CHARACTERISTICS OF PURCHASING
Purchasing is determining the need, obtaining the right material/product or supply in the right quality, in the right quantity; at the right price, at the right time, from the right source at the right place. The above definition defines the characteristics that a good purchase should have.
Buying the Right Quality:
The term quality, according to Giwa – Asaju (1989) refers to the suitability of a product for its intended use. The term quality is relative or subjective. What is quality in one product may not be in another product. Some quality characteristics include:
The quality that is required in a product at a given period is known as “specification quality”. . This is what denotes the reliability or the probability that the product will form under stated conditions for the indicated period i.e. that the product is not defective.
Defects in products may be classified under three headings:
a) Critical defects: These are’ dangerous or could hamper performance. In expensive products e.g. aircraft manufacturing, the manufacturers must adhere to the specifications or product design for good performance.
b) Major Defects: These are defects that can materially increase the likelihood of failure to perform or reduce usability e.g. worn out of parts.
c) Minor Defects: These are defects that may not materially affect product usability but may affect the level of performance,
Buying the Right Quantity: Which is the Right Quantity?
In many cases, about a third of a company’s investments is in the form of inventories – raw materials, parts and finished products. There is but one right quantity to purchase for any given transaction, but the determination of the right quantity is not easy. To arrive at the right quantity, the scientific purchaser applies some mathematical tools. The application of this tools bring us to the realm of inventory management.
Inventory management tries to answer the following questions essential for decision-making:
a) How much should be ordered or bought?
b) When should an order be made?
c) When should quantity discounts be taken?
d) When should cash discounts be taken?
e) At what price should surplus-inventory be sold?
f) Which are the non-profit items?
g) How much of a speculative risk item should be purchased?
Determining the Right Quantity:
In determining the right quantity to be produced, the officer must consider the following:
The demand for the final product,
The inventory policy of the firm
The production process -job, batch or process
Market conditions – financial, political etc.
The cost of acquisition
The holding cost
The cost of stockouts,
Determining the Economic Order Quantity (EOQ):
The EOQ is that size of order that minimizes the total cost of acquiring and hold stock. In many forms, about 30% to 50% of the total worth of the firm may be in inventory.
This is why some refer to inventory as the lifeblood of the business, Too much inventory is as bad as too little. The former results in tied up capital while the later results ads to cost of operations.
To determine the EOQ algebraically, we use the formula.
Where 2z = Total annual usage
C0 = Cost of Ordering
Cc = Carrying cost
C = Price
Example: A firm has an annual usage of 6000 units of a component purchased at N2 each. Ordering cost amount to N15.00 per order and an annual carrying cost of N0.05 per component.
Determine the EOQ.
Solution; Using Formulae
Total annual usage (2z) = N 6,000
Ordering cost (Co) = Ml5.00
Carrying cost- (Cc) = 140.05
Cost per unit (C) = N2.00
= = 1342 Units
Solution – using Trial and Error
No of orders
Value of order
Average stock (N)
Ordering Cost (N)
Carrying Cost (N)
Total Cost (N)
By observations, EOQ will be either 4 or 5 orders and the quantity will therefore be between 1,200 and 1,500 = 1350 ……. Very close to 1,342.
Giving Allowance for Discount
To encourage large purchases per order, quantity discount is usually given, A quantity discount is simply a reduction of the price per item, which is purchased, in large quantities.
Assume an annual usage (z) of 10,000 units bought at N 10.00 each (c) Holding cost (cc) as a percentage cost of average inventory of 20% or 0.2 and an ordering cost (C0) of N50.00 per order, The unit price is reduced to N9.80 and N9.70 respectively for orders of 1000 – 2000 units and over. Find the EOQs.
= = 707 units
= 718 units
= 718 units
These answers can be crosschecked using the trial and error table above.
Buying at the right price:
The professional buyer applies his knowledge of economics in his duties. Economic theory shows that demand and supply are balanced by the influence of price of the equilibrium. When the price is high, the producer is encouraged to produce more, but the buyer is reluctant to buy. When the price is low, the buyer wants more but the producer is not willing to sell the quantity demanded.
At times, a little change in the price may register a considerable change in the level of demand. Demand then is inelastic when a substantial change in the price makes little difference to the quantity demanded e.g. salt.
Buying at the Right Time
The right quantity has a relationship with the right time. The reason is that the right quantity is often determined not only by the production requirements, but also by external factors that influence lead times and availability.
Since the price of inputs are ever changing, there is the need to determine when to buy i.e. time. The following are some of the factors to be considered along with the decision of when to buy.
a) The seasonality of production
b) The available storage facilities
c) The cost of storage
d) The lead time
e) The cost of work stoppage
f) Market conditions – information as to supply.
Buy from the Right Source / Place:
Supplier sourcing and evaluation refers to the process and procedures by which the buyer seeks, surveys and evaluates suppliers and determines policies relating to those who can most meet the requirements intends to achieve. Since business operates in a dynamic environment, purchasing too operates in an equally dynamic. In determining the right source, the professional purchaser must consider
a) Changes in the needs of the ultimate consumer
b) Changes in the suppliers’ products
c) The possibility of financial savings
d) Technological improvements in the production process
e) Benefits from alternative suppliers
f) Changes in the product requirements.
