Lesson 2, Chapter 3

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Purchasing and Supply Chain Organization

Organizations need to achieve continuous process improvement in order to produce their products or services more effectively.  There are many ways a firm can organize the purchasing/supply function in its quest to achieve this objective.  Purchasing's role in the organization depends on management's perspective of the function.  Organizational planning and delegation are important segments of the integration of strategic goals and organizational designs.  However, successfully making the transition from an operational, trouble-avoidance function to an integrated supply chain organization requires the acknowledgment and recognition by others in the organization that the purchasing/supply function does play a strategic role in the organization.

The major themes in Chapter 3 are:

1.  Purchasing's Position within the Organizational Structure
2.  Factors Affecting Purchasing's Position
3.  Organizing the Purchasing Function
4.  Placement of Purchasing Authority
5.  Organizing for Supply Chain Management
6.  The Team Approach as Part of the Organization Structure
7.  Creating the Organization of the Future

Purchasing's Position Within the Organizational Structure

Purchasing's location in the management hierarchy of a firm is important because it either facilitates or limits the influence purchasing policies and actions can have on the firm's total performance.  A firm's organizational structure reflects management's basic attitudes toward the major activities involved in its operation.

Your text defines the factors that affect Purchasing's position.  I would add to that discussion the following.

Availability of Materials

If the major materials used by the firm are subject o periodic shortages and price instability, creative performance by analytical purchasing professions is required which makes the purchasing organization a top-level group.

Absolute Dollar Volume of Purchases

If a company spends a large amount of money for materials or services, the sheer magnitude of the expenditure means that top-flight purchasing can usually produce significant profit.  Small unit savings add up quickly when thousands of units are purchased.

Percent of Product Cost Represented by Materials

When a firm's materials costs are 40% or more of its product cost (or its total operating budget) small reductions in material costs increase profit significantly.  Top-level purchasing and supply management usually pays off in such companies.

Types of Materials Purchased

Perhaps even more important is the amount of control purchasing and supply personnel actually have over materials availability, quality, costs, and services.  Most large companies use a wide range of materials, many of whose price and service arrangements definitely can be influenced by creative purchasing performance.  Some firms, on the other hand, use a fairly small number of standard production and supply materials, from which even a top-flight purchasing and supply department can produce little profit, despite what it does, as a result of creative management, pricing, and supply selection activities.

To Whom Does Purchasing Report?

Studies have shown that purchasing usually reports to a president or executive vice president, vice president of manufacturing, other functional vice presidents or other units.  In some companies, this function should be a top-level, profit making function that receives close attention from general management.  In other firms, purchasing performs primarily a service activity for a major operating function.  In such cases, purchasing properly should report to that functional executive.  Similar types of considerations dictate the location of all organizations.

Organizing the Purchasing Function

Your text breaks the purchasing activity into four groups.  An alternate way to look at it is by function.  The classifications of work found in a purchasing operation can be described as follows:

Management.  Management of the purchasing and supply function involves all the tasks associated with the management process, with emphasis on the development of policies, procedures, controls and the mechanics for coordinating purchasing operations with those of the departments.  It may involve the management of unique supplier and commodity problems and may include managing countertrade arrangements as described in your text.

Buying and Negotiating.  This includes a wide variety of activities, such as working with users to help develop requirements and specifications, reviewing requisitions, analyzing specifications, investigating suppliers, analyzing supplier capabilities, interviewing salespeople, studying costs and prices, analyzing bids, negotiating, and selecting suppliers.  Some firms have expanded the buying job and now see it as improving supplier capability and performance, particularly in the quality area.

Follow-up and Expediting.  Order follow-up activity involves various types of supplier liaison work, such as reviewing the status of orders, writing letters, telephoning and faxing suppliers, and occasionally visiting suppliers' plants

Strategic Planning and Research Work.  A well-developed purchasing and supply management operation has an unending number of research projects and systems studies requiring specialized knowledge and analytical ability.  The more an organization has progressed toward a supply chain focus, the more emphasis it places on strategic activities.

