PART II

PROCUREMENT
MANAGEMENT
 2.1 Meaning of Procurement

 Procurement function comprises the essential

activities associated with the acquisition of material
used in the operation of an organization.

 Because all organization requires supplies of

materials, purchasing functions is common in almost
all organizations.
 Functions of Procurement

 Generally: Purchasing is the activity of buying

things that a company needs, such as material, parts
and equipment’s.

 Specifically: Purchasing is the activity of acquiring

materials with

 right quality, quantity, price, source

and time.
There are two basic types of procurement in
business

 Purchasing for sale is performed primarily by

merchants.

 Purchasing for consumption or conversion

performed primarily by manufacturing firms.
2.2 Objectives of Procurement

General More specific

managerial level operational level
 General managerial level:

 From their prospective, relates to the five rights the managements expects the
procurement department to achieve:

 the right quality

 the right quantity
 From the right supplier
 At the right time
 At the right price
 Functional level
 To support company operations with uninterrupted flow of
materials
 To procure material wisely
 To keep inventory investment and inventory losses at a practical minimum.
 To develop effective and reliable source of supply.
 To develop good relationship with supplier community and
good continuing relationship with active suppliers.
 To achieve maximum integration with other departments
of the firm.
 To hand the purchasing functions proactively: in a
professional, cost effective manner.
 2.3 Procurement Policies
 Purchasing polices are aids for purchasing
decisions.
Procurement Policies

Centralize
Decentralized
d
 I. Centralized Procurement

 Centralization exists when the entire procurement function is

made the responsibility of a single person i.e. procurement
personnel.

 This person is held accountable for performance of purchasing

activities. 

 This type procurement is suitable for

 Industries having single plant or

 Number of plants nearby locations, which are manufacturing

similar products at various plants.
 Merits
 Quantity discount

 Simplifies purchasing procedures

 Simplifies the payment of invoices

Demerits
 Slow decision making

 May not satisfy departments interest

 Does not spread risk

 II. Decentralized Procurement

 Decentralization of purchasing occurs when personnel

from other functional areas-operation marketing,
finance, HRM, and others decide unilaterally on
sources of supply or negotiate with suppliers directly
for major purchases.

 This type procurement is suitable for

 Industries having plants at different location and

manufacture variety of product.
Advantage
 Improved efficiency
 Faster procurement
 Diversity of risk
Disadvantage
 Losing control
 Difficulty of obtaining discounts
 3.4 Procurement Procedures
Procurement procedure/purchasing cycle/purchasing process comprises the following
basic steps.
1. Recognize, define and describe the need (purchase requisition)
2. Verification of purchase requisition
3. Request for Quotation (Bids, price quotation)
4. Evaluation and selection of suppliers
5. Issuance of purchase order
6. Follow up and expediting
7. Receipt, and inspection of materials
8. Checking of invoices and bill payment
9. Completion of the records and files
10. Evaluation of the purchase process
1. Recognize, define and describe the need
(Purchase Requisition)
 The need for purchase typically originates in one of a firm’s
operating department or in its inventory control section.

 The purchasing department is usually notified of the need

by one of the three basic methods;

 Standard Purchase Requisition (SPR)

 Material Requirements Planning (MRP)

 Bill Of Materials (BOM)

 a) Standard Purchase Requisition (SPR)
 It is an internal document numbers serially for requests originating in the operating
departments.

 SPR is used for materials that have to be ordered from suppliers.

 This Requisition form includes;

 Material name/code identification

 The amount needed

 Desired delivery date

Sample Standard Purchase Requisition
.
Date___________________ S.No________________
Date by which material is required_______
Department___________

Item No Description Qty.

____________ _______________
Inventor Authorized by
 b) Material requirement Plan (MRP)

 MRP is a technique for determining the quantity

and timing for the requisition of dependant
demanded items.
c) Bill of Materials (BOM)
 It is a complete list of all items incorporated in to
a finished product with specifications and
quantity required of each item of materials.
 2. Verification of Purchase Requisition

 It involves the procurement department

responsibility for
 Checking the document for accuracy and
completeness

 Determining that the need has adequately defined

 Ensuring that the appropriate method of description

has been used.
3. Request for Quotation (Bids, price quotation)

 A request for quotation is a process of

initiating potential suppliers that are willing to
compete to supply the required material.

 The request depends on the type of materials

because some materials need “Request for
quotation” and others not.
Competitive bidding is dictated by five criteria.

 The Birr value of the specific purchase must be large enough to

justify expense to both buyer and seller.

 The market must consist of an adequate number of sellers.

 The sellers that make up the market must be technically

qualified and willing to compete.

