Chapter 1

Purchasing
and Supply
Management

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc., All Rights Reserved.
 Learning Objectives and Outcome

• Supply Management Terminology

• The Size of an Organization’s Spend and Financial Significance
• Supply Contribution:
• The Operational versus Strategic Contribution of Supply
• The Direct and Indirect Contribution of Supply
• Supply Qualification and Associations
• Challenges Ahead.

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc., All Rights Reserved.
 Purchasing and Supply
Management
• History
• Although some people may view interest in the performance of the supply
function as a recent phenomenon.
• It was recognized as an independent and important function by many of the
nation’s railroad organizations well before 1900. Yet, traditionally, most firms regarded
the supply function primarily as a clerical activity.
• During World War I and World War II, the success of a firm was not dependent on
what it could sell, since the market was almost unlimited. Instead, the ability to obtain
from suppliers the raw materials, supplies, and services needed to keep the factories
and mines operating was the key determinant of organizational success.
• During 1950s & 1960s many company elevated the chief purchasing officer to top
management status

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc., All Rights Reserved.
 History
• As the decade of 1970s organization faced two vexing problems: (shortage of all basic raw
materials & the price)
• The Middle East oil embargo during the summer of 1973 intensified both the shortages
and the price escalation.
• These developments put the spotlight directly on supply, for their performance in
obtaining needed items from suppliers at realistic prices spelled the difference between
success and failure.
• At the decade of the 1990s, it become clear that organizations must have efficient &
effective supply function.
if they were to compete successfully in the global marketplace.
• The early 21st century has brought new challenges in the areas of sustain-ability, supply
chain security, and risk management .

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc., All Rights Reserved.
 Effective is doing the right things while being Efficient is doing things right.

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc., All Rights Reserved.
 Evolution of the term “Supply Chain”

SUMED
Pipeline
1980 - date

1914 - 1977

The terminology “Supply chain” was first introduced by Oliver and

Weber in their journal publication of year 1981.
Developed countries realized the importance of assessing the risk of
global supply after the Arab oil ban of year 1973.
The US and European Manufacturing outsourcing to China and
India have fueled the need to focus on Supply Chain Management.
6
World wide Crude Oil Logistics

SUMED
Pipeline

7
 Supply Management Terminology
• Purchasing, supply management, and procurement: are used
interchangeably to refer to the integration of related functions to provide
effective and efficient materials and services to the organization.
• Purchasing: a major function of an organization that is responsible for
acquisition of required materials, services, and equipment of the right
qualities, in the right quantities, at the right prices, at the right time, and on
a continuing basis
• Supply management: the identification, acquisition, access, positioning and
management of resources the organization needs or potentially needs in
the attainment of its strategic objectives

• The supply function continues to evolve as technology and the worldwide

competitive environment require innovative approaches

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc., All Rights Reserved.
 What is Procurement
• Procurement is concerned with acquiring (procuring) all of the goods, services and work
that is vital to an organization
• The process of procurement is often part of a company's strategy because the ability to
purchase certain materials will determine if operations will continue.
• A business will not be able to survive if it's price of procurement is more than the profit
it makes on selling the actual product
• the procurement process:
1. The recognition of need,
2. The translation of that need into a commercially equivalent description,
3. The search for potential suppliers,
4. The selection of a suitable source,
5. The agreement on order or contract details ex; Disposals and other related functions,
price negotiation, financing
6. The delivery of the products or services,
7. the payment of suppliers.

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc., All Rights Reserved.
 Selecting Vendors

Establishing Payment Terms

Procurement
Involves

Strategic Vetting

Selection & Negotiation of Contracts

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc., All Rights Reserved.
 What is Purchasing
Further responsibilities of supply may include:
1. Receiving, inspection,
2. warehousing,
3. inventory control,
4. materials handling,
5. packaging scheduling,
6. in- and outbound transportation
7. traffic, and disposal.
8. the organization’s customers and their customers and their suppliers’ suppliers.
9. This extension represents the term supply chain management, where the focus is on
minimizing costs and lead times across tiers in the supply chain to the benefit of
the final customer.