In selecting the source of supply too, the following should be considered and evaluated.
a) Whether supply shall be localized or internationalized
b) Whether purchase shall be concentrated or splitted
c) Whether to buy directly from manufacturers or through middlemen.
When the decision must have been made, the suppliers “are then rated against an agreed formula for standard e.g. quality 40% price 35% and service 25%.
The Buying Methods:
There are two basic methods of buying i.e. negotiating and bidding,
Negotiation (Giwa – Asaju, 1977) is the art of arriving •at a- common understanding through bargaining on the essentials of a contract. Lysons (1990) sees negotiation as a form of communication whereby participants seek to exploit the relative strength of their bargaining positions to achieve explicit objectives to resolve an identified area of disagreement,
Some of the matters to be negotiated include:
a) Terms of conditions of service
b) The price of the item-quantity, cash and trade Privacy changes on the long term-credit terms
d) Who does what and who is liable for what, when goods rejected have to be replaced, repaired/credited.
e) Who does the transportation, inspection, packaging, etc.
Negotiation is not an easy exercise but one that involves the use of tactics such as:
Have the negotiation carried on your own ground
Let the supplier do most of the talking
Base your arguments on facts and figures
Avoid emotional reactions to suppliers’ arguments
Let the supplier retreat, let him gracefully avoid premature show.
Satisfy the emotional need of the co-negotiator.
What are Purchasing Activities:
Purchasing activities are the major elements of purchasing. According to Giwa – Asaju (1983), it includes the following:
a) Identification of the right product
b) Identification of the right source
c) Identification of the right quality
d) Identification of the right quantity
e) Identification of the right time of supply
f) Identification of the right place of supply
g) Identification of the right price.
The problem then arises as it is difficult for the procurement officer lo actualize all the rights in a single purchase. More often than normal, high quality products are normally sold at high prices. Also, if a supplier is in dear iced of a product, and order has to be expedited, the price nay have to go up.
Identification of the Right Supplier
For smooth business relationship, the procurement officer must develop good client customer relationship. The buyer seeks, surveys and evaluates, suppliers to determine policies relating to those who can most suitably meet the requirements of his business. Thus, supplier sourcing has grown in importance the last few policies.
When the buyer feels that his goals are being actualized, the need to make further search for a supplier may not be pressing. When he does the exercise may merely aim at making ordinary routine check to collect and up-date his information.
Sources of Search Information
The buyer may seek information about sources of supply from the following:
Catalogues: These are useful for new product requirements for information about location, technical aspects etc.
Track Directors: These are useful for new product requirements for information about location, technical aspects etc.
Sales Persons: The would-be-purchaser can draw immensely from the fountain of knowledge of the salesmen. Such information may relate to supply or to competitors.
Exhibitions: This, provides a unique opportunity of comparing competing products and meeting. The representatives of the suppliers of other products.
Trade Journals: New products in the industry are-advertised. Also information about substitutes, changes in production technicalities and policies are found.
Prospective Suppliers: In the same way that purchasers are looking for suppliers, suppliers are also looking for purchasers. Such suppliers supply information as to their capabilities and qualities of their products.
Business can only take place between two parties when they are fully informed. Sometimes, the seller informs the consuming public about the available products through advertising. In some cases, the purchaser takes the initiative to ask the seller.
i) Enquiry: The action of the buyer in knowing whether a seller stocks a particular item or not is called enquiry. A letter of enquiry usually states:
a) The type of good required
b) The purpose of the good
c) The terms and conditions of trade
ii) Tender: A tender is an offer to carry out work, or supply a given quantity of goods at a stated price. It is thus a statement of the price of which one offers to buy/provide a service: it usually contain:
The price of the good
The cost of preparation
The terms of trade/payment
iii) Quotation: Unlike the tender that starts off 1 prospective purchaser. The quotation is from the seller. It usually states:
a) The available items (quantity & description)
b) The price(s) of the items(s)
c) The terms of trade.
The Process of Negotiation:
Negotiation is the term of verbal communication in which the participants seek to-exploit the relative strength of their bargaining positions to achieve explicit/implicit objectives. Negotiation is wider than bargaining as the later deals with changing positions on the price continuum. Negotiation involves debates not only on the price but also on posturing, persuasion, warnings and ultimatums.
Negotiation is used to arrive at an agreement when
The contract is for a capital item e.g. building
The final price cannot be determine with certainty as a result of unforeseen circumstances.
The item is custom – made
The tooling costs form an important part of total cost
The contract is on a long-term and changes in prices and specifications are expected.
The terms of the buyer not the seller’s are appropriate.
In determining the positions of either the buyer or the seller, the following must be noted:
Urgency of the supply
The number of competitors
The possibility of alternatives
The reputation of the parties
The capacity of the parties
The amount of information available to each.