs with a minimum of supervision, permit intelligent mistakes in the name of creativity, and generally allow workers greater freedom to help the organization achieve its goals. 2.0 Supervisor-centered A supervisor-centered style would be more consistent with McGregors Theory X. A Theory X manager believes that employees are lazy, uncreative, undisciplined, and generally not interested in doing a good job. This type of manager takes a command-and-control approach to management, often micromanaging workers. Self-directed workgroup The typical self-managed work group should consist of a group of workers who perform roles and make decisions traditionally reserved for management. They can consist of a group of people from the same department or, more typically, be cross-functionally represented. The self-directed work group is set apart from traditional teaming efforts because of its independent management style and longevity. Most are formal, functionoriented, and permanent. Self-directed work groups set work schedules, deal directly with external customers, hire and fire group members, set budgets, conduct performance appraisals, deal with suppliers, set organizational training requirements, purchase equipment or services, participate in product design, and much more.

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No magic formula exists for self-directed work groups, but there are two critical ingredients: having unqualified support from top management, and supporting the needs of the internal customer. Unqualified management support is the most important factor in the success of self-directed groups. Self-directed groups require management to step back not an easy task the first time around. The second consideration deals with the internal customers requirements. Territorial limits and traditions often prevent the best possible service to the internal customer. Self-directed groups should be designed in whatever way best serves the customer, traditions not withstanding. G) Empowerment Empowerment has many definitions. However, most organizations accept that empowerment works to build people so they will develop and act, often without supervision, to jointly contribute to the organization and themselves. Empowerment includes being empowered (creating power for oneself), giving empowerment (helping others grow toward a state of empowerment), and an empowering environment (giving power to other groups for organizational benefit). For empowerment to work, there must be a vision of where the organization needs to go and a strategy for getting it there. Managers need to delegate more (i.e., lead rather than manage) and employees must have more say in daily and future work. Implementing empowerment requires serious background work; preparation of all people involved; careful training; and the development of interpersonal skills, incentives, resources, and action plans.

3)

TOPICS IN GROUP DYNAMICS The human character is essentially social, and the workplace is no exception. Virtually no work in the modern organization is done in isolation. At some point assistance and cooperation from others is required for task completion. The use of groups for decisionmaking is time-consuming. All individuals need an opportunity to share ideas and express their feelings. The advantage of groups is that additional ideas and expertise are available for decisionmaking. In the purchasing department, some purchasing teams are comprised solely of purchasing department staff, while some may include personnel from other parts of the organization, and even suppliers. A) Formal work groups Formal work groups refer to the managers relationship with individuals as members of a formal group (i.e., the department or functional sections within the department, task forces, and committees). Informal work groups Within every formal organization, experience demonstrates the existence of one or more informal groups. Typically, these groups are fairly small and structured around specific interest patterns of the members. They may be social groups, special-interest groups, or sometimes pressure groups pushing for change. Whatever the case, such informal groups are an integral part of the organization, and their attitudes and actions can either assist or hinder the attainment of objectives.

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Module 4 An effective manager uses the potential influence of informal groups in a constructive manner. To do this, the manager must first recognize the existence of such groups and identify the informal group leaders. Then, by practicing the concepts of open communication and group involvement in the decisionmaking process, the manager attempts to align the objectives of the informal group with the objectives of the department. This represents an extension of the participative management strategy employed in dealing with individuals and formal work groups within the department/organization. Specific approaches that can be used include: Solicit appropriate input on decisions that affect individuals and the informal group using various individual, committee, and brainstorming techniques. Use this input to arrive at genuinely group-oriented decisions whenever possible. Create and develop a work climate and a reward system that encourages teamwork and cooperation. Attempt to develop the degree of informal group cohesiveness that produces a positive influence on the activities of the formal work group.

The managers goal in using this integrative approach is to promote cooperation of the various groups, formal and informal, in daily activities that contribute to attaining the departments overall objectives. C) Group characteristics Characteristics that define a group include group size, diversity, experience, education, age, and group longevity. There is little evidence that these factors affect the groups output, but they do have some effect on coordination and communication within the group. Characteristics of a good group include: D) The ability to focus on the mission. The recognition and admission of its strengths and weaknesses. The ability to place the teams agenda first and to integrate a personal agenda into the teams agenda. The ability to define, simplify, and solve problems using facts and logic, without involving personal conflicts. Commitment and enthusiasm. The ability to experience and express pleasure in others' success. The ability to accept praise with grace.

Advantages/disadvantages A number of organizational benefits can result from the successful use of groups, such as: The ability to bring greater knowledge and skill together. Creating a group whose members have heterogeneous skills, backgrounds, and experiences increases the probability that each member can contribute the knowledge and skill required to support team assignments. 452

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Unique contributions by individual members, in turn, increase the likelihood that a group will benefit from dynamic, cross-functional interaction. Reduction in the time required to solve a problem or complete an assigned task. Limitations of groups include: E) They often do not have the power or authority to make major decisions. The group has little insight into its performance over time. Managers outside the group attempt to control activities or influence decisions. Meetings may be dominated by one individual.

Group leadership Group leaders are individuals who set direction, align people and resources, motivate, and inspire. They enable others to work together to achieve the groups vision. The effective group leader: Facilitates the groups analysis and decisionmaking processes. Is skilled at encouraging member participation, conflict resolution, and consensus building. Is able to work with little, no, or unclear authority. Is willing to adapt as requirements and working conditions change. Works with the group to establish goals.

BIBLIOGRAPHY Dozbaba, M.S. Taking the Lead in Leadership Development, Purchasing Today , February 2000, pp. 46-56. Monczka, R.M. and R.J. Trent. Cross-Functional Sourcing Team Effectiveness, Center for Advanced Purchasing Studies, Tempe, AZ, 1993. Parker, G.M. How to Succeed as a Cross-Functional Team, Proceedings of the 1997 NAPM International Purchasing Conference, NAPM, Tempe, AZ, 1994. Ray, D.W. Teaming: Bringing It All Together, NAPM Insights, March 1993, pp. 33-35.

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TASK 410: Hire, promote, and/or dismiss purchasing/supply personnel.

1) ISSUES IN SELECTION AND RECRUITMENT Every purchasing department strives to hire and develop ambitious, promotable personnel to build a creative organization. When a persons job no longer offers a challenge, the individual may become discontented and leave the organization or perform less effectively. Turnover can cost many thousands of dollars in direct and hidden costs for each hire. For these reasons, it is essential that personnel be selected with care. During the hiring process, most managers attempt to match an individuals qualifications to current and anticipated job requirements of the department. It is much easier and less costly to address such issues before hiring has occurred. A properly trained purchaser is invaluable; a poor one can be a major liability. Recruitment Recruitment answers the simple question: Where will the organization find qualified individuals to perform the job? The task is to match who will apply with who will do well. The organization will need to be as specific as possible in all recruiting. Before the process begins, work with the human resource management department to determine the appropriate recruiting strategy for the job. Typically, entry-level jobs have many applicants, so the manager will want to minimize the number of people who actually apply. Selectivity is the key. For more technical jobs, with few applicants, casting as wide a net as possible is necessary. The relevant job market (labor pool) identifies the area from which the organization should recruit. More technical or managerial type jobs will have a regional, national, or international pool, while lower level workers might have a smaller pool, typically in the local metropolitan area. Position requirements Determining what is to be done by an individual is the first step in the selection/recruitment process. This begins with a review of goals and a determination of how the expenditure of funds in human resources can help achieve those objectives. Next, a functional analysis can begin to identify the value-added activities and skills required. It is important to focus on the nature and scope of activities rather than on a title for a position. Basically, the position could fall into one of five categories: management, buying, specialized staff, administration, or training. Generally, the more strategic in nature the position is, the broader the required skills base. These skills relate in great part to the breadth of the organization, its size, the dollars committed by the function, and the ability to affect cost and/or profit. Job analysis is the process of collecting job-related information. It is the cornerstone of all human resource management processes. Job-related data allows the organization to make hiring decisions, determine types of training employees should receive, identify performance-related successes and problems, and make compensation decisions. The job analysis is composed of the job description, job specifications, and job evaluation.

A)

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Module 4 Job description This is composed of all job-related items, and is usually written by stating the essential functions of a job. This should be written by direct examination of the job itself. The following are typically part of the job description: - Job title - Position summary statement - List of essential functions - Identify title of each function - Prioritize each function - State the percentage of time the worker spends in each function - List specific behaviors for each function - Reporting relationships - Other working relationships - Size of budget or impact of job - Tools and technology - Normal working conditions Job specifications This is a listing of all items related to the successful performance of the job. Job specifications should be written by identifying what is necessary for a person to successfully accomplish the tasks identified in the job description. The following are typically part of the job specification. - Knowledge, skills, abilities required to perform the task These are commonly referred to as KSAOs (knowledge, skills, abilities, others) or, more generally, KSAs. - Education requirements Where might the typical individual learn the knowledge identified above? Education requirements should usually be listed at the minimum level, so as to not preclude those experienced people with a minimal education from being considered for the job. - Experience requirements Where might the typical individual develop the skills and abilities identified above? Again, the absolute minimum should be listed, in this case to ensure that people with higher levels of education are not automatically eliminated. Experience requirements should be specific. What skills should the person possess? What tasks should the person have accomplished? Experience requirements should never focus merely on time in position. - Certifications Certification is an added criterion of professionalism where an outside agency, such as ISM, indicates that the individual has passed minimum standards. Certification standards are typically related to broadbased KSAs, Certification states that the purchasing professional has met certain standards recognized by senior-level individuals within the profession, and has the tools to do a good job.

B)

Knowledge, skills, and aptitudes of applicants Following a description of the position and its requirements, a determination of the skill and knowledge base required must be made. This can occur through a formal or informal job analysis. This analysis should 456

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determine from the position description the specific qualifications, skills, background, experience, and personal qualifications necessary to perform the required work satisfactorily. Ordinarily, position descriptions, requirements, skills, and knowledge required are summarized in a job description. Generally, the characteristics of purchasers will include product knowledge, principles of supply management, analytical ability, computer-based skills, negotiation skills, interpersonal skills, customer focus, and the ability to deal with and manage change. As the position leans more toward the managerial environment, the greater will be the need for general, more strategic skills, backed by proven, resultsbased experience. Many employers will require potential employees to take one or more tests to determine knowledge and skill levels for the position for which they are being considered. For each type of test listed below, the burden is on the employer to ensure that the test is job related. Tests that are used because it sounds good are likely to waste money, lead to poor hiring decisions, and may cause legal problems. Managers should identify the validity of all tests they use. Skills testing helps identify basic abilities. In purchasing, a negotiations simulation might be developed to identify this ability. Evaluating the results of this type of test might be difficult. Aptitude testing helps determine the applicants knowledge base. These are typically paper-and-pencil tests, asking what an individual knows. These tests typically do not determine if the candidate can apply the knowledge. Personality/intelligence testing may have some broad-based uses, but rarely is job related. Most studies indicate that personality and intelligence are rarely good indicators of job performance. Physical tests/physical exam For most purchasing jobs, these tests will have little relevance. If the test is job related, it must be given to everyone (the Americans with Disabilities Act requires this). If the test is for insurance purposes, it should be given after the employment offer is made. Other tests (drug, honesty, etc.) These and similar tests have all been used in recent years. The job of the employer is to identify the results (both positive and negative) of giving these tests. Many applicants claim that they will not work for organizations that use certain kinds of tests.

C)

References, experience, and training Employers should attempt to get prior performance information on the final slate of candidate(s). Managers should always verify all information given, such as job title, salary, dates of employment, degree, and certifications. Because of the proliferation of forgery, universities and certifying institutes should be contacted for information. Performance-related references: Verify information from immediate past supervisors. Ask for performance appraisal documentation. Expect to receive only basic information. Some ways of resolving this include: 457

Task 410

Module 4 - Ask candidates to describe what their supervisors would state (candidates are often quite revealing). - Place the burden on the candidate. Tell the candidate that you cannot hire without a specific reference from a past or current supervisor. Based on libel and slander laws, individuals and companies have been sued for giving incorrect reference information. This prevents employers from collecting information they need to make a good hiring decision. - Some state laws protect reference checks if made in good faith, and if verifiable facts are used. - Never ask for opinions (e.g., Would you rehire?).

