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November 08, 2011

Eliminate, Simplify, Integrate

BY Jovy J. Jader

The Death of Traditional Purchasing

In an age when firms face intense local and global competition, and product value is the name of the game for customers, the success of any finished products relies greatly on the worth of its components. And as more products and operations are outsourced, the ratio of purchased cost to internal cost continues to rise. Thus, the importance of purchasing as a function in the supply chain has grown from that of traditional buyer to strategic partner.

Purchasing practices in the traditional sense have been tagged negatively by the following:

Uncertain need dates. A need date is the date an item needs to be made available for use in a supply chain operation, as in production or logistics. Unfortunately, operations managers confuse a need date either as a planned schedule to restore inventories to targeted levels or as a contingent time to ensure component availability for production. Muddled need dates result in purchased receipts coming in either too early or too late, which leads to confusion with vendors on deliveries and unnecessary rework.

Too much paperwork. Purchasing departments deal with staggering quantities of paperwork, which can include requisitions, quotes, purchase orders, and contracts, not to mention back-and-forth vendor qualifications for quality assurance and engineering or technical specifications. Imagine a firm that buys 10,000 items three (3) times a year. That translates to 30,000 requisitions and purchase orders. If there are two (2) vendors bidding for each item, purchasing professionals would be dealing with 60,000 quotations. No wonder purchasing can be cumbersome if not expensive overhead-wise.

Over-focus on price. Many firms still gravitate toward awarding purchasing contracts on the basis of price despite the abundance of expert advice that suggests otherwise. Price plays a strong influence on purchasing decisions even as supply chain managers argue for the big picture of total cost and end-product value. I’m reminded of a firm that bought a printer for the cheapest price only to discover that its replacement ink cartridge came at a cost of almost 40% of the printer price.

More and more firms have repositioned their purchasing functions to vitally contribute to: (1) profit via minimizing the total cost of products, (2) cash flow via inventory reduction, and (3) customer satisfaction via better vendor quality and service.

Information technology platforms such as Enterprise Resource Planning (ERP) have greatly enhanced purchasing management efficiency via less paperwork and better communication between vendors and firms. Nevertheless, purchasing professionals need to adopt certain principles if they wish to step away from the muddle of traditional purchasing:

Analyze purchasing spend. Instead of the day-to-day management of pending orders and items for delivery or past due, purchasing professionals need to spend more time understanding what drives their purchasing spend. What are the critical purchase items which would pose risks to the firm’s ability to serve its customers? Which items are good candidates for long-term contracts? Which few items, when given more focus and attention, would generate significant improvement in cost, quality, and service?

Develop collaborative long-term partnerships. Strategic partnerships with key vendors improve supplier response, quality, and service. Building partnerships expands a firm’s sphere of influence from its internal operations to the greater supply chain. Visible benefits include lower inventories due to better coordination and less cost from a higher level of teamwork and trust.

Award the business based on total cost of ownership. Purchasing professionals should be privy to the total cost and value of the end-product rather than be limited to the acquisition cost of component items. They should be allowed to see the costs of storage, the cost of having inventories, and inherent losses from obsolescence and poor quality. This is the concept of the total cost of ownership where information on the value of a firm’s product is shared.

In one multinational firm, purchasing managers view vendors’ accounts payable and in-transit shipment information on computer screens, which normally are reserved for financial managers and logistics planners. The purchasing managers seek discounts on the contract prices of items sourced from international suppliers and want to leverage the cost of transit of incoming shipments with longer payment terms or price discounts. Incentives would be offered for faster shipments.

It is in this sense that purchasing managers share ownership in the value of finished products. It advances the purchasing profession from mere traditional seekers of bargains to that of strategic collaborative players in the supply chain.

Jovy Jader is a consultant and regional speaker on supply chain management. He has directed and implemented supply chain management projects both local and international, which have resulted in company-wide improvements in inventory, total cost, response time, quality, and on-time delivery. Mr. Jader was formerly with Procter & Gamble Philippines and Coopers & Lybrand/PricewaterhouseCoopers. For questions or comments, e-mail jovy@highimpactasia.com.