As everyone knows, a company’s profit margin reflects the company’s ability to control top line costs. Many people don’t realize it, but purchasing typically spends ‘half of every dollar’ the firm receives. Therefore, it is important to properly manage purchases.
Equally important, companies rely on the revenue streams generated by their product lines. Purchasing must ensure that the firm has an adequate and ‘uninterrupted supply’ of needed raw materials. Consequently, the question becomes, ‘does your company have a purchasing strategy for its raw materials that addresses these issues?’
The Starting Point
Executive management formulates its business plans from the top down. Therefore, the company’s sales plan, for its products and services, provides the starting point. This allows each department to develop their individual objectives.
Accordingly, procurement must develop their purchasing strategy in support of the company’s product sales. To start with, purchasing evaluates the products that will be sold using value and risk. This is usually done by their importance to the company, highest volume and value to lowest volume and value.
Next, purchasing breaks down these products into their elemental parts. This shows what raw materials and components are needed. Again, this is accomplished by importance, highest volume and value to lowest volume and value. This can be done in various ways. Here we graph the products. For this example, I have taken two theoretical materials, steel bars and tungsten powder.
Next, we combine this information with the company’s objectives for these products. Finally, when graphed, we have a starting point for each item. There can be many criteria when developing strategy. Naturally, the more criteria used the more details you will get and plan for.
Purchasing Strategy for a Product
Let’s go through the development of purchasing strategy. We’ll use purchase price as the criteria and objective for the finished goods. Likewise, we’ll only address one raw material, steel bars. Here are some of the questions asked helping us to formulate the strategy. Answers have been added in blue so that we can form our purchasing strategy for this product.
- What is the current price paid per metric ton for steel bars? $400/mton
- What cost initiatives are needed for this raw material? The company would like to reduce the cost of steel bars 3% in the next six months
- What is the company’s demand forecast for steel bars next year? 500 mton
- Are there any specific barriers to overcome when supplying this product, i.e. special processes, specifications, or delivery requirements? No
- How many suppliers can provide the steel bars? 7 Suppliers: 2 locally, 4 additional suppliers domestically, and 1 internationally
- What leverage does our company have when requesting proposals from these suppliers, i.e. is there one or multiple divisions using this product, etc.? Only one division uses the material; there are two supplier relationships; it is low volume;
- As a function of the first three points, what is the company’s policy with regards to sourcing, e.g., is it permissible to sole source?Multiple sourcing is allowed for this product
- What if any previous performance measurements are available for these suppliers? Both suppliers achieved a 99 out of 100 on their supplier scorecards
In this case, the steel bar is a commodity. The only restriction is using a supplier that is already on the Approved Vendor List (AVL). Furthermore, it is already known that the quality and delivery metrics can be met by each supplier on the AVL. The purchasing strategy for this product is to use multiple suppliers and competitively bid the product trying to reduce purchase prices by 3%.
It is important to note that there can be more granularity to this strategizing process. Each scenario is different and may require additional research. Consider the following:
- If your current AVL does not support the strategy that you’ve developed, then what?
- If the company has a ‘supply base optimization plan’ in place, what needs to be done with a current supplier?
- What are the logistical or inventory issues when dealing with a global supplier?
Purchasing must identify a complete list of issues for each product or commodity. Only then, can it properly layout the purchasing strategy for each of those items it needs to source.
Plan Review and Approval
After selecting and documenting the purchasing strategy, the next step involves soliciting management approval. If management desires, adjustments can be made before continuing.
Evaluation and Control
In addition, after strategy development and implementation, it is important to evaluate performance and see if the purchasing strategy you developed is meeting your goals.
Business Health and Success
The company’s business health and success is much more predictable when managing and controlling the cost of the raw materials as well as the supply. A well-defined purchasing strategy is a fundamental part that ensures overall business success and profitability.
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