 The specification/description is clear to both the buyer and seller

 The time available must be sufficient for using competitive

bidding
Competitive bidding should not be used:

 When it is impossible to estimate costs with a high degree

of certainty.

 When price are not the only importance variable.

Example, quality, schedule and service also variables of
equal importance

 Repetitive and routine purchase

 Items of low value

 Single/few suppliers
Invitation For Bids (IFB) or Request For Proposal
(RFP) or Request For Quotation (REQ) includes:
 Purchase description /specification
 Delivery schedule (timing and mode)
 Special terms/conditions
 Eligibility of suppliers
 Bid security (Bid bond and Performance bond)
 Any amendments
 Address for further information
 Purchasing company
 Term of payment
 Last date of submitting bids
 Time, date and place of opening the bid
4. Evaluation and Selection of suppliers
 There are two primary supplier sources:
Internal
External
 The internal source: - is the company itself.
 The external sources: - are the outside suppliers and the
market place.

 Thus, when evaluating and selecting a supplier, a buyer

should try to find a supplier who would meet the needs of
the quality, quantity and delivery time (purchase
description and specification) at lower cost
5. Issuance of Purchase Order (PO)

 Once a supplier has been selected, the procurement

department prepares and issues a serially numbered
purchase orders.

 Purchase order (PO) is the instrument by which goods

are procured to fill a requirement.

 Once accepted, it has the legal force of a binding

contract.
The essential information in every purchase
order includes.
 Name and address of purchasing company
 Identifying order number
 Date, number and address of the vendor
 General instructions
 Delivery date required
 Shipping instructions
 Descriptions of materials ordered and the quantity
 Price and discounts
 Terms and conditions
 Signature
 6. Follow-up and Expediting

 Follow up: The objective of follow up is to see that the right quality and quantity of

materials is received at the right place and time. This means

ensuring that
 Quotations are received on time

 Replies are received on time from suppliers.

 The supplier(s) acknowledge the order and accept the delivery schedule given.

 Materials are received according to the delivery schedule

 Expediting: It is speeding up or accelerating the receipt of the item before the agreed
upon time.
7. Receipt and Inspection of Orders

This procedure involves the following activities:

 Unpacking and checking the materials
 Completing the receiving report and distribute to each departments.
 Receive incoming goods
 Sizing the delivery notice presented by the carrier
 Identify and record all incoming materials
 Report their receipt to the purchasing department
 Make prompt desperation of the goods to the appropriate department
Inspection:
 Whenever it is necessary to take technical inspection, we may make
sample/all inspection. This depends on the nature of material and/or
the description of those materials.
8. Checking of invoices and Bill payment
 A simultaneous check and review of purchase order the receiving
report and the invoices.

 By checking the receipt report against the purchase order the

purchaser determines whether the quantity and type of
ordered is received.

 Comparing the invoice with the purchase order and receiving

report the firm verifier that the supplier’s bill is correctly
priced and that if covers the proper quantity of acceptable
material
9. Completion of the records and files (Closing the order)
 Closing the order simply entails a consolidation of all documents and
correspondence relevant to the order.
 The completed order is filled in the close order file. In most
forms, a completed order consists of:
 The purchase requisition (PR)
 Copy of the purchase order (PO)
 Acknowledgment
 Receiving report
 Inspection report
 Any notes and any notes/correspondence inventorying to the
order
 The completed order file thus, constitutes records of all
activities encompassing the total purchasing cycle.
 10. Evaluation of the purchase process

 This stage refers to the evaluation of the

purchase process against the objective and
requirement of the overall organizational
system.
 3. 5. Supplier Evaluation & Selection

I. Survey Stage

 All possible sources are explored to obtain information about

available suppliers and searching for all likely suppliers. Potential
sources to a buyer in establishing a list of potential suppliers
include;
 Supplier information file - Trade journals
 Trade exhibits - Company personnel
 Other purchasing depts. - Personal contacts
 II. Inquiry (analysis) Stage
 Inquiry stage involves prequalification of potential sources which narrows the filed
sources from possible sources to acceptable sources.

 Factors to be considered:

 Location

 Services, which include arrangement of transport,

insurance, after sale service- installation,
maintenance, repair warranty, discounts, convenient
packaging, on time delivery, purchase reforms.
 III. Selection and Negotiation

 Leads to the issuance of Purchase order and both subjective

(qualitative) approach and quantitative approach can be
used.