D)

Questions in the interview process The candidate pool for a position can be narrowed by the interview process. Review of a potential candidates qualifications should focus on the combination of skills, experience, background, and personal traits that will best serve the organization. The process of interviewing should not be taken lightly, for it is here that information on paper from an application or resume comes to life. This is important, for once hired, considerable resources will be invested in the individual. Poor performance, combined with rehiring costs, can be expensive in both dollars and impact on customer service. Although proper preparation and interview skills are essential, they are often underrated. The interview is the most used selection technique, but perhaps the most incorrectly used. Managers often believe that they can identify such items as character, motivation, personality, and organization fit. Unfortunately, without training, this technique is rarely as successful as it could be. Interview types - Screening interview This first interview chooses those candidates who should receive a final interview by the hiring manager or search team. A final interview should not occur until the search team is assured that the candidate has the minimum qualifications for the job. The first interview is typically done by the human resource department. - Final interview The search team or hiring manager will focus on detailed specifics of the job, as well as questions related to whether the candidate will work well with other members of the purchasing team. The Structured Interview The purpose of the structured interview is to eliminate bias and increase validity. This type of interview uses similar questions for all candidates (follow-up questions are usually permitted), thereby helping everyone collect similar information. This type of interview also helps everyone to focus on this particular job, ignoring other externalities. Steps involved in conducting this interview include: - Develop hiring criteria from the job description. - Identify the job-related information that must be collected. - Develop questions that are connected to the hiring criteria. - Identify potential answers (good, bad, and neutral) for all questions. 458

Part B: Human Resources Management Develop a scoring sheet for each type of answer. Train interviewers in listening skills. Train interviewers to give the candidates an opportunity to speak. Train interviewers in their legal obligations.

Task 410

When this is done, the structured interview will improve the ability of managers to make good long-term hiring decisions. The art of asking questions requires training. The purpose of asking questions is to gain as much knowledge about the candidate as possible. Because of legal implications, questions should be only job-related. Those dealing with relatives or friends, age, conviction records, or other personal matters, should be avoided, because none of these factors relate to the work the person will be asked to perform. Skill in asking questions involves listening more than speaking. This is done most effectively through open-ended questions, which allow a greater range of response and encourages the candidate to speak. Rather than general questions about work experience that require short answers, a candidate might be asked questions such as: Describe the last time a supplier of critical materials delivered late. How was the situation handled, and what was the outcome? What was your most difficult negotiation? What were your goals, what problems were overcome, and what were the results?

Questions such as these encourage a candidate to enter into a discussion. This, in turn, can lead to further dialogue through questions that clarify or explore topics of choice. Open-ended questions lead to a better understanding of individuals, their capabilities, and their ability to blend into the organizations culture. E) Organizational hiring and human resource policies The selection process must be done in accordance with organizational policies and requirements. When hiring, knowledge of these requirements is essential. These can include such issues as internal job posting, hiring from within, affirmative action, promotions, transfers, or any legal or civic implications expressed by the organization. Diversity in the workplace extends beyond legislation protecting the rights of employees. It seeks to acknowledge and optimize benefits from all differences in individuals, such as age, gender, ethnicity, or culture. Diversity also encompasses physical limitations, as well as most other differences. When hiring, developing, or promoting individuals, those organizations that promote diversity will optimize the value of each individual.

459

Task 410 2) ISSUES IN EMPLOYEE PROMOTION A)

Module 4

Standards/certification Certification is an added criterion of professionalism that denotes a standard of competence. For the individual, certification may ensure peer recognition, better job opportunities, enhanced value to the employer, and quicker professional advancement. For the employer, it states that the purchasing professional has met certain standards deemed important by the profession, and has the tools to perform acceptably. It will assist the employer in removing loose, haphazard, or arbitrary promotion practices, and provide for the establishment of sound criteria for advancement. It will enable the employer to realize the greatest potential from the purchaser. Career advancement Usually, there are not enough vacancies to accommodate everyone. When a persons job no longer offers a challenge, the individual may become discontented and leave the organization or perform less effectively. For these reasons, it is essential that personnel be selected with care. During the hiring process, most managers attempt to match an individuals qualifications both to current and anticipated requirements of the department. This should be addressed in the interviewing process, as it is much easier and less costly to address before hiring has occurred. A good purchasing person properly trained is invaluable; a poor one is a major liability. Advantages/disadvantages of promoting from within Purchasing personnel at all levels are available either from within the organization or from external sources. When vacancies occur, the common practice in many organizations is to promote personnel from within the department. Promotion from within produces several distinct benefits. First, the practice tends to keep morale high because employees know that they are not trapped in dead-end jobs. It stimulates individual performance by offering an avenue of advancement. Second, promotion from within reduces total training costs. It entails a minimum of training for the person because his or her experience in the organization is generally pertinent to the new job. If a person is hired from the outside to replace the promoted individual, the new person can be brought in at a lower level. Third, the personal characteristics of the individual are known, and this perspective helps in selection. The person will also be knowledgeable about the organization. This background, combined with a varied perspective from other departments, can be an advantage. A person coming from related areas in the organization will have experience that may be useful in buying activities and may provide strong liaison with user departments. Promotion from within also can produce problems. One promotion may result in a chain of lower-level promotions, simultaneously moving several people one step up the organizational ladder. This may cause the organization to lose stability because many individuals are learning new jobs. When an organization is growing rapidly, this policy sometimes results in the promotion of people who are not ready to be promoted. The mediocre performance resulting from such action may compound the problem of instability. 460

B)

C)

Part B: Human Resources Management

Task 410

Promotion from within produces inbreeding. If carried to extremes, it may hinder the flow of new ideas into the organization. Internal promotions can also lead to poor morale on the part of individuals who were not selected. It may affect their future performance, or even encourage them to seek employment elsewhere. Prospective candidates should be trained in tasks related to jobs to which they might be promoted. It is worth the additional resources necessary for this development, because when an emergency job opening exists, a candidate is immediately available. An internal job posting policy allows the organization to inform all employees about job openings. It eliminates many questions of favoritism, and lets any employee ask about career opportunities in purchasing. The job-posting policy should include email and Internet access, as appropriate. D) Advantages/disadvantages of recruiting/hiring outside employees Occasionally, promotions from within may not be feasible or desirable, so skilled individuals are drawn from external sources. This practice has considerable merit, because it brings new ideas into the organization. It also prevents the substituting of seniority for management ability. Another alternative to consider is acquiring personnel from other departments within the organization. The person transferred is likely to be familiar with the organizations operations and can usually assume full job responsibilities sooner than a new employee. Such a transfer also brings into the purchasing department experience in a related functional area that may be useful in purchasing activities, and may provide strong liaisons with other departments. External recruitment is typically accomplished through: Advertisements using newspapers, magazines, radio, or television. Advertising can be either open or closed. Open advertising lists the organizations name while closed advertising does not. The listing of the organizations name may attract strong candidates or it may limit the attraction to candidates from that industry. Poor performance by an organization preceding a turnaround may also limit the organizations attractiveness to candidates. Professional associations, including direct contact (networking), allow the organization to readily identify available professionals. Beyond ISM, also use associations directly related to the organizations industry. Search organizations can be helpful. Staffing agencies and executive search firms have the ability to screen candidates for qualifications and have access to currently employed candidates. Search firms typically charge what sometimes appear to be high rates; however, when staff time, turnover rates, and job performance are all considered, search firms generally cost less than might otherwise be thought.

461

Task 410

Module 4 The organizations best workers can be good sources of applicants. Paying bonuses for referrals, and paying additional bonuses when the successful applicant passes a six-month or one-year anniversary date may be quite motivational for everyone. Although training costs may be higher with external candidates, sound purchasing skills can be applied in any environment, and a qualified candidate will have a short learning curve. Typically, the outside perspective and ideas brought to the position outweigh the lack of organization-specific knowledge.

E)

Training needs Further development of professional purchasing and supply professionals competence and interpersonal skills is an ongoing requirement if professionals are to continue to add value and contribute to the organization. Individuals with management potential must develop general administrative, managerial, and leadership skills. Management has the responsibility to work with each employee to identify training and educational needs and encourage development. Each organization is responsible for determining and providing resources required for human resource development. Self-development is a partnership between the organization and the individual, requiring both to participate in education and training decisions (see also Task 412).

F)

Succession planning All purchasing departments should have a formal process to identify future needs, and to help determine who might move into which positions in the future. Succession planning typically refers to plans that organizations make for replacement of their key executive personnel. Purchasing departments should perform the same type of planning, usually with the assistance of the human resource department. Whenever there is a job opening, the needs assessments should be compared with available skills to identify the next steps to be taken. The long-term plan should identify the departments needs over a three-year (or longer) period while the short-term plan should identify the most immediate, pressing needs. Goal attainment Perhaps the single most important aspect of the goal-setting process is the review with the employee. This begins with a discussion of organizational goals, and the individuals contribution to that end. The ensuing discussion and creation of mutually agreed upon, measurable goals removes ambiguity and gives the person a clear direction with clear expectations. Behavior can be geared accordingly, leading to more positive results and a higher degree of satisfaction.

G)

3)

ISSUES IN THE TERMINATION OF EMPLOYEES A) Consistent documentation/evaluation Evaluation of employees is a critical part of the development process. Effective evaluations should provide continuous, rather than periodic, feedback. Although scheduled reviews that are part of organizational policy

462

Part B: Human Resources Management

Task 410

might be completed, required corrective action should not be delayed until this time. In cases of unsatisfactory performance, the employee needs to be made aware that a change in behavior or performance is required. When a need to replace an individual is evident, it should not be done lightly. Employees should never be terminated for vague, personal reasons. Generally, employees should be terminated for consistently poor performance, insubordination, or serious violations such as theft or chronic substance abuse. Depending on the circumstances, an employee should be given a reasonable amount of time to improve the poor performance or change behavior. In all cases, reasons for termination should be documented, and the employee should be aware that he or she is on probation before actually being dismissed. Termination should also be distinguished from a layoff. In the latter, dismissal is not performance based, but rather is based on elimination of work and/or positions in the organization. B) Adherence to established personnel policies/procedures/union requirements/ due process Most organizations have well-outlined policies for the termination of employees. In the case of union employees and layoffs, union contracts usually specify a laid off workers right to be recalled based on seniority. Quantifying/qualifying discussion to terminate employee Most organizations have established procedures and records for ensuring that termination is handled objectively. In any case, reasons for termination should be well documented. Where appropriate, a witness should be present. Typically, the individuals personnel file is reviewed with the human resources department to ensure that this is the correct course of action and that organizational policy has been followed. Outplacement In situations where dismissal is not for cause, organizations may offer outplacement services to the employee. This will occur through organizations specializing in this service. Counseling is provided, as well as networking and professional skills development, all of which aid the person in finding new employment. Exit interviews Exit interviews are a means of meeting with the person and discussing issues following dismissal. Always attempt to have some organizational representative speak with the departing employee, whether it is an organizationally initiated termination, or a voluntary separation. It is a chance for the individual to vent or provide feedback on a number of issues that can help both parties better understand what has occurred and the underlying issues. The departing individual can provide great insight into management, employees, organizational processes, politics, and other useful information. This feedback can help both the organization and the former employee better understand and learn from an unpleasant event.

C)

D)

E)

4)

LEGAL ISSUES Although there are numerous federal regulations regarding the selection and dismissal of individuals, several key acts affect the majority of activities (see also Task 414).

463

Task 410

Module 4 Equal Pay Act of 1963 This requires that individuals who perform the same work and are substantially equal in skill and responsibility receive equal compensation. Federal Civil Rights Act of 1964 (specifically Title VII) Title VII of the 1964 Act makes it illegal to discriminate among employees on the basis of race, religion, color, sex, or national origin. The Act also includes sexual harassment. It prohibits unwelcome physical or verbal sexual conduct that is perceived as a condition of employment, or that creates a workplace environment that limits or interferes with an individuals performance. Executive Order 11246 of 1965 This regulation prohibits discrimination in federal employment on the basis of race, religion, color, national origin, and sex. Federal employment includes any organization that has a government contract or subcontract. Age Discrimination Act of 1967 This regulation restricts employers of more than 20 employees in the public and private sector from discriminating in the employment and termination of individuals who are over 40 years old. Equal Employment Opportunity Act of 1972 In 1972, the Equal Employment Opportunity Act (EEOA) was passed to provide a series of amendments to Title VII, expanding its coverage and strengthening its enforcement. Coverage was extended to virtually all organizations with 15 or more employees. The EEOC was given the power to directly file lawsuits against offending organizations. Another significant provision of the EEOA requires organizations meeting certain criteria to take affirmative action to move toward achieving a workforce that accurately reflects the composition of the community. In other words, an organization must compare its employment, by department and by job level, with data on the availability of talent in the relevant labor market. National Labor Relations Act Sometimes referred to as the Taft-Hartley Act, this Act grants individuals the right to organize and bargain collectively. Occupational Safety and Health Act This legislation prohibits work from being performed under conditions that are dangerous or unsanitary. In 1983, OSHA also issued the Federal Hazard Communication Standard. This first federal standard required that workers be informed of all hazardous materials present in their working environment. This is referred to as the employees right to know, and focuses on five key areas: - Identification of hazardous materials - Product warning labels - Emergency response techniques - A written hazardous communication standard - Employee training Americans with Disabilities Act This Act prohibits private employers of 15 or more people from discriminating in hiring because of a disability. Employers must provide candidates a list of essential functions required for the job, and must make reasonable accommodations that may be required. These can include access to the facility, workstation modifications, work schedule flexibility, or even job restructuring.

BIBLIOGRAPHY Veates, C. and C.E. Lee. The Fundamentals of Human Resources, NAPM InfoEdge, (3:9), May 1998. 464

TASK 411: Evaluate purchasing/supply staff performance.