Clerical Activities.  Every department must write orders and maintain working files, catalog and library materials, and records for commodities, suppliers, prices and so on.

Your text goes into a discussion of the various activities of today's purchasing department.  I would include transportation under Buying.  Insourcing/Outsourcing is more thoroughly covered in Chapter 7 of your text.  Value analysis is covered in Chapter 12.  Strategic Supply Management is included in the buying function but moves the buyers into a closer working relationship with the supply base.

Your text includes the entire materials management activities into "Other Responsibilities."  Functions included in Materials Management include:

Material Planning and Control which includes planning of quantities of key and critical materials needed to produce the approximately number of end products needed in specific time periods.

Production Scheduling is concerned with the number of units to be produced, the time intervals over which production will occur, and the availability of materials and machines to produce the number of units specified within the schedule time constraints.

Receiving is responsible for the physical handling of incoming shipments, the identification of such materials, the verification of quantities, the preparation of reports, and the routing of the material to the place of use or storage.

Materials and Purchasing Research is concerned with the collection, classification, and analysis of data necessary to find alternate materials; forecasts of supply, demand, and the price of major purchased commodities; analysis of supplier costs and capabilities; and devising new and more effective methods of processing the data necessary to operate the materials systems.

Stores has physical control and maintenance of all inventory items.

Investment Recovery is responsible for the disposal of scrap and surplus items.

Incoming Quality Control ensures that incoming raw materials, supplies, and services meet or exceed requirements.

Inventory Control keeps detailed records of materials and parts used in the production process and non-production materials such as expendable tools, office supplies, and maintenance, repair and operating supplies.

Recently, Logistics has received attention.  By logistics, we mean "the process of planning, implementing, and controlling the efficient, cost-effective flow of storage of raw materials, in-process inventory, finished goods, and the related information from point of original to point of consumption for the purpose of conformity to customer requirements.  Logistic will include the flow and storage of items, from raw materials to customer delivery.

The precise manner in which purchasing and inventory work is subdivided and grouped depends on the size of the department, which in turn depends on the size of the company.  Obviously, in a small firm, where there is a one-person purchasing/supply department, no specialization is possible and the one person must be a  "Jack of all Trades".

I would like to reiterate one point your text makes.  When time becomes an issue and customers are waiting for you to place an order, strategic responsibilities and adequate contract administration take second place to the immediate customer needs.  It is the old cartoon:  do you take time to drain the swamp or fight off the alligators.

Placement of Purchasing Authority

This topic concerns whether purchasing is centralized or decentralized in that the buying is done by the purchasing organization or whether it has been delegated outside the purchasing organization.  It has nothing to do with the physical location of buying personnel.   It refers to whether buying is done outside the purchasing organization such as customers handling their own purchasing with payment by credit cards or the issuance of release orders against authorized purchase orders.  The most recent move in the industry is toward the allocation of limited small purchasing to customers through the use of a purchase (credit) card.

I believe four major prerogatives of the purchasing\materials management department should be emphasized in the company's written objectives and policies.  First, selection of the supply source is wholly a matter of purchasing authority.  The need to buy originates in other departments, where required quality is defined.  So long as those measures of what to buy are satisfied, the decision on where or from whom to buy is the responsibility of the purchasing manager.  Second, all contacts with vendors and their representatives should be made through the purchasing department, from the first sales interview, through the process of negotiation and ordering, follow-up for delivery, and correspondence relating to materials and purchases, to approval of the vendor's invoice or any adjustments that may be necessary.  Legitimate contacts with technical and plant personnel should be arranged only with the knowledge of the purchasing department and are not to be conducted or construed as in any way prejudicing the purchasing department's freedom of negotiation or its latitude of choice in selecting the supplier.  Some exceptions may arise in centralized purchasing for branch plant requirements.  Third, it is the duty of the purchasing managers and buyers to check purchase requests against the need, currently referred to as “Demand Management.”  It is their duty to suggest modifications of the requested quality for more economical or more expeditious procurement and to revise quantities on a particular order so long as the total quantity is procured in time to meet the need.  Fourth, the commercial aspects of the purchase are wholly within the jurisdiction of the purchasing\materials management department.  These include the manner of purchase, the price and pricing method, the terms and conditions of the order or contract, packing and shipping instructions, and the like.  This is not to say that the internal customers are not involved in these decisions, but the responsibility rests in the purchasing department.