IV. Experience Stage

 This stage involves follow up to ensure that the supplier(s)
meet the terms and conditions of the contract and rating and
evaluating supplier performance.
 3.6 Supplier Evaluation Criteria

 A supplier or vendor rating system is a continuous

management process, designed to measure, evaluate and
improve supplier performance, enabling companies to make
informed future sourcing decisions.
 The buyer evaluate the suppliers based on four rights

 The right quality

 The right quantity
 At the right time
 At the right price
 Cont’d…..
 Quality: the buyer compares the delivery to the
agreed requirements (specifications).
 Quantity: the buyer compares the delivery to the agreed amounts.

 Delivery Reliability: the date, a delivery is made should be checked against the agreed
date.

 Price: the buyer compares actual prices against the agreed price.

 After evaluating the supplier based on the above criteria, supplier that fulfills all
requirements will be selected.
 3.7 Make or Buy Decisions
 An organization may be in need of different raw
materials, parts, components or products
which are processed and/or assembled into a
finished product.

 In sourcing a part or product, it either purchases

from an outside source or the firm may seek to
undertake production.
 Cont’d….

Accordingly any firm has the following three basic

alternatives.

 Buy the parts or products completely from an outside

source

 Make all the parts or products within the firm

 Buy some materials or products and make the

remaining.
 Factors influencing make-or-buy decisions

 Two factors stand out above all other when considering the make
or buy decisions; Cost and availability of production capacity.

 There are also certain factors on which make or buy decisions can
be based.

 Quantity, quality, availability and flexibility of supply, control

of trade secret and patents, research and development, and
alternative sources of supply are the important factors.
Considerations which favor making
 When the cost to make is substantially lower or less than the cost to
buy

 When the suppliers are unable to meet specification in terms of

quality and performance

 When the company has idle capacity like idle space, skilled human
resource, equipment

 Need to exert direct control over production and/or quality

 Design secrecy required or trade secrets,

 When the experience is well suited to make

Consideration which favor buying
 When the cost to buy is substantially lower or less than the cost to
make

 Suppliers research and specialized know-how

 Small volume requirements

 Limited production facilities

 Desire to maintain a multiple-source policy

 When other companies hold trade secrets or patents on a required

material so that it is not possible to make it
Examples for Make-or Buy decision
 Example 1:ABC Automobile factory produces luxury automobile.
It has an opportunity to produce tires which are currently
purchased at 80 Birr each. Annual demand for the product
depends largely on economic conditions and this has been
estimated at 37,500.

 If the company produces the tire itself, it must renovate an

existing work area and purchase machines which will result in
annual fixed costs of Birr 80,000. Variable costs for labor,
materials and over head are estimated as Birr 60 per tire.
 Required:

 Should the company make or buy the cases?

 At what volume of production is it more profitable to produce

in-house rather than purchase from an outside supplier?

 Solution:
 Total cost of buying TCB = Price x Demand
= Birr 80 x37, 500
= Birr 3,000,000
 Total cost of making, TCM = TVC (D) + TFC
= variable cost/unit* D+ TFC
= 60 x 37,500 + 80,000
= Birr 2,330,000
 Decision  to make (produce)
 Amount saved  Birr. 3,000,000 – 2,330,000 = Birr 670,000
 Breakeven Point
 The breakeven point is the volume of production where the total costs to make equal
the total cost to buy
 Total Cost of Make = Total Cost of Buy
VC + TFC = TCB
60 + 80,000 = 80
20 = 80,000
Q = 4000 tires
 For volume below 4000 tires  buy
 For volume above 4000 tires  make
 Example
 Toyota Automobile factory produce different automobiles.

 The tires are currently purchased at Birr 42 each. The company is considering
producing in house.

 The labor, materials and overhead costs are estimated as Birr 28 per tire and fixed
costs would be Birr 58,800. Demand is estimated as shown:

 Required
I. Should the company produce the tires?
II. How much is saved by the company?
III. At what volume of production it becomes profitable to
produce them rather than buy from a supplier?
Demand D Probability P(D)
2000 0.05
3000 0.10
4000 0.30
5000 0.40
6000 0.15
 Demand, D =2000 x 0.05 + 3000 x 0.10 + 4000 x 0.3 +5000 x 0.4 + 6000 x 0.15
 = 4500 tires
 Cost to buy: Birr 420 x 4500 = Birr 189,000
 Cost to make: TVC + TFC
 = 28 x 4500 + 58,800 = Birr 184,800
 Decision: to make
 Saved amount: 189,000 – 184,800 = Birr 4,200
 TCM = TCB
 28 + 58,800 = 42
 42 – 28 = 58,800
 14 = 58,800
 = 4,200 tires
 Cont’d….
 For volume below 4,200 tires  buy
 For volume above 4,200 tires  make
Thank You Much For Your
Time!

Further reading is MANDATORY to have a

comprehensive understanding of the subject.

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