The performance appraisal process can be an important element in employee job success. The process is predicated on effective year-round communication between employee and manager. Managers who view the process as a one time, once a year activity will lose significant opportunities for performance improvement. The managers key appraisal tasks are to observe and identify performance that has occurred, and communicate those observations to the employee along with suggestions for improvement. 1) ISSUES IN THE EVALUATION OF EMPLOYEES The organizations goals should be present in all appraisal activities. These goals include: Employee performance improvement The performance appraisal system is based on increasing the long-term productivity of employees. Information development Information is developed for the employee, the manager, and overall organization systems. Legal requirements An effective performance management system must be legally sound, and should provide managers with the ability to make future personnel decisions (such as promotion or termination) that can be supported if challenged legally. Determine employee objectives One function of the performance appraisal process is to bring congruence to the organizations and the employees needs. The employees objectives for the performance appraisal process are to identify areas for improvement, career paths, and rewards. Coaching/training/development - A prime objective of the performance appraisal process is to assist the employee in improving performance. This can be a continuous process if the purchasing manager interacts regularly with the employee as a coach and mentor Determine potential promotions, demotions, transfers, or terminations. Appropriate performance appraisal information will allow the organization to determine career paths for individuals. Reward past performance/motivate future performance. Most employees see financial rewards as the key reason for a performance appraisal. If managers also view the appraisal in this way, then a significant training opportunity will be lost. Where appraisal is used as part of the reward system, managers must ensure that employees can receive a large enough pay increase to make a difference, that employees understand why people received those increases, and that undue competition for scarce financial resources does not cause significant employee conflict.

A)

B)

Determine criteria for success The evaluation criteria should be job-related success criteria, developed from the job description and established goals. Example criteria include: 465

Task 411

Module 4 Critical incidents, based on established goals. A critical incident is any important action that the worker performs. It is not necessarily good or bad; it is, however, vital to the successful performance of a job. Behavioral measures. Evaluating behaviors (employee actions and behaviors) ensures that workers perform the tasks necessary for their long-term success. For example, a purchaser who keeps track of suppliers who can ship product at a moments notice will be prepared when an emergency shipment is necessary. Output measures. These are results. Examples include cost, quality of product received, timeliness, and so on. Traits should never be appraised. A trait is a personality or physical characteristic that is resistant to change. Dependability, initiative, motivation, or a bad attitude are examples of traits. They are difficult to evaluate, impossible to interpret, virtually useless as a legal defense, and provide no feedback to employees who desire to improve performance. The effective manager will learn to provide feedback by identifying specific critical incidents or behaviors.

C)

Determine appraisal factors How does a purchasing manager determine exactly which factors of an employees performance should be evaluated against? The factors should be taken from the essential functions of the job therefore, each purchasing department must choose the factors that are related to its specific job responsibilities. The factors should include behavioral and output measures as stated above. 1.0 Quantitative factors Quantitative factors are measurable on a numeric scale and are objective. They usually measure results such as supplier quality levels, delivery performance, and costs. Qualitative factors Qualitative factors are subjective but are just as important as quantitative measures. Examples include communication, responsiveness to change, and ability to follow procedures.

2.0

D)

Conduct interviews/give feedback Performance reviews are usually conducted as face-to-face interviews by the supervisor with the employee. Plan for the appraisal interview. As in any other important business meeting, the performance appraisal should be well thought out. The following template will assist any manager. Establish goals for this session. Focus on goals of the process (see above), as well as the specifics for this employee at this time. Review employee goals for the year. If these were not prepared at the conclusion of last years appraisal process, try to meet with the employee a month or two before this years discussion and identify how the employees key goals evolved.

466

Part B: Human Resources Management

Task 411

Review notes and file from past year. Review critical incidents. Collect data from others. Begin contacting other participants in the process a few weeks before the appraisal, informing them of your goals. Sometimes a short open-ended questionnaire might facilitate the process. Gather input from the employee. Ask the employee what else should be reviewed before the meeting. Have the employee go through similar process. Respond to questions and establish expectations about what might occur at the session.

Appraisal interview. Supervisors often resist doing appraisals for a number of reasons. Supervisors often lack the interpersonal skills necessary to provide impartial feedback to subordinates. Raters often have a distaste for critical analysis of others performance and the conflict that sometimes results from a performance review. Supervisors may get little positive reward from the entire performance review experience The supervisors appraisal may often differ with the subordinates self appraisal. Use of a 360_ review is used in some organizations today to help this. The 360o review incorporates appraisals from supervisors, co-workers, and even external customers. The advantage of the 360o review process is they accumulate more information about an employees performance and development

Proper managerial training or development of organizational infrastructure may alleviate some of these. The meeting should be a private, face-to-face meeting, planned out in advance, in a convenient time and place. No interruptions should be permitted. Performance improvement and problem solving should be constantly discussed throughout the process. Managers need to ensure that they give employees adequate time, allowing them to describe their performance throughout the year. A performance plan, outlining goals and commitments should be agreed upon. If the plan cannot be signed at the meeting, a date for completing and signing the document should be established. Employees should always be required to sign a statement indicating that the interview occurred, and that they had an opportunity to respond. The following steps are useful in developing performance related goals: Use (rewrite if necessary) the employees job description With the employees help, as well as input from other managers, identify the employees developmental needs

467

Task 411

Module 4 Goals should be written in specific, not general terms. Do your best is not as effective as reduce cost of all widgets by 2%, or ensure that 99% of widget deliveries are made on time. Goals must be accepted by the worker. Studies show that lack of acceptance leads to lesser performance Challenging/difficult goals lead to higher performance. However, in order to get employees to accept these goals, negative sanctions for failure to achieve difficult goals must be eliminated. Identify how feedback will be provided to the worker

Feedback. For feedback to be effective it should be: As precise as possible. Managers should not speak in general terms because what they are saying could be interpreted in a number of ways. Feedback should be timely and be given shortly after the incorrect performance or behavior has taken place. Impersonal. Criticism of personal traits is especially likely to cause an emotional reaction. As a result, the nature of the performance deviation itself may be overlooked. Feedback should focus on what the person did and what resulted from those actions. Also, feedback should be obvious and clear, so that the individual is made aware of the information and can take a corrective action when required. Given often. Understanding of performance is enhanced when there is frequent review and when feedback is received early enough to identify problems in achieving goals.

E)

Team and/or peer input At times, feedback and review can come in the form of team or peer appraisals. These approaches have been used for many years in the military and in academia, as well as in industry. The unique first-hand knowledge peers often have of each others performance is the rationale for their use. However, if conditions of competition exist, this type of rating may not be very effective. Self-assessment The advantages of self-assessment by employees are that employees are in a privileged position to evaluate themselves with respect to job knowledge and performance frequency. Such assessments also foster development and less defensive appraisals. Bias is a concern with this technique; employees may inflate or deflate ratings when making self-assessments, so self ratings should only be used as a starting point for appraisals. Employee accountability A good performance appraisal will identify for the employee those areas in which he or she has problems and will specify what he or she needs to do to correct them. The appraisal thus provides the employee with guidance on how to improve, and makes him or her accountable for that behavior with a definite time span for improvement. It is also important to identify and build on areas in which the employee is doing well.

F)

G)

468

Part B: Human Resources Management H)

Task 411

Internal customer input At times, the purchasing manager may obtain useful performance appraisal data from the user departments with which the purchaser has frequent contact, to see if their needs are being met promptly, courteously, and accurately. Supplier input The purchasing manager may obtain useful performance appraisal data from the organizations with which the purchaser has frequent contact, to see if their needs are being met promptly, courteously, and accurately.

I)

2)

USES OF PERFORMANCE APPRAISAL DATA A) Compensation No department operates at its full potential for long if its salary structure fails to reward individuals in relationship to their respective performance levels. A good performance appraisal program does not guarantee an equitable salary structure. It does, however, provide data that can be used in developing a sound compensation plan or in correcting an inadequate one. Promotion How do managers know which people in their departments are likely to become candidates for the top jobs? They determine this by analyzing each aspect of an individuals performance record. It is imperative that such analysis be made using detailed and accurate written data. A well-designed appraisal program provides the required data. Personal/career development The most important benefit that can come from a good employee-evaluation program is the information needed to stimulate and direct each individual employees professional development. A supervisors prime responsibility is to develop capable and effective personnel. The data provided by appraisals can be analyzed to determine each employees strengths and weaknesses. This determination facilitates the development of a realistic professional improvement program for each individual. Employee morale Every purchasing manager must develop a carefully-structured program for appraising the performance of personnel. Haphazard or inconsistent evaluation of individual employee performance can have an adverse impact on department morale. Disciplinary action A well-designed employee performance appraisal is a necessary guide for disciplinary actions that are focused, fair, and provide direction for employee improvement. Employee recognition Purchasers (as well as other staff) want to know that their diligence will be rewarded. Most purchasers are motivated when their managers make them feel good about quality work through acknowledgement of superb efforts. Many organizations have found that programs that allow purchasers to be recognized and rewarded for their performance benefit the entire organization.

B)

C)

D)

E)

F)

469

Task 411 G)

Module 4 Improvement of performance The primary objective of the performance appraisal process is to improve performance. The entire system is based on increasing the long-term productivity of employees.

470

TASK 412: Conduct/authorize job training for the development of the professional competence of the staff.
1) DETERMINATION OF TRAINING AND DEVELOPMENT NEEDS Many processes exist for an organization to increase its organizational capabilities. The first step in determining training and development needs is to conduct an organizational analysis based on the organizations strategic plan to align the departmental goals and responsibilities with the organizations strategic plan. The organizations structure is then set to meet the goals and responsibilities. With the structure established, the process continues to conduct skill assessments, to prepare individual development plans, and to set implementation plans. In particular, what crucial purchasing task changes will occur within the next few years, and how are those likely to change over time? This helps determine the training emphasis in the future. The last step is measurement of the increase in skills and competencies. A) Skills assessment Skills assessment is a process to identify the skills that are currently available within the organization. Using skills inventories and performance appraisal data, purchasing managers can identify individuals throughout the organization who can effectively add value to the purchasing and supply management process. Gap analysis Gap analysis compares an individuals skills and competencies with the essential tasks to be performed, as identified in the job descriptions (see Task 410 for a discussion of job analysis). Managers compare required skills with actual skills to produce a comprehensive list of deficiencies. This list is used to design and plan training programs. Designing and planning training programs Each skill needs to be mapped to a set of educational tools that an individual can then apply to achieve the expected skills and competencies required for satisfactory job performance.

B)

C)

2)

TYPES OF INITIAL JOB TRAINING (FUNCTIONAL ORIENTATION) If a new employee is expected to achieve a desired level of productivity in a reasonable period of time, a certain amount of job training is usually required. There are five major approaches to initial job orientation. A) Orientation Employee orientation involves the introduction of the new person to the job and the organization. Most applicants receive a superficial orientation to the new job during the hiring process. The new employee will need a more formal and complete orientation. Employees will want to know what is expected of them. This will help eliminate possible future problems. An orientation program should be designed to relieve feelings of insecurity in a new environment. The employee should be told about the organizations history, products,

471

Task 412

Module 4 services, and operations. Such orientations often include formal instruction, introduction to employee manuals and handbooks, and tours, as appropriate. Orientation programs are sometimes run by the human resource department, but the new employees supervisor will also play a major role in orienting the employee. An employees first few days and months on the job play a formative role in developing commitment to the organization. By investing adequate time in assimilating newly hired staff, businesses will realize higher job satisfaction, and reduced turnover.

B)

Learn by doing The most basic method of training new employees is to give general guidelines about what needs to be done and have the employees teach themselves the nature of the job. In fact, many new employees learn their jobs through this process. This method should be used with caution. The sponsor/mentor system A commonly used practice involves the assignment of a sponsor (or a buddy") to each new employee. After the supervisor has provided adequate initial orientation, new employees are assigned specific jobs where they typically receive selected basic initial job instruction from the same supervisor. The bulk of the training load, however, rests with the individuals sponsor, who is an employee doing similar work. The sponsor acts as an informal trainer during the entire period the new person is learning the job. Sponsors should be chosen for their experience, teaching ability, and understanding of organizational policy. This approach can be quite effective if the sponsor is a good teacher. It has the disadvantage, however, of restricting the new persons initial training. Some time may elapse before the employee realizes fully the many implications of the activities of the job and how they relate to departments outside purchasing. Also, the time devoted to such training activities may significantly reduce the sponsors productive output.