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc., All Rights Reserved.
 What is the Difference Between Procurement and Purchasing?
Conclusion

• Procurement deals with the sourcing activities, negotiation and strategic selection
of goods and services that are usually of importance to an organization.
• Purchasing is the process of how goods and services are ordered.
• Purchasing can usually be described as the transactional function of procurement
.
for goods or services
• Because procurement is an umbrella term that includes several core business
functions it should be considered a core part of any organization’s corporate
strategy .
• Procurement & purchasing as a discipline
1. Responsible
2. Professional
3. Effective
4. Efficient

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc., All Rights Reserved.
 PRINCIPLES OF PURCHASING
(Quantity, Quality, time, price &place)

RIGHT
QUALITY

RIGHT RIGHT
SOURCE QUANTITY

PRINCIPLES

RIGHT RIGHT
PLACE PRICE

RIGHT
TIME

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc., All Rights Reserved.
 Supply Management Terminology
• Operational role of supply: the transactional, day-to-day operations
traditionally associated with purchasing; characterized as trouble avoidance.

• strategic responsibilities: Strategic sourcing focuses on long-term supplier relation

and commodity plans with the objectives of identifying opportunities in areas such
as cost reductions, new technology advancements, and supply market trends.

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc., All Rights Reserved.
 Supply Management Terminology
• Lean purchasing or lean supply management: refers primarily to a manufacturing
context and the implementation of just-in-time (JIT) tools and techniques to ensure
every step in the supply process adds value, that inventories are kept at a minimum
level, and that distances and delays between process steps are kept as short as
possible.
• Lean is the elimination of waste in all forms

• Example : Toyota Production System identifying seven wastes: Overproduction,

Inventory, Waiting, Transportation, Extra Processing, Motion and Defects
• Waste is activity that doesn't add customer-perceived value to the product/service.
• https://youtu.be/kce2L23yLcw

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc., All Rights Reserved.
 Supply Management Terminology
• Logistics management: is that part of supply chain management that plans,
implements, and controls the efficient, effective forward and reverse flow and
storage of goods, services, and related information between the point of origin and
the point of consumption in order to meet customers' requirements
• Supply influences a number of logistics-related activities such as how much to buy
and inbound transportation. With an increased emphasis on controlling materials
flows, the supply function must be concerned with decisions beyond supplier
selection and price

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc., All Rights Reserved.
 What is the difference between Logistics
and Supply Chain?
World War II, US Logistics to
Normandy

United States Army Logistics: The Normandy Campaign, 1944

by Steve R. Waddell

The terminology “Logistics” was developed by the US

Department of Defense (DOD) during World War II
Logistics is classified into three different components:
 Logistics of material flow
 Logistics of information flow

 Logistics of cash flow Origin:

The Roman Logistica

Supply Chain is the integration of the three logistics components

McGraw-Hill/Irwin 17
Copyright © 2011 by The McGraw-Hill Companies, Inc., All Rights Reserved.
 Supply Management Terminology
• Supply chain management: The design and management of seamless,
value-added processes across organizational boundaries to meet the real
needs of the end customer.

• Value chain:
• primary and secondary support activities that can lead to
competitive advantage.
• tracing the various moves and transformations of a product or
service and identifying the costs added at each successive stage. Also
called supply network or supply web.
•

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc., All Rights Reserved.
 The Size of The Organization’s Spend
And Financial Significance
The Financial impact of the corporate spent is
often illustrated by:
•Profit-leverage-effect.
•Return-on-assets.

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc., All Rights Reserved.
 The Size of The Organization’s Spend And
Financial Significance
Profit-leverage effect of supply savings is measured by the increase in
profit obtained by a decrease in purchase spend.

Example:
Organization Revenue $100 M. Purchasing $60 M.
Profit $8 M before tax.

• 10% reduction in purchasing would result in 75% increase in profit,

giving a leverage of 7.5.
OR
• To achieve $6 M increase in profit by increasing sales, assuming the
same percentage hold, require an increase of $75 M in Sales.
Which is more likely to be achieved?
A decrease in purchasing expenditures directly increases profits before taxes
(assuming no decrease in quality or purchasing total cost)

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc., All Rights Reserved.
 The Size of The Organization’s Spend And
Financial Significance
Return on assets (ROA) Effect: A profitability ratio used to measure how hard the
assets of an organization are working. ROA is calculated by dividing the net income by
total assets.
A high ROA indicates managerial expertise in generating profits with lower
spending (ROA ratios vary from one industry to another)

Example:

