Purchasing Strategy Considerations

 A solid supply chain strategy is essential for a successful and healthy business but equally important is a subset, the Purchasing Strategy. There's stacks of books written on the subject to go in depth. This article aim's to open up some consideration to purchasing strategies and avoid common pitfalls.

Vendor base consolidation

In the relatively recent P2P hype, one area that generally receives considerable attention is the consolidation and reduction of vendors. This is both hugely important for increasing purchasing power but also for reducing vendor management costs. Its also a perfect time to weed out some of the under-performing vendors and to elevate the company's supplier base. The consolidation should be done with a clear strategic eye on vendor qualities that the company considers most important. What should not be forgotten is the hidden costs of doing day-to-day business with the vendor, these "soft" measures such as: ease of invoicing, accuracy of documents such as packing lists and others can end up costing dearly if ignored.

Minimum order quantities

When making contracts with vendors, among the many items that are negotiated is the minimum order quantity. Usually the sourcing group is measured by achieved cost savings and as such are motivated to reduce costs. This may lead to agreeing to minimum order quantities that deliver better prices but also higher inventory holding costs. Therefore order quantities need to be calculated, analyzed and aligned with the supply chain strategy prior to signing on the dotted line. A good purchasing strategy will therefore include inventory turnover targets that will help formulate the direction of the sourcing agreements. In addition, flexibility can be added to the setup by allowing for quantity based price breaks.

Landed Cost vs Piece Price

Most procurement professionals understand the difference between the two but in many cases, the company accounting system is not configured to be able to provide item level landed cost numbers. For example, not only do you want to know the transportation costs but also inventory holding costs which can be significant in terms of tied up capital en-route from China for instance. This will mask the true cost of items and may lead to some very unhealthy practices. In these cases, its necessary to have a purchasing strategy that makes it easier, perhaps through using the appropriate Incoterms in the contract. The other option is to develop the accounting system to provide the level of details necessary to calculate part costs. Ultimately, your goal is to be able to make apples to apples purchasing decisions between different vendors and create value to your company by being cost effective through the whole supply chain.

In-Sourcing vs Out-Sourcing

These term's can have several meanings, within a company it can mean either using a vendor for a product or service or using the company's internal capabilities. On a political level it can also mean bringing the purchasing and/or manufacturing volume back to the home country. In the last decade, this movement has received more press, especially with rising transportation costs and long transportation lead times. BCG published a well known article on this topic in 2011.

Within the company, often the focus is on core competencies and out-sourcing the more repetitive processes that add little value to the product. A good purchasing strategy therefore addresses what are the core competencies and align with the business strategy. What should not be overlooked is a movement to utilize contract manufacturers for the final configuration. Perhaps the company core competencies are in a sub-level assemblies but find it difficult to scale up in the final configuration phase at which point an outsourcing partner may provide greater flexibility and responsiveness.

Lastly, not only should the component procurement be considered but also the whole procurement function. There's very successful setups where the day-to-day purchasing functions have been outsourced and the company has been able to focus on tactical and strategic procurement tasks. Even strategic procurement has been successfully outsourced. There are many possibilities that should be carefully weighed with the maturity of the organization.

Vendor Contracts, ERP system setups, Control

Modern ERP systems offer massive amounts of information to procurement professionals. But often the discussion turns to the quality of the provided data. Unless the company has only a handful of vendors and the products or services being offered are relatively simple, you will have possibilities for supply chain challenges. Ask your procurement personnel if they know the details of every vendor contract, such as non-conforming materials policy, on-time delivery penalties, invoicing discrepancy handling etc., more likely than not the details are cloudy at best. A good procurement strategy should include clarity and transparency and be easily accessible so that when the abnormal situation occurs, the main terms of the agreement can be checked and referenced.

Technology Requirements

Technology plays a key part in modern P2P systems. Old fax based ordering setups are quickly fading and being replaced with EDI connections that make ERP systems talk to each other. When selecting vendors, the purchasing strategy should include consideration to the technical capabilities of the vendor. Will they be able to accept your orders electronically and will they be able to respond in-kind with electronic invoices? Do their packing lists include barcode's, are the products labelled perhaps with RFID tags? The purchasing strategy should therefore include consideration for technology requirements that make lives easier not only at your company but also at the vendors side because ultimately, extra labor on their end, will result in overhead that will need to be paid for in sales pricing.

Vendor development

A vendor is ultimately a partner. Their success will facilitate your success and vice versa. There should therefore be a common mutually agreed need to employ collaborative continuous improvements. Perhaps your company is highly adept at quality inspections but the vendor does not have the same capabilities. In a good partnership, companies will help each other to become better. This knowledge sharing should be a frequent practice and part of company culture. Dedicated resources are generally needed to manage and improve processes and make it part of the company culture. Therefore, the purchasing strategy needs to answer the level of vendor development that will be provided and how that should be leveraged for cost improvements. Annual fixed cost reductions as part of the contract are fairly common but in the long term are only sustainable through continuous improvement activities.