C)

D)

Classroom training In some organizations, initial job training consists of a series of brief classroom courses dealing with team building, organizational culture, regulations, purchasing processes, and related activities. Such programs prepare the new purchasing employee to do a better job and also aid in establishing rapport with personnel in related departments. Functional rotation To minimize the shortcomings of the buddy system, many organizations modify it by adding an element of functional rotation training. Before a new employee is assigned to a specific job, the employee is considered a trainee for a period of time. Much of the initial training is frequently spent in departments other than purchasing. The basic idea is to expose the individual to a number of functional activities both within and outside the purchasing area, and to facilitate the individuals understanding of the various purchasing functions and their relationships to other operating functions. A typical program may include assignments in such areas as receiving, stores, purchasing records, expediting, buying, inventory control, and selected line-production departments. Specific assignments vary, depending on the persons background and first

E)

472

Part B: Human Resources Management

Task 412

permanent job assignment. The program objective, however, is to help the individual develop a general understanding of the complete material cycle in the organization. Upon completion of rotational training, the new employee is assigned to a specific job where the employee may receive further job training from a sponsor or from the supervisor, as necessary. 3) TYPES OF CONTINUOUS PROFESSIONAL DEVELOPMENT A manager who expects to use employees effectively over the long term must assume the responsibility for assisting and guiding them in the continued development of their capabilities. Determination of an individuals specific development needs is a product of observation and periodic counseling by the manager with the individual employee. These needs should be jointly determined, and plans for subsequent training experiences should also be planned jointly for the ensuing six- to 12-month period. A) Job rotation Job rotation training can take several forms. As the name implies, it involves a process in which the purchasing employee is rotated from one job assignment in the department to another, until the employee develops reasonable competence in each of the jobs. The objective is to give the employee as wide a base of skills useful to the purchasing department as the individuals development permits. For example, following experience as an expediter and subsequently a junior purchaser, an individuals first full-fledged buying assignment may be in the MRO section or in the general-purpose material section. From this position, the individual may elect to specialize in buying a particular type of raw material or production component. Such job rotation training provides the purchaser with experience in various types of departmental activity, each with increasing complexity. Although each production purchaser typically becomes somewhat of a skilled specialist, the purchasers capabilities can be expanded further by providing experience in several specialized buying jobs. This type of rotation naturally occurs slowly, because of the extensive background and knowledge required in each buying area. The experiences and opportunities afforded to purchasers in other sectors would be different. If conducted wisely, this technique not only fosters professional development of personnel, but also provides purchasing flexibility within the department. However, care must be taken not to dilute technical buying competence by rotating purchasers too frequently. B) On-the-job training Most on-the-job training is conducted informally. It can be initiated by various members of the purchasing department in response to the managers observed needs among departmental personnel. Such training may simply consist of supervisory coaching for selected individuals. In other cases, it may take the form of periodic discussions among management and selected groups of personnel. Each session is conducted in seminar fashion and focuses on the exchange of ideas about relevant purchasing topics. On-the-job training may also include periodic lectures and demonstrations. Some organizations periodically hire consultants to 473

Task 412

Module 4 conduct refresher sessions on such topics as value analysis, cost estimation, negotiations, and similar practical purchasing skills and techniques.

C)

Self-training As noted above, responsibility for recognition of specific needs lies with individuals and their supervisors. For this reason, much of a purchasers professional development is acquired through carefully directed self-training. Self-training takes many forms, but commonly involves: Studying purchasing periodicals, books, and research reports. Studying selected business publications. Studying trade magazines and special resource books on materials. Attending purchasing association meetings and special commodity group meetings. Enrolling in selected university evening courses and correspondence courses. Attending special seminars and workshops sponsored by universities and professional societies, including those offered through distance learning.

During the course of an individuals self-training, one of the managers responsibilities is to help the individual attain a balance between the development of business skills and technical knowledge of materials. Both the manager and the employee are responsible for identifying skills needed for future performance. D) Management development training In addition to developing professional purchasing competence, individuals with potential for future management positions should also develop general leadership and managerial skills. Procurement management programs sponsored jointly by ISM and various leading universities represent a significant development opportunity in the management training area. These programs are typically designed for experienced purchasing people, and involve from one to several weeks of intensive study on a university campus. Program content typically focuses on management and decisionmaking concepts outside of, but related to, the materials/supply function. With appropriate management guidance, an individual can also develop such skills through expanded self-training activities and practice. Apprenticeship training This is a detailed form of on-the-job training that typically involves rotation between an employer and schooling. Formal/classroom training programs Many organizations have in-house training programs that are provided by professional training departments, ISM and its affiliated local associations, colleges and universities, and other professional trainers. They often employ combinations of filmed lectures, case study work, and programmed instruction. Smaller organizations that lack the funds or expertise needed for formal, internally developed training programs, often turn to outside agencies and programs, such as the Harvard Seminar Case Study Program and seminars run by ISM and the American Management Association (AMA). A major advantage of outside instruction is that it

E) F)

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exposes the participant to colleagues from a wide variety of organizations. However, these programs, by necessity, tend to be general in order to meet the needs of a broad scope of purchasing participants. G) H) Continuing education offerings These are seminars given by schools, organizations, and professional groups. Site visits to organizations/suppliers Training of purchasing personnel should include visits to suppliers. From such visits, trainees obtain knowledge of the suppliers capabilities as well as industry knowledge. With such knowledge, the trainee can evaluate the potential use of each suppliers organization for the purchasers organizational needs. Audio/videotapes Training by viewing and listening to tapes and other media. Books/publications Accessing education through print media. Peer-to-peer Purchasing professionals can learn an enormous amount from their peers who have more training and experience in different areas. An atmosphere of cooperation and harmony is necessary in order for such interaction to take place. Experiential learning Development by hands-on activities with reflection about what was gained and could be done differently next time. Job analysis/diagnostic evaluation A job analysis process, and the use of a diagnostic evaluation, are tools to identify knowledge and skills needed for successful job performance. At its simplest, the goal is to identify tasks, or duties, that make up a job or position. Once this information is available, subject matter experts are used to identify the knowledge and skills an individual must possess to successfully perform each duty. The next step is to determine the knowledge and skill level of each person. Finally, training and development plans are created to cover those areas in which an individual is deficient. A variety of diagnostic tools are available in the marketplace to assist management and employees with this process. Computer-based training Using computer programs that are designed to present material either one-way or in an interactive format. Interactive training Interactive training involves the trainee interacting with others as part of the learning process. Many of the various types of training are interactive. Competency-based training Competency-based training can take place when a job or task is well-defined, and a definition of and measure of competency exists. The individuals abilities can then be compared against the standard, and areas where additional training is required can be identified. A program of training can then be created that meets each individuals needs.

I) J) K)

L) M)

N) O)

P)

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Task 412 4) PROFESSIONAL CERTIFICATION

Module 4

Certification programs require the individual to demonstrate proficiency and knowledge in specific job-related areas based on a common body of knowledge. Certification reflects an individuals ability to perform because it focuses on job-related expertise. A certification awarded by a third party endorses skills beyond the requirements of a specific position or role. Recertification provides guidance for individuals to stay current in their profession. Certification opportunities for the purchasing and supply manager include the Certified Purchasing Manager (C.P.M.) and Accredited Purchasing Practitioner (A.P.P.) offered by ISM, the Certified Public Purchasing Officer (CPPO) and Certified Professional Public Buyer (CPPB) offered by the National Institute for Governmental Purchasing (NIGP), and the Certified Professional Contracts Manager (CPCM) and Certified Associate Contracts Manager (CACM) offered by the National Contracts Management Association. Other related certifications include Certified Production and Inventory Manager (CPIM) and Certified Integrated Resource Manager (CIRM) offered by APICS, the Project Management Professional (PMP) offered by the Project Management Institute, and the Certified in Transportation and Logistics (CTL) offered by the American Society of Transportation and Logistics. 5) FORMAL EDUCATION/ADVANCED DEGREES Formal education programs exist at a number of colleges and universities around the country. They offer undergraduate degrees in the fields of purchasing, supply and logistics management, transportation and logistics, and supply management. Some of these programs are oriented toward the student who is working full- or part-time, while others are more traditional. A fewer number of graduate degree programs are available, but the supply management professional can also benefit from a more general program such as a Masters in Business Administration. 6) PROFESSIONAL ASSOCIATION INVOLVEMENT An excellent forum for the individual to develop managerial, interpersonal, and facilitation skills is involvement in the operation of the professional organization. Serving on committees, chairing committees, serving on the board of directors, and any other opportunities for taking a leadership role, including community activities, are examples. Other benefits include access to other professionals, to professional literature, to seminars, to formal learning programs, to conferences, and to the organizations Web site. BIBLIOGRAPHY Kolchin M.G. and L. Giunipero. Purchasing Education and Training: Requirements and Resources, Center for Advanced Purchasing Studies, Tempe, AZ, 1993. Oshea, D.J. Skills Sets: Take Inventory, Take Action, NAPM InfoEdge, (4:1), September 1998.

476

TASK 413: Resolve employee performance problems.

Managers and their employees have an obligation to develop sophisticated and effective skills to deal with employee performance problems. The goal is to help each and every employee to be successful. Managers often ignore their role and find that they are ill prepared to counsel employees on performance improvement. Managers who have the ability to work with their people in this way are highly valued by their organizations. Outcomes of their behavior include improved individual performance, increased morale, and decreased turnover, leading to improved departmental productivity. In the purchasing department, this translates directly into better working relationships with other members of the organization and with suppliers. 1) ISSUES IN EMPLOYEE NON-PERFORMANCE Most organizations have work rules that, if violated, can result in various penalties, including dismissal. A) Corrective action process Corrective action is a process consisting of a series of steps and actions to correct and improve inadequate employee performance. This model provides the framework that many managers believe will help them solve performance and discipline problems through counseling and discipline. It lets managers treat all employees in the same fair way, and assures the organization that managers have kept clear documentation while working on improving employee performance. Counseling Effective managers view counseling as an effective corrective action tool that provides an opportunity to improve employee performance. When a manager approaches counseling from a strictly discipline-related perspective, the employees goal becomes one of self-protection. The manager then becomes an authoritarian referee, and a negative spiral often occurs. The two crucial goals of the corrective action process are: To focus on increasing the employees job-related capabilities. Problemsolving.

B)

Whenever performance is not up to standard, there is some type of problem. The managers job is to identify and understand the root cause of the problem. When only symptoms are addressed, there is no opportunity to understand why the problem occurred and what can be done to resolve it. Without this understanding, employee performance rarely improves. The principle of corrective action (sometimes called progressive discipline) means that management responds to a first offense with some minimal action, but to subsequent offenses with more serious penalties such as layoff or discharge. The steps in this process are:

477

Task 413 1.0

Module 4 Notice of the problem The first step is to warn the employee of the problem. Usually, this is first done orally, and if the problem continues, discussions are then put in writing and include possible consequences of future offenses. Efforts to identify the problem Employee behavior is a symptom of the problem. Causes may include lack of training, improper training, and personal issues. It is crucial that the manager differentiate between those employees who cannot or will not do the job, and those employees who break the organizations rules or are in other ways insubordinate. The effective manager will treat the two types of employees differently, because different approaches are necessary in order to solve the problem. Individuals who cannot perform the task must be treated differently from those who can. Effort to resolve the problem The employee must be given sufficient time to demonstrate a change in behavior. This may be several months, depending on the problem. If the problem is ability or understanding, the steps to resolve the problem include: Provide skills training to those who do not have the capability to do the task (see Task 412 for a discussion on the many ways to improve a persons capability to do the job). Give appropriate instructions to employees. There are many situations where the worker simply does not know what is expected. For example, when there are technical product needs, and it is determined the purchaser does not understand the need to work with a supplier to identify changes that may be occurring in the marketplace to share with internal customers, the manager can then work with the employee and identify ways to work with suppliers and communicate with internal customers.

2.0

3.0

If the problem is motivation, the steps to resolve the problem include: Place the responsibility for improvement on the employee. The unmotivated worker will often try to blame others for poor performance. Shifting responsibility away from the employee allows excuses to be made, thus perpetuating the problem. Determine what assistance the employee requires. Understand the specifics of the motivation difficulty while taking into consideration that there may be times when employees place unreasonable demands on the manager or the organization. Sometimes, overburdened, burned out employees become unmotivated. While it is still important to continue to place responsibility for improvement on the employee, often the manager can help the employee. Establish clear and specific goals. Unmotivated employees often understand the rules, and know how to play the game. Stating 478

Part B: Human Resources Management

Task 413

minimum requirements will motivate minimum performance, merely enough to keep the employee from being fired. Employees must know that they must produce at a high level in order to be successful. Establish agreed upon consequences. Be certain that the employee knows exactly what will happen if performance does not meet expectations. Commit agreements to writing. This eliminates misunderstandings. The manager and employee should both sign the document, and the employee should retain a copy. Receive assurances of support from superiors. Often, managers should talk with their superior before serious discussions with their employees occur. This gives the supervisor an opportunity to suggest ways of addressing the matter, and ensures that if the subordinate complains to the managers supervisor, the supervisor is aware of the situation and can support the manager. Coach on a basis of what you did, not who you are. The behavioral approach (what you did) assumes that the employee can improve. The trait approach (who you are) asks individuals to change basic parts of themselves. This involves long-term change and is beyond the scope of the managers responsibility. Always develop a performance improvement plan. Whether solving a motivational or basic ability problem, this plan communicates all aspects of what the employee must do to improve, identifies what the manager will do to support the employees improvement efforts, and states all appropriate timelines.