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc., All Rights Reserved.
 Return on assets (ROA) Effect
Total asset= 500000 $
Inventory value=30% of total asset
=0.3×500000=150000 $
inventory value after reduction 10%=150000*0.9=135000 $
the rest of asset=500000-150000=350000 $
Total asset after reduction 10% inventory=350000+135000=485000 $
ROA = Net Profit / Total Assets
50000 / 500000= 10%

ROA(after reduction in inventory)

100000 / 485000 =20.6%

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc., All Rights Reserved.
 Supply Contribution

The three major perspectives on supply are:

1. Operational versus strategic.

2. Direct and indirect.
3. Negative, neutral, and positive.

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc., All Rights Reserved.
 Purchasing’s Operational and Strategic
Contributions

1. Supply Contribution

Operational Strategic
•Trouble prevention(avoidance) •Opportunity Maximization
•Meet minimum expectations (opportunistic )
•Executing current tasks as •New and better solutions
designed

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc., All Rights Reserved.
 Purchasing’s Operational and Strategic
Contributions
2. Supply Contribution

Direct Indirect
Bottom-Line Enhancing Performance
Impact(net earnings or of Others
net profits). (supply’s role as information
Inventory reduction & source)
purchasing saving
measurable and tangible intangible contributions

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc., All Rights Reserved.
 Purchasing’s Operational and Strategic
Contributions

3. Supply Contribution

Negative Neutral Positive

Operationally acceptable
Operationally deficient Operationally acceptable
Strategically acceptable
Strategically deficient Strategically deficient
Directly acceptable
Directly deficient Directly acceptable
Indirectly acceptable
Indirectly deficient Indirectly deficient

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc., All Rights Reserved.
 SUPPLY QUALIFICATIONS AND
ASSOCIATIONS
Education:
• College degree in business administration or management
required for entry-level supply.
• Undergraduate degree major in Purchasing/Supply/Supply
Chain/Logistics Management as part of the bachelor in
business administration degree.
• Certificate programs or some courses in supply, for either
full- or part-time students.
• Supply chain management as part of a master of business
administration degree program

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc., All Rights Reserved.
 SUPPLY QUALIFICATIONS AND
ASSOCIATIONS
Professional Associations :
• In the United States, the major professional association is the Institute
for Supply Management (ISM), founded in 1915 as the National
Association of Purchasing Agents.
• ISM launched the Certified Professional in Supply Management (CPSM)
program in May 2008.
• There are more than 40 member national associations (worldwide)
representing approximately 200,000 supply professionals.

(Read P.17 &18)

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc., All Rights Reserved.
 CHALLENGES AHEAD
There are at least six major challenges facing the supply
profession over the next decade:

1. supply chain management (the small firms, extra value )

2. measurement (senior management, various supply experiments)
3. Risk management (most critical issues increasingly global …supply
interruptions, Financial and exchange rate fluctuations, lead time variability
and single sourcing has also created the increased risks for supply disruptions.
4. Sustainability (pressures from government and consumer groups ex,
greenhouse gas reductions and cuts to overall energy consumption )
5. growth and influence
6. and effective contribution to corporate success (how happy are the other
corporate team members to have supply on their team? Do they see supply’s
role as critical to the team success?
McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc., All Rights Reserved.
 CHALLENGES AHEAD
growth and influence:
1. Supply can grow in the percentage of the organization’s total spend such as
real state, consulting, marketing spend, relocation, marketing spend with
advertising.
2. The growth of the supply responsibilities for example, customer bid
support, and involvement with new business development.
3. The type of involvement of supply in what is acquired and supply chain
responsibilities. (What are the supply implications of this decision? )
4. The involvement in corporate activities from which it might have been
previously excluded. (Make or buy, forecasting, in-and outsourcing might be
expected, ) other activities such as strategic planning, mergers and
acquisitions, visionary task forces, and initial project planning

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc., All Rights Reserved.
 Questions for Review and Discussion
1. Is purchasing a profession? If not, why not? If yes, how will the profession,
and the people practicing it, change over the next decade?

2. What is the profit-leverage effect of supply? Is it the same in all

organizations?

3. Differentiate between purchasing, procurement, logistics, supply

management, and supply chain management.
4. How does supply management affect return on assets (ROA)? In what
specific ways could you improve ROA through supply management?

Answers to be submitted in the Moodle

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc., All Rights Reserved.