It will be recalled that the purchasing responsibility is defined as buying materials of the right quality, in the right quantity, at the right time, at the right price, from the right source.  Quality is definable in the specifications; the other factors are matters of judgment and decision.  In their constant search for the most advantageous purchases, these prerogatives must be reserved to the buyers as the means of making their judgment and decisions effective.

Responsibility for Analyzing Requirements

Here is another policy that should be written for companies and organizations.  The Purchasing\Materials Management Department has the responsibility for analyzing requirements.  In making requests to purchase, user departments are responsible for providing complete and accurate information on what is required.  The purchasing department has the duty of buying to fulfill any legitimate, properly authorized requisition.  It has the duty of questioning any requisition as to the material or quantity specified for purchase, if in its judgment, the request is out of line with current usage or best buying policy.  This is in no sense a challenge to the authority of other departments.  It is simply a prudent precaution, consistent with purchasing's position as a watchdog over purchase expenditures, wasteful duplication, possible errors in description or estimating, or occasional misuses of requisitioning privileges.  Usually, purchasing also has the right of revising quantities on a requisition for purposes of buying most advantageously, provided the total requirement is procured in time to meet the need and funds are available.  Examples are the adjustment of quantities to conform with economical lot sizes, quantity discount brackets or standard packaging and shipping units, and the deferring or anticipating of purchases to take advantage of expected market fluctuations when possible.

Where practicable, product specifications should be so clear and specific that when they are met, there is no question as to the acceptability of the purchased item.  The purchasing department should have a voice in the preparation of such specifications to avoid special details that would restrict the sources from which materials might be procured, that would entail extra costs for unnecessary deviations from commercial standards and tolerances, or would result in questionable means of determining acceptability.  In ways such as these, flexibility and competition are made possible in purchasing for company benefit without prejudice to the interest of the plant personnel who have to use the material.  Inspection and acceptance criteria contained in the specification must be clear and unambiguous so that no question can exist regarding whether or not the supplier has delivered conforming products/services.

The scope of responsibility suggested here is very broad.  But even the simple written delegated authority to buy may be limited qualitatively by stated exceptions to the general rule or quantitatively by a monetary limit on commitments made by the purchasing department.  Limitations on authority may reflect basic management policy and philosophy.  They may also be based on management doubts in the ability of the department to handle more than a certain degree of responsibility.  In the latter case the purchasing managers with initiative and ability, seeing ways to improve purchasing service and performance by broadening the scope of his or her activity, may persuade management to rewrite its definition of his or her authority.  Or in the absence of formal authorization, the purchasing manager may assume added responsibility, acting beyond the scope of his or her stated function, assuming that the manager does not infringe upon the authority of other departments.

Purchasing\Materials Management Responsibility

Ultimate responsibility for the type and quality of materials to be bought must rest with those who use them and are responsible for results.  In this sense, the user departments are “customers" of the purchasing department, and they must be satisfied.  But this does not place the responsibility or authority for selection in the user department.  Rather, theirs is a responsibility for accurate definition or specification of the product, in terms of formula or analysis, accepted commercial standards, blueprints or dimensional tolerances, or the intended purpose of the material.  Most industrial materials, supplies, and equipment can be bought in competitive markets and from a variety of sources; and it is the function of purchasing to select the particular material and source most advantageous to the company, patronizing two or more alternative sources if it is desirable to stimulate competition or assure continuity of supply, always bearing in mind that the essential requirement, as defined, must be met.

In addition to quality, the request for materials involves a statement of the quantity desired and the date or time at which they will be needed.  Written policy should state that it is the responsibility of purchasing managers to check these factors against the actual need, from their knowledge of the operating program or from their records of past purchases and use, and to question any apparent deviation from normal requirements, even though the authorization of a request may otherwise be in good order.  This kind of scrutiny is a part of the purchasing manager's duty to avoid duplication, excessive stocks, and unnecessary rush orders that would disrupt the procurement program and incur extra transportation and other costs.