If the problem is discipline-related, the steps to resolve the problem include: Use the organizations discipline process/policy. The starting point should always be the organizations stated process. If there is no specific process, other members of the organizations executive team should be consulted to determine what past practice has been. In most cases, past practice determines current policy. The manager should note his or her perception of the cause of the problem. Although a manager does not want to have preconceived biases, a few moments identifying an understanding of the problem will help when discussion with the employee begins. In particular, considering the impact of outside influences on the employee will help the manager discuss the situation. For example, were there specific individuals who affected the situation, perhaps influencing the workers actions? At the oral warning stage, allow the employee to explain the situation. This is the first part of most formal discipline processes. A major intent of this stage is to communicate the seriousness of the offense to the worker. At a minimum, the following should occur at this stage:

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Task 413

Module 4 - Say, This is an oral warning. The employee must know that this is not merely a discussion, perhaps typical of other discussions. - Managers should tell employees what they saw, why it is a problem, and what the consequences of a continuation of these actions will be. - The manager should explain the discipline process to the employee, making sure the employee understands the process. The manager should also give the employee a copy of the organizations discipline process or policy. - The manager should write down important aspects of the meeting. At a minimum, date, offense, and agreements should be noted. At the written warning stage, the manager writes a letter stating the facts and asks for a response. The letter documents all known facts of the situation. It should state that an oral warning had previously been given, and that the cause for discipline had continued. It should identify the subsequent steps to be taken. Be certain the employee understands the process. Keep clear documentation. Dates of all meetings should always be noted, along with all other pertinent facts. If there were witnesses or third parties in the meetings, these people should be identified. Develop a performance improvement plan. These are the same steps as the motivational points of performance related problemsolving, as stated above. - Place the burden for improvement on the employee. - Determine what assistance the employee requires. - Establish clear/specific goals beyond the minimum. - Establish agreed upon consequences. - Commit agreements to writing. - Receive assurances of support from your superiors. - Coach on a basis of what you did, not who you are.

4.0

Monitoring progress The manager should carefully monitor the progress of the employee and offer feedback (especially if the behavior change is positive) to give the employee a sense of whether or not the employees actions are appropriate.

C)

Types of issues 1.0 Performance problems Poor performance is one of the main employee work problems. Solving an employees inability to do the job is an important management task. Managers should focus on diagnosing and responding to these problems when they first appear. This category includes frequent errors, oversights, sloppy work, or slow performance. It can also include habitual lateness or missed days. These problems are typically caused either by lack of ability or lack of motivation. Stress and burnout often exacerbate the problem. 480

Part B: Human Resources Management 2.0

Task 413

Attitude, stress, burnout A great many employee performance problems can be linked to poor attitude, caused by job stress and burnout. Some organizations have in-house counselors to help troubled employees change their attitudes and develop a more positive approach. Theft Incidents of employee pilfering, embezzlement, and theft are serious violations that may involve criminal proceedings, as well as disciplinary action or dismissal. The organizations policies for such actions should be clearly communicated to all employees. Substance abuse Substance abuse includes both legal and illegal substances such as alcohol, prescription drugs, or illegal drugs. Organizational policy may cover usage on or off the job, coming to work under the influence, and items that are potentially as innocent as sharing a drink with a client or customer. The best policies are written to give managers flexibility to handle different situations. Organizational implementation must consider requirements of the Americans with Disabilities Act, which offers protections to individuals in certain situations. Many employers offer counseling and treatment for substance abusers. This expense is frequently covered by employee benefit packages. Ethical violations Policies are often unable to address each and every question of ethics. For example, is receipt of a gift from a client always a problem? Signals from the organizations leadership are often the best way to understand corporate ethics and to explain them to employees (see Task 119 for a discussion of purchasing ethics). Attendance If an employee is having attendance problems, it is often a symptom of other issues. A manager should address the issues to prevent them escalating later. The use of flextime may be a simple solution. All employees are expected to inform their managers when they will be absent or late. However, employees who are exempt from the provisions of the Fair Labor Standards Act are treated differently from those who are not exempt. Exempt employees (those employees who have significant supervisory or decisionmaking responsibilities) are judged by their ability to successfully complete their task, while non-exempt employees are required to be at work for a prescribed number of hour each day.

3.0

4.0

5.0

6.0

7.0

Legality other than theft Managers must use care when addressing problems that may have legal implications for the manager or the organization. Managers should discuss such problems with supervisors and legal staff, as appropriate. Examples that might require consulting with legal staff include employee misuse of the Internet or other technology, and inappropriate employee interaction with other employees or suppliers.

481

Task 413 D)

Module 4 Documentation In all cases, incidents of employee difficulties should be well documented by the manager, including dates of incidents, warnings, meetings with the employee, and the nature of all manager-employee discussions. Collective bargaining requirements Collective bargaining agreements set forth the terms and conditions under which union members work in an organization. Such agreements usually have specific requirements for dealing with employees who are performing poorly, and generally spell out the organizations discipline policy. It is the responsibility of the manager to ensure that those requirements are met when disciplining or dismissing an employee. Employee assistance programs Employee assistance programs (EAPs) are formal counseling programs aimed at assisting employees with problems due to such difficulties as personal or family crises, substance abuse, or emotional illness. Typically, these confidential programs are administered by the human resource department. While they may not focus on specific work-related matters, they can help improve the employees ability to deal with outside problems, and can also help improve communication and understanding between superior and subordinate. 1.0 Retraining Frequently training is an effective tool for management to use when resolving employee performance problems. Retraining employees in new skills is important today, given the fast pace of change. Retraining is often required when employees change jobs within the organization, move into management, or when new programs or new technology is introduced by their organization. What is perceived as a performance problem may in reality be a deficiency in a skill or a lack of understanding of how to perform the job. Management has the responsibility to work with employees to identify where new skills and knowledge will benefit the employee and the organization and resolve performance problems. Frequently, the responsibility for retraining and education is a joint effort between the employee and the organization.

E)

F)

482

TASK 414: Implement programs to prevent and respond to discrimination or harassment.

The workforce composition is changing at a significant pace. There are more women, minorities, and foreign-born people working together. This diverse workforce provides benefits, as well as challenges, to the organization. Organizations are recognizing that in order to effectively ensure a comfortable and productive work environment, employees must be enlightened about their responsibilities within the workplace. Working in concert with the organizations desires are a set of federal, state, and local laws that aim at decreasing discrimination against members of certain groups. One of the most significant laws in this arena is the Civil Rights Act of 1964, as amended. Court decisions, Presidential Executive Orders, and administrative guidelines have helped refine these statutes. 1) EQUAL EMPLOYMENT OPPORTUNITY LAWS AND REGULATIONS The effective manager has the ability and responsibility to discriminate between good and bad employees, between correct and incorrect job behavior. Thus, the managers job is to identify who is, or will be, performing up to the organizations standards and needs. Illegal discrimination, as defined by law and interpreted by federal guidelines and court decisions, involves the following: making any employment decision (including hiring, firing, compensating, appraising, selection for training programs, job choice, vacation decision, and so on) using irrelevant (non-job-related) criteria, where that decision has an adverse impact on members of a protected group. All four of these items must be present in order for illegal discrimination to occur. For example, non-job-related criteria can be used if there is no adverse impact on protected group members. If adverse impact occurs in situations where job-related criteria have been used (e.g., a Bona Fide Occupational Qualification (BFOQ) exists), again there is no illegal discrimination. A protected group is one that is covered by a federal, state, or local anti-discrimination statute. For example, age (40 or above) is protected by the Age Discrimination in Employment Act. Disparate treatment occurs when one person is treated differently than another. If, for example, one job applicant is required to respond to different interview questions or perform different employment tests than another individual, disparate treatment has occurred. Illegal discrimination may thus be present. If a manager is concerned about whether an applicant can perform a job-related function, then the manager should request that all applicants perform the same job-related function. Adverse impact occurs when the results of seemingly neutral employment practices have a negative impact on members of protected groups. For example, word-of-mouth recruiting appears to be neutral, but in an all-white, all-male work force, this practice is likely to have an adverse impact on women and non-whites. Illegal discrimination may thus be present. 483

Task 414 The relevant laws and regulations include:

Module 4

Civil Rights (Title VII) and Equal Employment Opportunity Acts, 1964, 1972, 1991 These acts: - Prohibit discrimination in all private employment practices based on membership in protected groups. Discrimination is not allowed based on race, color, religion, sex, or national origin. It is important to note that it is not just some groups, such as women or African Americans, that are protected. It is simply illegal to make any employment decision based on protected group status. For example, it is illegal to make employment decisions that discriminate against men, as well as against women. - Allow Bona Fide Occupational Qualifications (BFOQ) that let an organization use religion, national origin, or sex in cases where a legitimate business necessity exists for example, requiring a female to work in a womens locker room. - Require that an organization reasonably accommodate an individuals religious preference. - Established the Equal Employment Opportunity Commission (EEOC) in 1972 to administer all EEO provisions. Managers are encouraged to visit the EEOC site at www.eeoc.gov for current information, guidelines, and court rulings. Equal Pay Act, 1963 (amendment to the Fair Labor Standards Act, 1938) This act: - Prohibits sex discrimination in pay. Equal pay must be given for equal work. - Allows unequal pay for seniority systems, performance differences, unequal work, or shift differentials Age Discrimination in Employment Act (ADEA), 1967, 1978, 1986 These acts: - Prohibit discrimination against people aged 40 or over. Because there is no maximum age, this law effectively invalidates most mandatory retirement provisions. - Many individual states protect workers before they reach the age of 40. These states typically afford employment discrimination protection at the age of 18 or 21. Executive Order 11246, 1965 (including later revisions) This order: - Prohibits discrimination in federal employment on the basis of race, religion, color, national origin, and sex. Federal employment includes any organization that has a government contract or subcontract. - Created the Office of Federal Contract Compliance Programs (OFCCP) to ensure compliance with the law. - Requires government agencies, and federal contractors or subcontractors with contracts in excess of $50,000 and 50 or more employees, to have an affirmative action plan. Uniform Guidelines on Employee Selection Procedures, 1978, and Interpretive Guidelines on Sexual Harassment, 1980 These regulations are issued by federal agencies as interpretations of the various civil rights laws. Although these rules do not have the weight of law, the courts typically look at them when making rulings. Family Medical Leave Act The Family Medical Leave Act requires employers of more than 50 people to provide a minimum of 12 weeks unpaid leave to care for a newborn or adopted child, or to care for themselves or family members due to a serious medical condition. While on leave, the employee can continue health coverage and is entitled to job protection. 484

Part B: Human Resources Management

Task 414

Employment or termination at will, although not technically an EEO issue, is changing the American workplace. No longer can employees be regarded as either permanent or probationary. The appropriate terminology is now regular and introductory. When employees work without a contract (as most employees do), the traditional western belief (stemming from English law) is that they can be terminated for good cause, bad cause, or no cause at all. EEO law and union contracts have both served to attack this privilege. Today, although no federal law provides broad protection to an individuals right to remain employed at one company, court decisions and individual state laws have done so. The concept of the implied contract has replaced at-will employment. Any type of management promise may severely limit an organizations right to terminate an employee. Unless a specific term of employment for an employee is desired, no corporate documentation should refer to a term of employment. This begins with the employee handbook and continues with all corporate records. Permanent means that employees are here forever. Management should train all managers so that they make no promises of guaranteed employment. The letter of employment should be written by the human resource management department. Some companies use an at-will clause in their employment applications. Managers must be careful when they speak to employees, especially when hiring. It is easy to be excited about a new recruit. Promising promotions and implying what will happen is not only unfair to the recruit, but it will tie the organizations hands later on. The effective manager will outline a number of different career paths, while continuing to state ambiguities about how things change and that he or she must wait and see. 2) AFFIRMATIVE ACTION This is a poorly understood phrase. As originally intended by Executive Order 11246, Affirmative Action requires employers to take additional steps to attract, retain, and develop skills of protected group members that the organization has a record of discriminating against. The organization must attempt to achieve a work force comprised of approximately the same percentage of the various minority groups (including women) that exist in the available labor market. The enactment of this provision is an extension of Executive Order 11246, issued in 1965, which required organizations doing business with the government to prepare a written affirmative action plan to accomplish this same result. The development of a sound written affirmative action program is seen as a way for an organization to fulfill a social responsibility. In addition, some organizations today view affirmative action as a preventive approach to minimize the possibility of problems with the EEOC and also possible legal actions. In most organizations, responsibility for developing policies and procedures for complying with EEO regulations is assigned to the human resources department. An effective purchasing manager, however, should work closely with human resources to ensure uniformity and compliance across the organization. Additionally:

485

Task 414

Module 4 Affirmative action is only required of federal agencies and certain federal contractors (see above), unless state or local law requires additional coverage. Affirmative action never requires the hiring, promotion, etc., of any individual who is not qualified for the job. However, organizations covered under Executive Order 11246 are required to make a good faith effort to actively recruit those with low representation. Organizations that are required to have an Affirmative Action Plan (AAP) establish affirmative action goals, identifying how the percentage of protected group members in the organization will change in the time period of the AAP. Court rulings have specifically stated that quota systems are illegal.

