PROCUREMENT OPERATIONS

Introduction,
In a business environment, the procurement function is one of the most
critical functions as it provides the input for the organization to convert into
output. Materials today are lifeblood of industry. They must be available at
the proper time, in the proper quantity, at the proper place, and the proper
price. Company costs and company profits are greatly affected by them as
normally, a manufacturing organization spends nearly 50% of its revenue in
purchasing. Successful operational performance lies within the key areas of
cost, quality, flexibility, dependability and speed. Superior performance in
these areas enables organizations to outperform their competitors and
ensures long-term success.
Operational activities primarily focus on shorter-term implementation, but
are conducted within a strategic framework to set out the operational tools
and techniques for the control of supply chain operations.
Operational Objectives
Quality involves developing appropriate specification, meaning that the
products and services are ‘fit for purpose’; they do what they are supposed
to do. ‘Fit for purpose’ quality includes two concepts that are far more
usefully treated separately.
Speed indicates the time between the beginning of an operations process
and its end. It is an elapsed time. This may relate to externally obvious
events: for example, from the time when the customer requests a product or
service, to the time when the customer receives it. Or it may be used
internally in the operation: for example, the time between when material
enters an operation and when it leaves fully processed. One issue for these
organizations’ operations is how to define speed of delivery.
Dependability here is used to mean keeping delivery promises or honoring
the delivery time given to the customer. It is the other half of total delivery
performance along with delivery speed. The two performance objectives are

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often linked in some way. For example, theoretically, one could achieve high
dependability merely by quoting long delivery times: in which case the
difference between the expected delivery time and the time quoted to the
customer is being used as an insurance against lack of dependability within
the operation.
Flexibility: An operation that moves quickly, smoothly and cheaply from
doing one thing to doing another should be considered more flexible than
one that can achieve the same change only at greater cost and/or
organizational disruption. Flexibility of a whole operation and the flexibility
of the individual resources together, make up the system. For example, the
ability to increase or decrease production to meet customer demands.
Cost. To companies that compete directly on price, cost clearly will be their
major performance objective. The lower the cost of producing their
products and services, the lower the price to their customers can be. Yet
even companies that compete on things other than price will be interested
in keeping their costs low. Costs can be operationalized in terms of
operating expenditure, capital expenditure and financial expenditure. The
faster the operations process can move materials through the operation, the
shorter the gap between obtaining the materials and having products and
services ready for sale.

Objectives of Purchasing
The major objective of purchasing is to buy materials and services of the
right quality, in the right quantity, at the right place, from the right source
and at the right time. However, in general management terms the objectives
of purchasing are:
 To support company operations with an uninterrupted flow of
materials and services.
 To buy competitively and wisely
 To help keep a minimum Inventory

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 To develop reliable alternate sources of supply
 To develop good vendor relationship and a good continuing supplier
relationship
 To achieve maximum integration with the other departments of the
firm
 To train and develop highly competent personnel who are motivated
to make the firm as well as their department succeed
 To develop policies and procedures which permit accomplishment of
the preceding seven objectives at the lowest reasonable operating
cost

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Material Sourcing & Supply
Companies purchase resources from different locations, based on the scope
of their activities or services. Domestic companies usually go for local
resources even if the costs would be greater than purchasing from a foreign
country. On the other hand, global companies locate resources wherever the
cost is the lowest with respect to the overall cost dedicated to their finished
product. The source of material should be located within a reasonable
distance from the buyer’s organization. This will minimize the delivery
delays, higher transportation charges and improve the personal contact
between the buyer and the supplier and enable better after-sales service
etc.

Sourcing is defined as the act of securing parts, supplies, materials,

services and other items to support production. Sourcing requires
understanding supply market conditions; finding, evaluating, and engaging
suppliers and maintaining a supplier database; and tracking and managing
the movement of goods and material from vendor or donor to final
destination.
Sourcing, thus, involves much more than simply picking a supplier or
contractor for each requirement in isolation. It involves continuing
relationships, both with preferred sources which are actually supplying
goods and services, and with potential sources which may have been passed
over for the present but are still in the running. It involves decisions about
how to allocate the available business, and on what terms to do business

Approaches to Supplier Sourcing

Selecting the right source for the purchase of materials is an important
consideration in the purchase procedure. The right source for the
procurement of materials is that supplier who can supply the material of
right quality as ordered, in right quantity as ordered, at a right time at
which the materials were required to be supplied, at an agreed price with
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the supplier, who is in a position to honour the commitment without much
follow- up, who has necessary financial resources and adequate man-power
to handle the order and who is well established with higher reputation and
proven business integrity.