 When the quantity and delivery requirements have been established, it is the responsibility of purchasing and materials management to decide whether the goods shall be bought in a single lot, or in a series of smaller transactions over a period of time from one or more suppliers, or on a single long-term contract with delivery schedules to be specified according to the need.  All these considerations, weighed in conjunction with quantity discounts, carrying charges, market conditions, and the like, have a bearing on the ultimate cost of the material, so that there is a considerable range of opportunity or advantage open to purchasing judgment, even within the strict specification of quantity and delivery requirements.

Commercial aspects of the transaction--negotiations as to price, delivery, guarantees, terms, and conditions of the contract and adjustments as to over- and under-shipments or deficiencies in quality--are wholly purchasing and materials management responsibilities and should be stated in organizations' written objectives and policies.

The extent to which the purchasing\materials management departments are responsible beyond the point of issuing the order varies in different companies.  Instances can be found in which this act marks the end of purchasing\material management jurisdiction, but they are not typical; the test of purchasing\materials management performance lies in satisfactory deliveries against the order.  In some companies, the purchasing\material management function is interpreted to include the follow-up for delivery, reconciling receipts and vendors' invoices with the purchase order, and passing invoices for payment.  In well over half the cases, it includes the responsibility of storekeeping and complete accountability for materials until they are issued to the using departments.  Inspection and quality testing of deliveries for acceptance are sometimes included in the purchasing function.

Centralization versus Decentralization

It is suggested that organizations centralize purchasing when purchases are a very high percentage of product cost or budget; items used by most of the operating units; or management feels the need for tight control over purchases.  There are many advantages and disadvantages to centralize/decentralize.  Your book on pages 78 through 86 lists many of them:

Coordinate Purchase Volumes

Reduced Duplication of Purchasing Effort

Ability to Develop and Coordinate Procurement Strategy

Ability to Coordinate and Manage Company wide Purchasing Systems

Development of Purchasing Expertise

Managing Change to Benefit the Entire Organization

.  I would add to the list of advantages of centralization::

Haphazard purchasing practices are minimized.

Inventory control enhanced.

Reduces work of others who don’t have that responsibility.

Fewer orders, less operating expenses.

Communication with suppliers enhanced through consolidation.

It is easier to standardize the items brought if purchasing decisions go through one central control point.

By combining requirements, "clout" is generated by discussing an order quantity that is large enough to really get the supplier's interest and reduced freight costs by reducing deliveries.

In period of materials shortages, one department does not compete with another department.

It is administratively more efficient for suppliers since they need not call on several people within the company.

It provides better control over purchase commitments thereby reducing the possibility of illegal or unethical practices.

As one would imagine, there are disadvantages to centralization set out in an article from Purchasing Today::

• Narrow specialization and job boredom
• Lack of job flexibility
• Corporate staff appears excessive
• Tendency to minimize legitimate differences in requirements
• Lack of recognition of unique needs
• Focus of corporate requirements, not on business unit strategic requirements
• Most knowledge sharing one-way
• Common suppliers behave differently in geographic and market segments
• Distance from users
• Tendency to create organizational silos
• Customer segments require adaptability to unique situations
• Top management not able to spend time on suppliers
• Lack of business unit focus
• High visibility of purchasing costs

However, there are times when it makes sense to decentralize.  You frequently see decentralized purchasing when companies process single natural raw materials; technically oriented firms that are heavily involved in research (scientists); operation of multi-site institutional & manufacturing organizations (centralized planning at corporate level, ordering at plant level); autonomy of a manager; or purchase of non-technical odds and ends (purchase cards).

It too has advantages as defined by your text:

• Speed and Responsiveness
• Understanding Unique Operational Requirements
• Product Development Support
• Ownership

In addition, they include such things as:

• More authority to organizations charged with that profit center.
• Better communication with internal customers.
• Broader responsibilities for internal users.