3)

AMERICANS WITH DISABILITIES ACT The Americans with Disabilities Act (ADA) was passed in 1990 to protect the rights of disabled persons. The ADA prohibits employers from discriminating against applicants and employees in all terms and conditions of their employment (for example, hiring and promotions). Additionally, organizations must ensure that their facilities are accessible to persons with disabilities. The ADA prohibits discrimination against people with disabilities. Some disabilities are spelled out in the law itself, while others are simply implied. The law defines a person with a disability as one who has a physical or mental impairment that substantially limits one or more major life activities, or one who has a record of such impairment or who is regarded as having an impairment. An example of an employee having a record of having a disability may be someone who sought counseling when going through an episode of depression. An example of an employee being regarded as having a disability may be someone with a limp and the manager believes that person cannot do his or her job when the employee believes he or she can do the job. In order to be protected, the individual must be able to perform the essential functions of the job and meet the qualifications with or without a reasonable accommodation. An individual who can perform the essential functions with reasonable accommodation cannot be discriminated against. Note, the organizations definition of an unreasonable accommodation or one that will cause the organization undue hardship, may not be viewed the same by the governmental agencies that are reviewing the situation. Undue hardship means the costs (both intangible and tangible) would cause an extreme burden on the organization.

In determining if the organization can accommodate a disabled individual, a manager should consider: Would hiring this individual cause a direct threat to the individual or others without significant risk to the health or safety of others that cannot be eliminated by reasonable accommodation? Is the individual qualified to do the job with, or without, reasonable accommodations?

486

Part B: Human Resources Management 4) COURT RULINGS PERTAINING TO EMPLOYMENT DISCRIMINATION

Task 414

Managers, with support from their human resources departments, have a responsibility to keep up-to-date on rulings pertaining to employment discrimination. Adopting a proactive stance will help ensure that the manager is meeting the obligations that are part of hiring, supervising, coaching, and implementing programs to prevent and respond to discrimination or harassment. Due to the complexity of this area it is often wise to rely on legal counsel for the interpretation of court rulings and how, or if, they must be applied in the managers work environment. Internet sites with information on court cases include www.fairmeasures.com, www.shrm.org, and www.findlaw.com. 5) SEXUAL HARASSMENT A) Definitions Sexual harassment is a special case of employment discrimination. It falls within Title VIIs prohibitions against illegal discrimination in employment. Although most sexual harassment cases involve a male perpetrator and a female victim, sexual harassment can be same-sex harassment or female perpetrator and male victim. Most sexual harassment cases fall within one of these categories: Unwelcome sexual advances, requests for sexual favors, or any other verbal or physical conduct of a sexual nature. This is often referred to as quid pro quo, where a sexual favor is granted in return for some reward, or a refusal is attached to some punishment. Direct causality of a human resource action such as promotion or termination is not required for a case to be a quid pro quo. What is important is that there is a belief on the part of the victim that the sexual favor is part of the terms and conditions of employment. In addition, if someone else believes that they were adversely affected because someone gave in to sexual harassment, he or she may also file charges of discrimination. Intimidating, hostile, or offensive work environment. This situation may range from seemingly innocuous banter or touching in the workplace, to highly offensive pictures, jokes, and physical contact. Frequency and severity of the abuse is important, as is the victims attempts to stop the behavior. Once management is aware of claims, the burden for investigation and changed behavior shifts to management.

B)

Procedures Generally, the organizations first defense is to have a policy and training program that specifically communicates the fact that any type of harassment will not be tolerated. The policy should also inform the victim about what to do in the event he or she feels harassed or discriminated against. If the victim feels comfortable, he or she should first confront the harasser and tell the individual to stop the offensive behavior. If the behavior continues, the victim should notify management, human resources, or the individual who has been designated within the organization to investigate complaints. Once management is aware of an incident, it must investigate and respond. If found guilty, management (including the individual manager) can be required to pay the victim compensatory and punitive damages, as well as back pay. This process must remain confidential. 487

Task 414 Some ways to prevent sexual harassment and discrimination include:

Module 4

Make sure employees are aware of the organizations policies on discrimination and harassment. Treat others as they would like to be treated. Display professionalism at all times in the work environment. Always remember to think before you speak or act. Be mindful of your surroundings and how your behavior may be affecting others.

BIBLIOGRAPHY Bordner, D.A. Sexual Harassment: What Managers Should Know, NAPM Insights, March 1995, p. 28. Patrick, B.H. Relying on Common Courtesy and Manners, NAPM Insights, June 1994, p. 6. Ross, H.J. How Diverse is Diversity? NAPM Insights, September 1993, p. 5.

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C.P.M. STUDY GUIDE INDEX

C.P.M. Study Guide Index

A ABC concept, 296-297 Acceptance, of an offer, 89, 138 Acceptance testing, 203 Accounting, 12, 149-151, 210, 280-281 Acknowledgment, 89, 98 Act of God clause, 105 Activity-based costing, 24-25, 65, 73 Activity-based management, 73 Actual authority, 104 Actual damages, 140 Ad valorem duties, 38 Adjustment clauses, 94 Administrative budget, 11-12 Administrative costs, 24 Adverse impact, 483 Affirmative action, 485-486 Age Discrimination in Employment Act, 484 Agency, law of, 103-104 Agreement, defined, 89 All-in-costs, 21 Alternative dispute resolution, 143-144 American National Standards Institute (ANSI), 192, 323, 329-330 American Society for Testing and Materials (ASTM), 323, 330 Americans with Disabilities Act (ADA), 56, 464, 486 Annual Work Plan (AWP), 113 Anticipation inventories, 291 Anticipatory breach, 129 Anticipatory repudiation, 130 Antitrust, 52-54, 106, 109, 156, 183-184, 265 Apparent authority, 93, 104 Appeals, from suppliers, 255-256 Appreciation, of assets, 283 Approval requirements, for federal contracting, 115-116 Approved suppliers, 61 Arbitration, 143 Asset management, 196 Assignment of rights, 107 Associations, 263-264 Audit, of the purchasing function, 417-422, 428 Audit trails, 311-312 Authority, 10, 93, 103-104 Authority, delegation of, 443-444 Authorization, 8-10 Automatic storage and retrieval systems (ASRS), 300 B Back orders, 123 Balance of trade and payments, 372 Balance sheets, 71 Bankruptcy, 135-136 Barter, 42, 320-321, 376 Battle of the forms, 96-98 Behavioral theories of management, 448 Benchmarking, 82, 205-206, 334, 428-429 Best and final offer, 181-182 Bid bonds, 57, 136 Bid deposits, 58 Bid protests, 59, 101, 107, 255-256 Bidders list, 42 Bids/bidding, 47-60 cancelation of, 51 competitive, 9-10, 15-16 contents of, 51 debriefing, 100 electronic, 49, 52 errors and mistakes, 58-59, 129 evaluation of, 63-68 informal, 15, 48 notice of awards, 100 pre-bid conferences, 49-50 problems with, 58-59 procedures for, 50-51 regulations affecting, 52-57 sealed, 47 491

Index specifications, 63 two-step, 48 types of, 47-49 Bilateral contracts, 89 Bill of materials (BOM), 7, 438 Blanket orders, 9, 16-17 Bond markets, 283 Bonds, 57-58, 136-137 Brand names, 32, 327 Breach of contract, 129-131, 139-140 Break-even analysis, 270 Bribery, 154 Budget deficits, 373 Budgets, 11-12, 215, 431-435 Bundling, 394 Business cycles, 370 Business plan, 389, 391, 401 Buy American Act, 55 Buyer rotation, 403, 472-473 Buyers market, 4, 284 Buying strategies, 347-356 Buying to requirements, 347 C Cannibalization, 320 Capacity, 70-71, 243, 308, 353, 378-379 Capital budget, 11, 435 Capital equipment purchasing, 24, 65, 215, 439 Carrying costs, 38, 306-307 Cash discounts, 250 Cash flow, 287, 305 Cash-flow budgets, 434 Categorical method, of rating suppliers, 83-84 Cause-and-effect diagrams, 200, 206 Center for Advanced Purchasing Studies (CAPS), 423 Central tendency, 383 Centralized purchasing, 288, 337, 405-406 Certifiable suppliers, 62 Certification of purchasers, 456, 460, 476 of suppliers, 61-62, 203, 349 C&F, 135 Chain of command, 444 Change index, 367 Change management, 227-228 492 Change orders, 117, 439 Check request form, 439 Check with order, 18 Choice of law/forum, 105 CIF, 134-135 CISG, 39, 56, 107 Claims, 107 Clayton Act, 53, 106 Coincident index, 378 Collusion, 109 Co-located engineering, 241 Commodity councils, 337 Commodity exchanges, 349-350 Commodity markets, 285-286 Commodity plans, 390 Commodity segmentation, 393-394 Commodity speculation, 307 Commodity strategies, 393-394 Communication interdepartmental, 212-214 keys to effective, 265-266, 414-416 managing data, 413-414 methods of, 410-412 Competent parties, as a contract element, 90 Competition effects on purchasing, 35-36 levels of, 244 limited, 8-9, 165-166 Competitive bidding, 9-10, 15-16; See also Bids/bidding Competitive proposals, 47-48, 247 Compound duties, 38 Computers, 185-198 applications, 191-196 hardware, 187-188 impact of, 197-198 software, 188-189, 196 terminology, 185-187 training, 196-197 uses, 189-190 Concurrent engineering, 343 Confidentiality, 27, 59, 86, 153-155, 234-235, 359 Conflict of interest, 59, 155 Conflict resolution, 121-122, 143-144, 420-421 Consequential damages, 108, 130, 132, 140

Index Consideration, 89 Consignment, 17, 297, 313, 349 Consortia; See Cooperative purchasing Consortium buying, 53, 183-184 Consumer Price Index, 377 Consumer Product Safety Act, 132 Contingency planning, 127, 308, 390, 401 Contingency theories of management, 449 Continuous improvement, 236-237, 333-334, 446 Contract administration, 111-122; See also Contracts administrative responsibilities, 116-117 conflict resolution, 121-122, 143-144 defined, 111 federal government system, 115-116 financial responsibility, 114-115 flowchart of process, 111-113 supplier management, 118-120 Contract by conduct, 98 Contractor Purchasing Systems Review (CPSR), 116 Contracts; See also Contract administration change orders, 117 closeout, 117 compliance, 113-114 cost reimbursable, 15-16, 95, 111, 113115, 148 defined, 16, 89 elements of, 89-90 fixed-price, 15, 93-94, 114, 147-148 indefinite delivery, 15-16, 95-96, 111-112 legal issues; See Legal issues long term, 338, 351 oral, 18, 52, 90-91, 96-97 price adjustment clauses, 116-117 single source, 109-110, 167-168 sole source, 109-110, 168, 182 suspension of, 141 termination of, 140-141 written, 90-91 Control charts, 200 Convention on Contracts for the International Sale of Goods (CISG), 39, 56, 107 Cooperative purchasing, 39, 42, 183-184, 264, 285, 288, 337-338 Copyright, 99, 106 Corporate purchasing, 289 Corrective action for employees, 421-422, 477-482 for suppliers, 199-201 Correlation/regression analysis, 382 Cost avoidance, 335 Cost containment, 335 Cost control programs, 335-342 Cost plus contracts, 95 Cost reduction, 335 Cost reimbursable contracts, 15-16, 95, 111, 113-115, 148 Cost sharing contracts, 95 Cost-based pricing, 244-246 Cost/benefit analysis, 21-26 Cost/price analysis, 64-65, 172-173 Cost/price overruns, 147-148 Cost-ratio method, of rating suppliers, 85 Costs activity-based, 24-25, 65, 73 administrative, 24 allocation of, 23-24 carrying, 38, 306-307 direct, 21-22 expediting, 127 follow-on, 21 forms, 440-441 indirect, 22-24 in-house estimates, 9 life-cycle, 24, 65 opportunity, 24 ordering, 307 overhead, 23-24, 306 overruns, 147-148 relevant/irrelevant, 23 standard, 21, 431 stockout, 307 supplier, 72-73 total cost, 4-5, 21, 24, 65 transportation, 38, 66-67, 127-128 Counteroffers, 89, 97-98 Countertrade, 375-376 Cover, 139 Cover damages, 130 Cpk, 32, 74, 206 493

