Procurement Management

Procurement is the act of acquiring goods and services from outside the organization. The procurement process includes planning for the procurement, solicitation of the sources for the desired product or services, and defining the requirements, source selection, administration, and closeout. In a free market economy, the competitiveness of the product or service that is sought will have a great deal to do with the type of contract that can be written between the two parties. In other words, we must decide whether or not to acquire something, when and how to do it, and how much to acquire.

Commodities

Items that are sought that are widely available and for all intents and purposes identical are considered to be commodities. In the sale of commodities there are many people offering the same product. In all cases the products are identical for the purpose for which they are intended. Familiar examples of commodities are corn, wheat, and soybeans, but electrical components that are made by a number of different firms and are relatively standardized are also commodities.

Since there are many suppliers of the same commodity, competition drives the price to the lowest level. A supplier will not be able to sell a commodity if there is someone else offering the same thing for a lower price.

According to the theory of supply and demand, the price of a product rises as the demand increases. The higher price for the commodity causes other producers to enter the market until the supply increases to meet the additional demand. As demand for a commodity decreases, the price that people are willing to pay for the commodity decreases. Producers of the commodity leave the market, and the supply is reduced to a level that meets the demand. Eventually, in a completely competitive environment, the supply and demand will reach equilibrium.

In contracting for commodity items, the details of the contract and the description of the item being contracted for are relatively standardized. Most of the people in the business of selling commodity items will standardize on the purchase process. With standardization it becomes easier to purchase an item from competing vendors and know that the item will be the same from each vendor.

Unique Products and Services

When we are dealing with unique products and services there will be some risk involved on the part of the buyer and supplier that will modify the truly competitive environment. Unlike commodity buying and selling, the uniqueness of a project will make it impossible to compare the offerings of competitors, and many criteria other than price must be used.

Projects are frequently this type of purchased item. It is necessary to evaluate many different criteria among the offerings that are made. There will be differences in quality, performance, timeliness, and cost for similar projects from different suppliers.

Perfect competition, as in the commodities' type of purchasing, naturally drives the price to the lowest level that allows the producers to make an acceptable profit. In an effort to make a higher profit many companies try to add features to their product that make it unique. Once uniqueness has been established, it is possible to price the unique item higher than it would be in a competitive commodity situation.

Forward Buying

Forward buying is the process of buying items in anticipation of their need. As with all things, it is important to consider the cost and benefits that can result in doing this.

The advantages of forward buying are that there is some protection against running out of an item. In the world of production control this is called a ''stock out.'' Frequently, the vendor will also give a discount for buying larger quantities. The shipping cost will usually be lower to ship a large number of items in one shipment than to make several small shipments. This serves to reduce the cost of the product being made.

On the negative side of forward buying there is the risk that the large number of parts will become obsolete before they are used, as, for example, in the case of a company that purchased a large quantity of buggy whips right before the invention of the Ford automobile. Forward buying requires that the larger inventory of parts be stored in the facility as well. In most businesses floor space is valuable and better used for operating the business than for storing parts.

Blanket Orders

Blanket orders are a form of forward buying. A blanket order allows the buyer to take a quantity discount without actually taking delivery on the large quantity. In a blanket order the buyer agrees to buy all of the material that they need of a certain item from one or more vendors for a specified period of time. The vendor then agrees to sell the items at a discount price based on the expected quantity needed over that period of time.

As the need for the material items occurs, requests to the vendor are filled and tracked against the blanket order. At the end of the time period, the total quantity ordered and delivered to the buyer is checked against the blanket order quantity, and a cash payment is made to the buyer if the quantity has been higher and to the supplier if the quantity is lower.

This arrangement has advantages for both parties. The buyer is assured of a reliable supply of parts because he or she has made a long-term commitment to the vendor. The buyer gets a quantity discount without having to stock a large inventory of parts.

The supplier has the advantage of having a committed customer for the duration of the blanket order. This commitment allows the supplier to plan his or her own operation with the reliability that the customer will continue to purchase these items for a period of time. With the confidence that there will be future business the supplier may be able to invest in equipment and facilities to make these parts for the buyer.

Split Orders

Splitting orders is a process of dividing work between two or more vendors of an item. The purpose of splitting an order is to reduce the risk that the parts may not be delivered on time or may not be of acceptable quality. The advantage of this process is that the probability of one vendor supplying acceptable parts is increased.

Let's say, for example, that we have two vendors that have a 90 percent probability of delivering on time. We could increase the probability of having at least one vendor deliver on time if we give half of the order to each vendor. This is the probability of one vendor or the other delivering. (This is the ''addition rule'' we discussed in Chapter 7, Risk Management.) The probability of one or the other vendor delivering on time is the probability of one vendor delivering plus the probability of the other vendor delivering given that the first vendor failed to deliver.

The probability of one vendor delivering is 90 percent. The probability of the second vendor delivering given that the first vendor failed to deliver is the probability of both the first vendor not delivering and the second vendor delivering.

Probability of A or B delivering = Probability of A delivering (90%) + Probability of A not delivering (10%) times the probability of B delivering (90%)

We can increase the probability from 90 percent to 99 percent by splitting the order between the two vendors.

Splitting the order does not come without a cost. The quantity discount from either of the vendors will be reduced, since only half the quantity is being purchased from each. One of the vendors may not have the same quality as the preferred vendor, and this may add rework to the process.

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