However, the disadvantages are many:

• More difficult to communicate among business units
• Encourages users not to plan ahead
• Operational versus strategic focus
• Too much focus on local sources--ignores better supply opportunities
• No critical mass in organization for visibility effectiveness
• Lacks clout
• Suboptimization
• Business unit preference not congruent with corporate preference
• Small differences get magnified
• Reporting at low level in organization
• Limits functional advancement opportunities
• Ignores larger organization considerations
• Limited expertise for requirements
• Lack of standardization
• Cost of supply relatively high

The perception of many customers regarding the usefulness of the purchasing operation is changing through increased use of cross-functional teams in the sourcing process and separation of strategic versus tactical activities (ordering officials for delivery orders).

The Team Approach as Part of the Organizational Structure

Driven by pressures to reduce costs and improve the bottom line in today's cost conscience marketplace, purchasing/supply departments have, like most other functions, sought ways to streamline operations and improve efficiency.  One of the approaches that has enhanced the effectiveness of the purchasing/supply management function is the use of teams.  Organizations seek to combine the flexibility of decentralized purchasing and the buying power and information sharing of centralized purchasing through the use of teams--a number of people working together on a common task.  Various types of purchasing and supply management teams are used, including cross-functional teams, teams with suppliers, teams with customers, teams with both suppliers and customers, supplier councils (key suppliers), purchasing councils, commodity management teams, and consortiums (pool buying with other firms)

Cross-Functional Sourcing Teams consists of personnel from at least three functions brought together to achieve a purchasing or material-related task in which the team must consider purchasing/sourcing goals or decisions involving supply base management.  Frequently, you find staff from purchasing, finance, engineering and legal counsel.

Teams with Supplier Participation make sense when requirements are being developed by using supplier workshops to determine marketplace capabilities.  Confidentiality is the biggest obstacle to supplier participation, and teams or suppliers may have to sign a confidentiality agreement to minimize the potential effect of this obstacle.  However, this is one area that seems to still be off-limits in government purchasing.

Teams with Customer Participation are developed in an effort to be customer driven since customers are the ultimately consumers.

Supplier Councils are teams consisting of key suppliers who participate in cost reduction initiatives such as reducing lead time, eliminating waste in the system, or finding more efficient procedures.

Purchasing Councils focus on a particular commodity and are composed of purchasing managers and buyers throughout the organization.  The goals of the council are to properly manage the buyer-supplier relationship and encourage continuous improvement.

Consortiums are created by separate organizations that pool their requirements for common items to gain leverage with suppliers to attain lower prices and better terms and are commonly found in not-for-profit organizations, particularly educational institutions and health-care facilities.

Supply Chain Management

The supply chain management concept represents an integration of information flows, extending from the supplier to end user while materials management is generally involved with the flow in materials into an organization.  Many organizations combine materials management (input function) with logistics (physical distribution) management which includes all material flow function, both into and out of, an organization.

As business grow and personnel are added, it becomes evident that certain advantages would accrue if individual functions, such as purchasing, stores, traffic, production scheduling, inventory control, and quality control were separated and made full-time managerial assignments, thereby permitting occupational specification.  Because of communication and coordination problems, however, it becomes clear that bringing together those functions that are clearly interrelated, under one responsible individual, makes for a more effective organization.

However, as your authors note, few organizations have created positions specifically responsible for managing the entire supply chain from supplier to end customer.  In addition, I have found few suppliers and customers willing to develop the level of trust required to share information across the supply chain.

The following information is taken from a book entitled "The Executive's Guide to Supply Management Strategies" by Riggs and Robbins.

The supply management organization is not a traditional pyramid structure for a new functional initiative that will replace the procurement organization.  In fact, it isn't a structure at all.  Rather, it is a comprehensive collection of work tasks and role definitions, processes, organizational mechanisms, and competencies that work together to span functional groupings and geographic and business locations.  The trick is to provide strong, singular-focused leadership for a new initiative while making provision for various implementation tactics necessary to support different businesses and locations.

