1.3 What is Purchasing?

Before we define purchasing, let's take a moment to discuss how purchasing fits in your firm's value-added processes. Purchasing is one of the key functions in a business field known as supply chain management (SCM). You may be wondering, "What is SCM?" Answer: SCM is the value-creation engine of every organization. Your company—like every organization in the world—must 1) acquire inputs, 2) transform inputs into highly valued outputs, and 3) deliver those outputs (i.e., goods and services) to customers. Your is an interconnected web of suppliers, service providers, and customers. Your goal is to make sure they all work together to create unbeatable value for the end customer.

Let's take a quick look at a typical supply chain. Imagine you are a purchasing professional at a manufacturer of one product that Olympus sells, liquid laundry detergent. Figure 1-1 depicts your extremely simplified supply chain. To understand a supply chain map, you need to remember that materials, like the water in a river, flow downstream. Thus, the left side of Figure 1-1 is your upstream supply chain—that is, the network of suppliers providing you inputs. You buy from Tier 1 suppliers, and tier 1 suppliers buy from tier 2 suppliers et cetera. The right side of Figure 1-1 is your downstream supply chain—that is, your customers. Your company operates its own network of warehouses and sells through multiple channels: distributors, on-line distributors, and direct to large retail chains (often called "national accounts" or "key customers").

Figure 1-1: Simple Supply Chain: Liquid Laundry Detergent

As a purchasing professional, your job is to manage the key upstream side of the supply chain. Simply put, you buy the goods and services your company needs. To do this well, you must formulate sourcing strategies and select the right suppliers to ensure that the right inputs arrive in a timely manner and in good condition. If you don't make great decisions, your firm's value-added operations can come to a complete standstill.

The SCOR Model

To create a common vision of SCM, the APICS Supply-Chain Council developed the Supply-Chain Operations Reference (SCOR) 1 model shown in Figure 1-2. According to the SCOR® model, if you want to maximize value creation, you must manage six processes.

  • Plan: Planning processes help you use resources to generate and fill demand to meet your company's financial plan.

  • Source: Sourcing processes help you build an effective sourcing organization (think policies, procedures, and measurement) and then select the "best" suppliers.

  • Make: Production processes help you transform inputs into a finished product that customers value and are willing to pay for.

  • Deliver: Logistics processes help you manage inbound delivery of raw materials and outbound delivery of finished goods and services to customers.

  • Return: Return processes help you manage the return of products for any reason (e.g., customer service policy, product recalls, or environmental sustainability).

  • Enable: Enabling processes focus on measurement, data management, contracts, and risk to help you support the plan-source-make-deliver-return value creation activities.

As you look at the , your key takeaway is that value creation begins with purchasing and supply management.

Figure 1-2: The Supply Chain Council SCOR Model

The Seven Rights of Purchasing

The Institute for Supply Management—one of the world's oldest and largest professional associations for purchasing professionals—has formally defined supply management as follows, "The identification, acquisition, access, positioning, management of resources and related capabilities the organization needs or potentially needs in the attainment of its strategic objectives." 2

The good news: Supply management is easier to understand and far more fun than this definition lets on. A less formal definition is expressed by the seven rights of purchasing, which say that effective supply management is about,

  • obtaining the right material

  • in the right quantity

  • for delivery to the right place

  • at the right time

  • from the right supplier

  • with the right service

  • at the right price. 3

Let's dig a little deeper. As you looked at the seven rights, you may have noticed that three of the rights focus on what you are buying—that is, the right stuff. Two rights focus on assuring availability—that is, getting that stuff where you need it when you need it. The final two rights—supplier and price—stand on their own. They are, nonetheless, extremely important.

Buy the Right Stuff

If you have ever bought a piece of assemble-it-yourself furniture, perhaps you've had the following experience: Part way through the assembly process, you discovered that a critical piece was either missing or defective. As a result, you couldn't finish the assembly process—nor could you use the finished product.

The same is true in the business-to-business (B2B) marketplace. Partial deliveries or deliveries of defective product disrupt operations. You simply can't produce and deliver to plan. Of course, you could try to compensate for this by holding lots of extra "safety stock," but that solution is very costly—and it doesn't solve all of your problems. For example, what happens if defective parts slip past your incoming inspection process and are built into the product you sell to customers? When this happens, you can expect angry customers—and higher costs. If the defective part causes an injury, you might be sued. Buying the wrong stuff can damage your brand.

Assure Availability

Supply disruptions can cost you a fortune. For instance, if parts you buy don't arrive on time and you end up shutting down an auto assembly line, you will cost your company $10,000 a minute (or more)—that's $600,000 an hour or $14.4 million per day. 4 The same is true of purchased services. Consider, for example, oil and gas exploration and production: Companies that drill oil wells are "racing" one another to get the oil out of the ground first. A four-hour delay due to late services provider can make all the difference.

Attain Lowest Possible Total Cost

Because most companies manage purchasing as a cost center, top management pays close attention to the price you pay for goods and services. One of the metrics your boss will use to assess your performance is "purchase price variance." Simply put, your boss wants to know whether or not you got a good price. Purchase price variance is defined as follows:

Purchase Price Variance = (Actual Price – Budgeted Price) × Quantity Purchased

However, purchase price may not be the best price. You've heard the term: "You get what you pay for" (or more eloquently in Latin, " " or "Let the Buyer Beware"). The right price is really the lowest "total cost" of buying, using, and disposing of the item. In purchasing, we call this the , which is defined as follows:

TCO = Acquisition Price + NPVΣ(Ownership + End-of-Life Costs)

If you bargain too aggressively, you might get a low purchase price today, but drive up long-term costs as your suppliers scrimp on quality or quit investing in innovation. You might even turn a good supplier into an angry and resentful supplier. Worse, you might drive a key supplier out of business.

The bottom line: Companies place great emphasis on purchase price. Thus, you need to make sure you aren't paying above market prices for purchased inputs. But, you really want to obtain the lowest total cost of ownership. This almost always means paying a fair price—that is, a price that will help you build the most competitive team of suppliers.

Build a World-Class Supply Team

After looking at the seven rights of purchasing, you may have asked, "Which of these rights is the most important?" The correct answer: The right supplier. As the preceding discussion suggests, your choice of supplier affects all of the other rights. If you don't select the right supplier, you will experience quality and availability glitches. Your total costs will be higher than your rivals' costs. The result: You will be fighting tough competitive battles with an inferior team.

The bottom line: As a purchasing professional, your job is to find, develop, and work with qualified suppliers to assure the timely delivery of high-quality inputs at the lowest total cost. To do this consistently well, you will need to work closely with other departments—i.e., your internal customers—to design products and streamline the purchasing process. You will also want to start thinking about purchasing as managing the capacity and capabilities of your supply network.

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