Single sourcing– the selection of one supplier for 100% of a particular

requirement. This approach might be chosen by the organization for a
products or materials requiring high investment or where a strong
relationship is required. This can however lead to over-dependency and
supplier complacency.

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Advantages of single Sourcing
Partnership between buyers and suppliers allows cooperation, shared
benefits and long-term relationship based on high levels of trust
Reduction of risk of opportunistic behavior
Large commitment of the sup-plier that is willing to invest in new
facilities or new technology
Lower purchase price resulting from reduced production costs, due to
better knowledge of the manufacturing process by sup-plier and
achieved economies of scale (faster learning curve)
Disadvantages
Great dependency between the buyer and the supplier
Increased vulnerability of supply
Increased risk of supply interruption

Dual sourcing – the selection of two suppliers in order to maintain

competition and spread risk. The balance of business with each should be
considered to manage supplier complacency. This approach can also help to
avoid capacity constraints whilst maintaining high standards for quality and
technological expertise.

Multiple sourcing– pre-qualification and use of more than two suppliers to

give the buyer choice, maintain competition and manage fluctuations in
demand. Often used for less critical and low investment products and
services. By having a number of suppliers pre-qualified, the buyer could
respond better to urgent requirements for less critical products and
materials.
Advantages
Alternative sources of materials in case of delivery stoppage by a
supplier
Reduced probability of bottlenecks due to insufficient production
capacity to meet peak demand

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 Increased competition among suppliers leads to better quality, price,
delivery, product innovation and buyer’s negotiation power
More flexibility to react to unexpected events that could endanger
supplier’s capacity
Disadvantages
Reduced efforts by supplier to match buyer’s requirements
Higher costs for the purchasing organization (greater number of
orders, telephone calls, records)
Longer learning curve

Sole sourcing– where only one supplier can satisfy the requirement.
Usually a monopoly supply market with high barriers to entry and no close
substitutes. This carries very high risk for the buyer in terms of price and
security of supply. Due to the technical nature of some of the safety
materials there may only be one approved source. Solo sourcing is basically
due to scarcity of suppliers i.e. there is only one supplier, such as
monopolist.

Partnership sourcing– commitment by both customer and supplier to a

long-term relationship based on continuous improvement. E.g. high
spend/high risk requirements, technical complexity, and fast-moving
technology. This could also be a valid approach for an organization to
ensure that their products and materials keep pace with latest technologies
and quality requirements.

Sourcing Decisions( strategies and policies……………..)

Tactical
Tactical and operational sourcing is concerned with lower level decisions
relating to high profit, low risk, and non critical items. The formulation of
short range decisions as to how supply requirements are to be met, in
response changing or temporary conditions in the supply market.
Purchasing managers have to make decisions as to the type of sources that
needed materials will be obtained from. To guide them in these tactical
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choices and achieve consistent performance in the long run, they have to
develop sourcing strategies that form a consistent strategic framework and
help provide answers to such questions as:
 Make or buy?
 Lease or buy?
 Buy a source/acquisitions?
 Vendor Managed Inventory?
 Domestic or overseas sources?
 Local or national sources?
 Sourcing from distributors or manufacturers?
Purchasing managers must carefully select and evaluate the advantages
and disadvantages of either alternative to arrive at meaningful conclusions.