Rather than focusing on structures and organization charts, the new approach seeks to define the work and simply put in place those things necessary to complete it, share learning, and improve results over time.  In this way business can create a new order of things without creating new structures and new overhead costs.

In carryout out the work of supply management--developing and implementing supply-stream strategies that maximize the value of expenditures for purchased materials and services--a number of new work tasks and roles have been developed.  A supply-steam leader is accountable for optimizing the total supply stream by developing and implementing supply-steam strategies and improvement plans while the location supply leader is accountable for optimizing a location's total purchase expenditure by implementing a number of supply-stream strategies at that location (plant site, business unit, etc.).

These leaders work together as part of a team to develop supply strategies and select preferred suppliers.  Once the strategy is developed, both supply leaders in these roles shift their emphasis to improvement and implementation work.  For the supply-steam leader, this work is managing supplier resources to implement the supply-stream changes at all locations and benchmarking market and usage practices in order to continually improve the supply-steam strategy and introduce innovations.  For the location supply leader, this work is engaging relevant users and implementing the actual usage and flow changes at the point of use.

This supply network made up of Supply Stream Leader, Location Supply Leaders, Resources and Suppliers, and other Supply Team participants and functional inputs make up the supply team.  The supply network is like a cross-functional team except it crosses business units, locations, and often suppliers.  In so doing it spans the barriers to implementation that often exist by ensuring that specific plans in fact deliver results directly beneficial to the specific point of use.  The supply leader roles and the supply network are the building blocks of the supply management organization.

Adapting to Structural Change

There is an interesting article in the May 2000 issue of Purchasing Today regarding structural changes that I would like to bring to your attention.  This article provides pertinent information from a study which examined three purchasing and supply organization structures--centralized, hybrid, and decentralized.  Centralized purchasing is where all main purchasing is controlled at one central point for the entire firm.  In hybrid purchasing, purchasing is shared between corporate offices and business units, operating plants, and/or divisions.  In decentralized purchasing, all main purchasing is controlled at the business units, plants, and/or divisions.  I will be quoted some section from this article.

Mergers, acquisitions, management changes, and the emphasis on cost saving prompt organizations to continually reevaluate the way they conduct business.  Determining a purchasing organization structure requires consideration of the advantages and disadvantages of centralized, hybrid and decentralized structure for the company, then selecting the most appropriate.  It is very difficult to sustain a situation where the organization is decentralized and purchasing is centralized.  The article states that cost savings have been identified as the major instigator of structural change.  The toughest challenges in moving from decentralized to centralized is determine what the many decentralized units had been purchasing and exactly what they spent, and finding the right people for the newly created purchasing department.

To make a structural change successful, you need a skillful, purposeful execution; good people; the ability to identify the right opportunities; and the ability to negotiate the right contracts and establish workable procedures.  One of the negative issues was the displacement of some employees.  However, there were many positive sides such as substantial cost savings and getting the supply chain under control.

A hybrid structure can be beneficial when an organization is faced with a merger or acquisition.  This structure can help facilitate the blending of processes and cultures.  The purchasing organization can negotiate a contract, manage its implementation, including related systems and training, and then allow the users to complete the purchase transactions directly with the selected supplier.

Many of the organizations follow a three-step process in the change.  They prioritize spend categories, identify current and potential supplier(s) and establish a competitive process and resulting contract.

The study reports that no one structure is better than another.  The major findings include:

Changes are driven by factors external to the supply organization itself.

None of the major changes described in the study implied that the current performance of the supply organization had been unsatisfactory.

Major changes in the organizational structure of the entire organization are made without consultation with purchasing and supply and/or without considering the potential impact on supply.

All of the changes studied involved organizations attempting to improve their cost structure.  Cost was cited as a universal driver for major corporate structure change.

Additional external drivers included market change, political change, and parent organization change.

Consultants were present in 10 of the 15 changes studied, and six of the 10 cases included special supply consultants.

Twelve of the 15 changes documented involved a new CEO for the organization.

The implementation of the supply organizations' changes required a substantial amount of time and resources.  It significantly affected the lives of many people and, in particular, required the chief procurement officer to spend a lot of overtime managing the change process.

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