Index CPM diagrams, 120 CPSR, 116 Cradle-to-grave, 321 Credit card purchasing, 9, 18-19 Cross-functional teams, 215 Cure, 139 Currency markets, 283 Customer satisfaction, 427-428 Cycle counting, 312 Cycle time reduction, 70, 216, 237, 241, 299, 359 Cyclical systems, 295 D Damaged goods, 149 Damages, 108, 110, 130-132, 139-140 Data management techniques, 413-414 Data warehouse, 413 Database management systems (DBMS), 191 Davis-Bacon Act, 54 Dealers agreement, 96 Debit/credit memos, 149 Debriefing, of unsuccessful bidders, 59, 100 Decentralized purchasing, 337, 403, 405-406 Decision support systems (DSS), 195 Decisionmaking process, 391 Decision-tree analysis, 353-355 Decoupling, 291 De-escalation clauses, 94, 352 De-expediting, 125 Default, of contracts, 139 Defense Acquisition Regulations (DAR), 54 Deflation, 378 Delegation of authority, 443-444 Deliveries, 69, 82, 123-128 Delphi method, 382 Departmental strategies, 394-395 Dependent demand systems, 300-303 Depreciation, 279, 283 Design for manufacturability, 343 Design specifications, 31 Differentiation, 274 Digital signatures, 190 Direct costs, 21-22 Direct-release system, 9, 19 Disaster planning, 401 494 Discounts, 249-250 Discrimination in employment, 487 in pricing, 53 Disparagement, 154 Disparate treatment, 483 Disposal, 200-201 Dispute resolution, 121-122, 143-144 Disqualified suppliers, 62 Distribution Requirements Planning (DRP), 191, 197, 302-303 Distributors, buying from, 36-37 Diversity, 447, 459 Dollar averaging, 351 DRP, 191, 197, 302-303 Dry lease, 276 Duties, 38 E Early purchasing involvement (EPI), 210, 213, 345, 357 Early supplier involvement (ESI), 210, 241, 344, 357-359 Economic indexing, 379 Economic indicators, 371-373, 378 Economic order quantity (EOQ), 293-294 Economic price adjustment clauses, 116-117 Economics, 368-376 factors influencing, 374-376 governmental policies, 373 price indices, 376-377 Economies of scale, 291 EDI, 49, 52, 191-194 EFT, 151 Elasticity, of supply and demand, 368 Electronic commerce, 49, 191-194 Electronic data interchange (EDI), 49, 52, 191194 Electronic expediting, 126 Electronic funds transfer (EFT), 151, 194 Electronic mail, 190, 411-412 Electronic purchasing, 7, 49, 91 Emergency purchases, 13, 39 Employee orientation, 471-472 Employment discrimination, 487 Empowerment, 451

Index Encryption, 190 Engineering/design department, 209-210 Enterprise Requirements Planning (ERP), 191 Enterprise Resource Planning (ERP), 188, 303 Environment, 153, 317-318, 320, 376 EOQ, 293-294 EPA, 153 Equal Employment Opportunity Act, 464 Equal Pay Act, 464, 484 ERP, 189, 191, 303 Errors, 129, 149 Escalation, 93-94 Escalation clauses, 351-352 Ethics bidding process and, 50-51 confidentiality, 27, 59, 86, 155, 234-235 conflict of interest, 59, 155 gratuities, 155 laws governing, 154 Principles and Standards of Ethical Supply Management Conduct, 155, 157-158, 265 Evaluated receipts, 151 Exchange rates, 37, 283, 307-308, 372 Executive Order 95-507, 11 Expansion, 370 Expediting, 123-128 Expense allocation, 12 Express warranties, 145 Expression of interest, 51 Extranet, 194-195 F False Claims Act, 54 Family Medical Leave Act, 484 Federal Acquisition Regulations (FAR), 12, 54 Federal Civil Rights Act, 464 Federal government, contract administration and, 115-116 Federal Trade Commission Act, 54 Fiduciary duty, 103 Financial Accounting Standards Board (FASB), 280-281 Financial leases, 275-276 Financial tools, 25 Financing/leveraging strategies, 283-289 Firm-fixed-price contracts, 93, 114 First-in, first-out (FIFO), 303 Fitness for intended purpose, 145-146 Fixed costs, 22 Fixed-price contracts, 15, 93-94, 114, 147-148 Flat organization, 445 Flexibility, 70 Flexible budgets, 435 FOB, 66-67, 134, 137 Follow up, of orders, 123-128 Force majeure, 104-105 Forecasting, 367-386 commodity, 286 economics and, 368-376 factors affecting, 384-386 methodologies/techniques, 381-383 purpose of, 367-368, 401 sales, 3 sources of data, 379-381 volume, 355-356 Foreign Corrupt Practices Act, 55-56 Form, fit, and function, 341 Form and format standards, 323 Formal bidding, 15 Formal work groups, 451 Forms, 437-441 Forward buying, 4, 347 Free on board, 66-67, 134 Free trade, 375 Freedom of Information Act, 256 Free-market economy, 368 Freight terms, 66-67, 134-135, 137 Frustration of purpose, 140-141 Full and open competition, 35 Full payout lease, 275 Functional rotation, 472-473 Funding sources, 12 Future, 350 Future delivery contracts, 353 G Gantt charts, 120 Gap analysis, 471 General Agreement on Tariffs and Trade (GATT), 56 Genuine assent, 89 Global markets, 369-370 495

Index Goals, 397, 399 Government standards, 328-329 Gratuities, 155 Gross domestic product (GDP), 372-373 Group dynamics, 451-453 Group leadership, 453 Group purchasing organizations (GPO), 42, 264, 288 Groupthink, 218 H Hand-to-mouth buying, 347 Hazardous/regulated materials, 110, 135, 317318, 321 Health and safety laws, 153 Hedging, 350-351, 395 Histograms, 200 Historically underutilized businesses (HUB), 39, 182-183, 257-260 Hold harmless clause, 108, 132 Human resources management affirmative action, 485-486 Americans with Disabilities Act (ADA), 56, 464, 486-487 employment discrimination, 487 equal employment opportunity, 483-485 legal issues, 463-464 measuring departmental performance, 423-430 measuring performance of personnel, 465470 performance problems, 477-482 professional certification, 456, 460, 476 promotion, 460-462 selection and recruitment, 455-459 sexual harassment, 487-488 supervising and leading, 443-453 termination of employees, 462-463 training; See Training I Implicit price deflator, 377 Implied warranties, 145-146, 155-156 Import/export quotas Incentive programs, 447 Incidental damages, 139 496 Income statements, 71 INCOTERMS, 66-67, 107 Indefinite delivery contracts, 15-16, 95-96, 111112 Indefinite quantity contracts, 96 Indemnification, 107-108, 132 Indirect costs, 22-24 Industrial Espionage Act, 154 Industry standards, 30 Inflation, 371, 378 Informal bidding, 15, 48 Informal work groups, 451-452 Information technology; See Computers Inspection, 31, 141-143, 203-204 Inspection documents, 438 Insurance, 107-108, 133-134 Integrated supply, 36, 269, 297-298, 356 Intellectual property, 99-100, 105-106, 153, 359 Interest rates, 286, 371, 377-378 International Organization for Standardization (ISO), 75, 317-318, 323, 330-331 International purchasing costs, 38 countertrade, 375-376 duties, 38 ethics, 156-157 exchange rates, 37, 283, 308, 372 INCOTERMS, 66-67, 107 legal issues, 39, 55-56, 107 locating suppliers, 41 payment process, 37-38 transportation, 38, 66-67, 107 International standards, 33, 329 Internet, 18, 40, 42-43, 49, 194-195, 412 Interview process, 458-459 Intranet, 7, 194-195, 412 Inventory classifications of, 291-292 functions of, 291 Inventory management, 291-322 ABC concept, 296-297 carrying costs, 38, 306-307 consignment, 17, 297, 313, 349 cycle counting, 312 disposition of surplus/obsolete, 315-322 financial implications, 305-308

Index order timing, 298-299 order-point systems, 292-295 perpetual vs. periodic, 311 safety stock, 298 stockless purchasing, 17-18 stores systems, 299-300 supplier managed inventory, 19, 297-298, 350 turnover, 82, 300, 305 valuation methods, 303-304 Investment recovery, 226, 315 Invitations for bids (IFB), 47 Invoice problems, 148-149 ISM Report on Business , 367, 379-380 ISO 9000, 66, 75, 204-205 ISO 14000, 317-318 J JIT, 18, 295-296, 348-349 JIT II, 296 Job analysis, 455 Job description/specifications, 456 Job rotation, 403, 473 Joint ventures, 39 Just-in-time (JIT), 18, 295-296, 348-349 K Kaizen, 206, 446 Kanban, 19, 296 L Labor and materials bonds, 136 Labor hours contracts, 111 Labor laws, 76-77 Lagging index, 378 Last runs, 4 Last-in, first-out (LIFO), 303 Late bids, 58 Late deliveries, 123-124 Latent conditions, 146 Law of agency, 103-104 Law of mistakes, 129, 137-138 Lead buying, 403 Lead divisional purchasing, 288, 337 Leading index, 378 Leadtimes, 10-11, 13, 68, 70, 167, 299, 384 Learning curve, 65 Learning organization, 230-231 Lease/purchase, 275-276 Leasing, 275-281 Legal counsel, role of, 104 Legal issues, 103-110 acceptance, 89, 138 antitrust, 52-54, 106, 109, 156, 183-184, 264 bankruptcy, 135-136 battle of the forms, 96-98 breach of contract, 129-131, 139-140 confidentiality, 27, 59, 153-155, 234-235 contract modification, 138-139 damages, 108, 110, 130-132, 139-140 disposal of materials/equipment, 321 electronic purchasing, 91 environmental laws, 153 equal employment opportunity, 483-485 force majeure, 104-105 health and safety laws, 153 inspection/rejection rights, 141-143 intellectual property, 99-100, 105-106, 153 international purchasing, 39, 55-56, 107 law of agency, 103-104 leases, 280-281 letters of intent, 92-93 liability, 131-135, 321 offer and acceptance, 48, 89, 97 oral contracts, 18, 52, 90-91, 96-97 ownership of goods, 144 rejection, 138, 141-143 selecting/dismissing employees, 463-464 Statute of Frauds, 52, 90-91 tax laws, 286 terms and conditions, 57, 64, 92, 96-98, 117-118 unionization, 76 warranties, 145-146, 155-156, 321 Legality of purpose, 90 Lessors, types of, 277 Letter contracts, 96 Letter of credit, 37, 58 Letter of intent, 16, 92-93 Leveraged lease, 276 Liability, 108, 131-135, 321 Libel and slander, 154 497

Index Licensing, 100, 225 Liens, 150-151 Life cycle, product, 283-284 Life-cycle costs, 24, 65 Life-of-products, contracts for, 348, 352 Limitation of liability, 108 Limited competition, 35, 165-166 Limits of authority, 103-104 Line-item budgets, 434 Liquidated damages, 110, 130-131, 139 Litigation, 144 Local suppliers, buying from, 37 Logistics, 127-128, 211, 224-225 Long term contracts, 351 Long-term contracts, 338 Long-term forecasting, 381-382 M Macro vs. micro forecasting, 382 Maintenance, repair, and operating supplies (MRO), 11, 17, 36, 327 Make or buy, 3-4, 69, 269-274 Malcom Baldridge National Quality Award, 75 Management change, 227-228 delegation of authority, 443-444 group dynamics, 451-453 MBO, 445-446 risk, 225-226, 242 styles of, 450-451 theories of, 448-451 Management by exception, 119 Management by objectives (MBO), 445-446 Management controls, 401-402 Management information system, 211 Manifesting, 317 Manufacturers, buying direct from, 36-37 Manufacturing resource planning (MRP II), 301-302 Margin analysis, 25 Market conditions, 283-284 Market drivers, 243 Marketing/sales, 210 Master lease, 276 Material requirements planning (MRP), 19, 191, 301 498 Material return form, 439 Material safety data sheets (MSDS), 317 Materials budget, 11 Materials management, 224 Matrix organization, 447-448 Mediation, 143 Meetings, 261 Mentorship, with suppliers, 240-241 Merchandising, 211, 225 Merger/integration clauses, 108 Minority-owned business enterprises (MBEs), 11, 39, 41-42, 156, 257-260 Mirror Image Rule, 97 Mission statements, 397-398 Money supply, 371 Monopoly, 244, 369 Monopsony, 244 MRO, 11, 17, 36, 327 MRP, 19, 191, 301 MRP II, 301-302 Multiple sourcing, 35-36 Multi-year contracts, 352-353 Mutual assent, 89 N NAFTA, 56, 121 National Institute of Standards and Technology (NIST), 329 National Labor Relations Act, 464 Negotiations, 165-184 defined, 19-20 documentation of, 183 factors favoring the use of, 15-16, 49, 165168 objectives of, 169-170 philosophies, 175-176 preparing for, 168-175 tactics, 179-181 teams, 170-171 Nonconformance form, 439 Non-conforming goods, 142, 200-201 Non-disclosure agreement, 359 Non-disclosure agreements, 27, 154 Non-performance, 149 North American Free Trade Agreement (NAFTA), 56, 121

Index Notice of awards, to bidders, 100 Notices to Proceed (NTPs), 113 O Objectives of employees, 465 of the organization, 397-398, 423 Obligation documents, 90-96 Obsolescence, 278, 309 Obsolete materials, 292, 315-322 Occupational Safety and Health Act, 464 Offer and acceptance, 48, 89, 97 Offer responsiveness, 63-64 Offset, 376 Oligopoly, 244, 369 Oligopsonistic, 244 Online bidding, 49 On-time delivery, 82 Open orders, 123, 149 Open-to-buy budget, 435 Operating lease, 275 Operational analysis, of a bid, 64 Operational theories of management, 448 Operations/production, 210 Opportunity costs, 24 Oral contracts, 18, 52, 90-91, 96-97 Order timing, 298-299 Ordering costs, 307 Order-point systems, 292-295 Orders back, 123 blanket, 9, 16-17 change, 439 late, 123 open, 123, 149 standing, 18 Organization standards, 328 Organizational standardization, 323 OSHA, 153, 464 Outplacement, 463 Outsourcing, 197, 269-274, 350, 447 Overages, 149 Overhead costs, 23-24, 306 Ownership issues, 144 P Pareto charts, 200, 206 Paretos Rule, 296-297 Parol evidence rule, 108-109, 145 Partial payments, 147 Partial payout lease, 275 Patent infringement, 133 Patents, 99, 105-106 Pay on production, 151 Payment, 37-38, 114, 135, 147-151 Payment bonds, 58 Payment terms, 287 Penalty clauses, 110, 139 Perfect competition, 244, 369 Performance bonds, 57-58, 136 Performance measurement of the department, 423-430 of purchasers, 465-470 Performance specifications, 31 Perpetual inventory systems, 311 PERT, 33, 120 Petty cash, 18 Pipeline inventories, 291 Plant visits, to suppliers, 77-78, 126-127, 235, 364 Point-of-sale replenishment, 298 Policies/procedures, 404-405 Pool buying, 337-338 PPV, 21 Pre-bid conferences, 49-50 Preferred suppliers, 61 Pre-qualified suppliers, 61-62 Pre-sale technical service, 64 Presentations, making effective, 261-263, 410412 Price adjustment clauses, 116-117 Price analysis, 65 Price elasticity, 370 Price indexes, 196, 248, 376-377 Price/pricing, 243-250 analysis, 247-250 cost-based, 245-246 discounts, 249-250 discrimination, 53 elasticity, 370 errors in, 129 499

Index escalation, 93-94, 352 factors affecting, 243-244 measuring price paid, 426 methods of determining, 244-250 regulations affecting, 52-57 target, 338 Principles & Standards of Purchasing Practice, 155, 157-158, 265 Privatization, 269, 272-274 Problem solving, 219, 421 Process capability (Cpk), 32, 74, 206 Process certification, 75 Process control, 74 Process improvement, 333-334 Process mapping, 241-242 Procurement cards, 9, 18-19 Producer Price Index (PPI), 196, 376-377 Product co-development, 359 Product development, 215, 236, 241, 308, 343345, 357-362 Product differentiation, 30 Product interchangeability standards, 323 Product liability, 132-133 Product life cycle, 283-284 Productivity, 70, 447 Product/service substitutions, 64 Profit analysis, 65 Profit center, 429-430 Profit planning, 391 Profitability ratios, 25 Program Planning Budgeting Systems (PPBS), 434-435 Program/project budgets, 434-435 Progress payments, 135, 147 Project management, 33, 195, 220 Promissory Estoppel, 91 Promotion, 460-462 Prompt Payment Act, 54 Protected group, 483 Protectionism, 375 Protest resolution, 101 Pull signals, 19 Purchase option, 353 Purchase order draft, 18 Purchase orders, 16, 91-92, 96-97, 160, 438 Purchase price variance (PPV), 21, 435 500 Purchase requisitions, 7-10, 12-13, 404, 437-438 Purchasing collection/dissemination of data, 362-365 methods of, 16-20 primary functions of, 223-226 role in the organization, 226-227 Purchasing councils, 403 Purchasing department audit of, 417-422, 428 budget, 431-435 communicating with management, 409-416 forms, 437-441 goals and objectives, 398-399, 424-425 interdepartmental communication, 212214 measuring performance of the department, 423-430 policies/procedures, 404-405 profit center concept, 429-430 relationship with other departments, 209214 sales and marketing interaction, 308-309 workload distribution, 402-403 Purchasing services, 8, 33, 97, 118, 224 Q QFD, 207 Qualified products list, 344 Quality analyzing supplier, 73-75 assurance, 203-205 benchmarking, 82, 205-206 continuous improvement, 236-237 corrective action, 199-201 defect rate, 82 defined, 203 inspection, 31, 141-143, 203-204 ISO 9000, 66, 75, 204-205 purchasings role in, 339 QFD, 207 root cause analysis, 199-200 SPC, 31-32, 74, 207 TQM, 69, 73, 205-207 Quality Function Deployment (QFD), 207 Quantity discounts, 249 Quotation, requests for, 47

Index R Rate of return model of pricing, 245-246 Ratification, 9, 104 Receiving, 150 Receiving documents, 438 Recession, 370 Reciprocity, 53, 156, 235-236 Reclamation, 320 Reconcile inventory discrepancies, 311-313 Record systems, 311 Records management, 159-161, 225, 440 Recruitment, of personnel, 455-459 Recycling, 320 Reengineering, 406-407, 447 References, for potential employees, 457-458 Reformation, 144 Regression analysis, 382 Regulations, importance of tracking, 287 Rejection, of goods, 138, 141-143, 149 Relevant/irrelevant costs, 23 Remedies, 139-140 Renegotiation, 144 Repudiation, 129-131 Requests for Information (RFI), 47, 49 Requests for proposals (RFP), 47 Requests for qualifications (RFQ), 47, 49 Requests for quotation (RFQ), 47 Requisitions authorization of, 8-10, 437 information required, 8 prioritization of, 12-13 procedures for controlling, 404 traveling, 7, 438 types of, 7 Rescission, of contracts, 139 Reservation of rights, 110 Resource Conservation and Recovery Act (RCRA), 110, 321 Restraint of trade, 52-53, 106, 183-184 Retention, of forms, 440 Return on assets employed (ROAE), 25 Return on investment (ROI), 25, 305 Return on total assets (ROTA), 25 Reverse marketing, 240 Revocation of acceptance, 131, 138, 143 Rework, 200 Right to subcontract, 100 Right to work laws, 76 Rightsizing, 447 Risk management, 225-226, 242, 285-286 Risk of loss, 134-135, 137 Risk/value matrix, 284 Robinson-Patman Act, 53, 106 Root cause analysis, 199-200 Royalties, 100 Rush orders, 13, 123-125 S Safety stock, 298 Sale and leaseback, 276 Sales, 251-254 Sales forecasts, 3 Samples, from suppliers, 27-28, 32 Sampling, statistical, 205 Scrap, 142, 226, 317 Sealed bidding, 47 Seasonal discounts, 250 Seasonal requirements, 13 Securities Exchange Commission (SEC), 72 Self-directed workgroup, 450-451 Sellers market, 284 Semi-variable costs, 23 Service Contract Act, 54 Services, purchasing of, 8, 33, 97, 118, 224 Sexual harassment, 487-488 Sherman Antitrust Act, 52-53, 106, 156 Shipping terms, 66-67, 134-135, 137 Ship-to-stock, 205 Shortages, of supply, 4 Short-term forecasting, 381-382 Shrinkage, 306 Simplification, 323-324 Single sourcing, 35, 109-110, 167-168 Six-Sigma, 74, 206-207 Small Business Act, 55 Small businesses, buying from, 39, 156, 182183 Smoothing, 383 Socially and economically disadvantaged suppliers, 11, 257-260 Society of Automotive Engineers (SAE), 323, 329 501

Index Socioeconomic goals, 11 Sole sourcing, 35, 109-110, 168, 182 Solicitation; See Bids/bidding Source code escrow accounts, 106 Sources existing vs. new, 43-45 internal vs. external, 40 large vs. small, 37 locating, 40-43, 257-259 manufacturer vs. distributor, 36-37 multiple, 35-36 national vs. local, 37 single, 35, 109-110, 167-168 sole, 35, 109-110, 168, 182 SOW, 8, 29, 33, 63, 118, 120, 439 Span of control, 444 SPC, 31-32, 74, 207 Specifications defined, 29 design, 31 evaluation of, 63 format, 8 performance, 31 problems with, 32-33 procedures for developing, 29-30 quality and, 31-32, 358 Speculative buying, 347 Speed to market, 345 Sponsor/mentor system, 472 Spot buying, 351 Spot price, 350 Standard costs, 21, 431 Standard requisitions, 7 Standardization, 30, 323-331, 335, 395 Standards, 30, 33, 73, 192, 323-331, 335, 417 Standing orders, 18 Statements of work (SOW), 8, 29, 33, 63, 118, 120, 439 Statistical Process Control (SPC), 31-32, 74, 207 Statistical Quality Control (SQC), 74 Statistical sampling, 205 Statistical tools, 206-207 Statute of Frauds, 52, 90-91 Stockless purchasing, 17-18 Stockout costs, 307 Stores management systems, 299-300 502 Straight markup, 245 Strategic alliances, 237-240 Strategic planning, 4, 389-395 Strategy, defined, 3 Subcontracting, 100 Supplier certification, 61-62, 203, 349 Supplier clinics, 235 Supplier inquiries, 255-256 Supplier lists, 61-62 Supplier managed inventory, 19, 297-298, 350 Supplier management, 118-120 Supplier mentorship, 241 Supplier partnerships, 9, 36, 61-62, 237-240 Supplier samples, 32 Supplier strategies, 392-393 Supplier surveys, 234 Supplier visits, 69, 77-78, 126-127, 235 Suppliers approved, 61 certifiable, 62 certified, 61-62, 203, 349 developing relationships with, 233-235 disqualified, 62 evaluation of potential, 69-79 financial evaluation of, 25, 71-72, 135-137 financing, 288 labor status, 76-77 locating, 40-43, 257-259 management analysis of, 75-76 measuring performance, 81-87, 118-120, 127, 195 methods of rating, 82-85 payment issues, 147-151 preferred, 61 pre-qualified, 61-62 Suppliers market, 4 Supply base rationalization, 394 Supply chain management, 211, 224-225, 241242, 356 Supply management, 224 Supply strategies, 3 Surety, 57-58 Surplus, 226, 315-322 Surveys internal customer, 213-214 supplier, 234

Index Suspension, of contracts, 141 Systems contracts, 9, 17 Systems generated requisitions, 7 Systems theories of management, 449 T Taft-Hartley Act, 76 Target cost/price, 338 Task order and delivery order contracts, 96 Tax laws, 286 TCO, 21, 24 Teams, 215-221 advantages/disadvantages, 217-218 cross-functional, 215 evaluation of, 219-220 negotiation, 170-171 phases of, 218 problem solving, 219 project management, 220 purchasings role, 216-217 types of, 215-216 Technical analysis, of a bid, 64 Technical competition, 35 Termination of contracts, 140-141 of employees, 462-463 Termination for convenience, 109, 140 Terms and conditions, 57, 64, 92, 96-98, 117118 Theory X/Y, 450 Time and material contracts, 96, 111, 114-115 Time-based systems, 295 Time-series analysis, 382-383 Tolerance stack-up, 206 Total acquisition cost method of supplier rating, 85 Total cost concept, 4-5, 21, 24, 65 Total cost of ownership (TCO), 21, 24 Total Quality Management (TQM), 69, 73, 205207 Toxic Substances Control Act, 110 Trade Agreements Act of 1979, 55 Trade deficit, 375 Trade discounts, 249-250 Trade secrets, 153 Trademarks, 99 Trading partner agreements, 91 Training continuous professional development, 462, 473-475 delivery methods, 231, 473-475 determining needs, 471 development of manuals, 229 inhouse vs. outside, 197 initial job training, 471-473 measurement of effectiveness, 230 selection of personnel, 232 of suppliers, 234-235 Transportation costs, 38, 66-67, 127-128 delivery problems, 137 deregulation, 371 international, 38, 66-67, 107 ownership of goods, 144 risk of loss, 134-135, 137 terms, 66-67, 134-135, 137 Traveling requisitions, 7, 438 Trend analysis, 383 Turnover, of inventory, 82, 300, 305 Two-step bidding, 48 U Unauthorized buying, 9 Uncertainty, of supply and demand, 291 Underwriters Laboratories (UL), 323, 331 Uniform Commercial Code (UCC), 18, 52, 56, 203, 280-281 Uniform Trade Secrets Act (UTSA), 153 Unilateral contracts, 89 Unionization, 76 Universal theories of management, 448 V Valuation methods, of inventory, 303-304 Value analysis, 215, 339-341 Value engineering, 339-341 Value-based pricing, 246 Variability, 383 Variable costs, 22 Variable pricing, 246 Vendor managed inventory (VMI), 19, 297-298, 350 503

Index Verbal contracts, 18, 52, 90-91, 96-97 Vision statements, 397-398 Volume purchase agreements, 347-348 W Waiver, 139 Walsh-Healy Public Contracts Act, 54-55 Warranties, 145-146, 155-156, 321 Weighted-point method, 83 Wet lease, 276 Win-win negotiating, 176 Women-owned business enterprises, 11, 257 Working capital, 305 Workload distribution, 402-403 World Trade Organization (WTO), 56 Wrongful rejection, of goods, 131 Z Zero-based budgets, 434

504