Strategic Sourcing
Strategic sourcing is concerned with top level, long term decisions. It is also
concerned with the formulation of long term purchasing policies on: supply
base optimization/rationalization, partnership sourcing, reciprocal and
intra-company trading, globalization and counter trade the purchase of
capital equipment and ethical issues.
The Sourcing Process https://slideplayer.com/slide/1435666/
1. Identify or re-evaluate needs
2. Define or evaluate user requirements
3. Decide to make or buy
4. Identify type of purchasing
5. Conduct market analysis monopoly oligopoly, competitive etc
6. Identify possible supplier’s i.e. old or new suppliers.
7. Prescreen possible suppliers. This process will reduce the number of
suppliers to those that can meet the purchaser’s demands.
8. Evaluate the demand supply base i.e. competitive bidding.
9. Choose supplier- the choice of the suppliers determines the relation
ships that will exist between the purchasing and suppliers
organization and how the relationship will be structured and
implemented. It will also determine how relationship with non
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 selected suppliers will be maintained, purchased/make performance
evaluation.
10. Deliver product/perform service the generation of performance data
to be used for the next performance evaluation.
The supplier performance must be evaluated to determine how well the
purchase needs have been met.

Make or Buy, In-sourcing or Outsourcing

Introduction
One of the most critical decisions made in any firm concerns make or buy.
When any firm starts its life, a whole series of make-or-buy decisions need
to be made and as the firm grows and as it adds or drops products and/or
services from its offerings, make-or-buy decisions continue to be made.
In-sourcing: Refers to reversing a previous buy decision. An organization
chooses to bring in-house an activity, product or service previously procured
from outside.
Outsourcing: An activity, product or service previously done in-house will
be procured from outside.
Outsourcing
Outsourcing is the process of delegating a company's business process to
third parties or external agencies, leveraging benefits ranging from low cost
labor, improved quality to product and service innovation.
For any brand new product or service, make-or-buy decisions need to be
made. In some cases, a firm may be able to make a required component or
provide a service more effectively or economically than by buying it. A
firm’s objective is to arrive at make-or-buy decisions whose composite effect
enhances the utilization of its productive, managerial and financial
capabilities.
In a going concern, past managerial decisions and the firm’s long-term
plans often establish the current pattern of operations. Historical policy
decisions may at times prompt a firm to provide certain parts or services
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internally even if it could buy more advantageously from outside supplier.
Similarly, the pattern will also dictate that some parts or services will be
procured from outside suppliers regardless of the firm’s capability. Within
this framework, make-or-buy investigations often originate in one of several
ways:
1. New products/services: The development of a new product or
service and the major modification of an old one are typical situations
requiring make-or-buy investigations where a major part of the new
product/service is studied to determine the most advantageous
production and sourcing decisions.
2. Unsatisfactory supplier performance: Less than desirable
performance by present suppliers may trigger the investigation into
the possibility of making such parts in-house as well as the
possibilities of improving the supplier’s performance or finding a more
efficient supplier.
3. Changing sales demand: Periods of significant sales growth or sales
decline also generate situations that initiate make-or-buy analysis. For
instance, reduced sales result in reduced production activity, leaving
plant facilities and workers idle. When this happens, management
naturally attempts to bring into its own shops work previously
performed by outside suppliers.
4. Restructuring/relocation: In organizational restructuring and
facilities relocation exercises the fundamental questions such as ‘what
business do we really want to be in’ are addressed. Then, make-or-buy
analysis of individual parts or every product/service that aligns with
‘the business we really want to be in’ is carried out to identify the
parts, which are most profitable to make or provide internally and
those, which can be procured more economically from outside
suppliers.

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Make-or-buy possibilities may require small capital expenditure for tooling
or minor equipment, to making a sizable additional investment in tooling,
facilities or know-how. A decision of this type usually does affect a firm’s
resource allocation plans; however, its effect on the firm’s future is much
less significant than is a decision requiring a major capital investment. Top-
management’s responsibility is to develop an operating procedure, which
provides for the pooling and analysis of information from all departments
affected by the decision. In other words, management should ensure that
the decision is made only after all relevant inputs have been evaluated.

Reasons for Buying or Outsourcing

Organizations buy or outsource materials, components and/or services from
suppliers for many reasons:
Cost advantage: For many firms, cost is an important reason for
outsourcing, especially for supplies and services that are non-vital to the
firm’s operations and competitive advantage. This is usually true for
standardized or generic supplies and services for which suppliers may have
the advantage of economy of scale because they supply the same item to
multiple users. In most outsourcing cases, the quantity needed is so small
that it does not justify the investment in capital equipment and/or other
resources to make the item or provide the service. Alternately, they could
outsource to foreign suppliers, which may offer a cost advantage because of
lower labour and/or materials costs.
Insufficient capacity: A firm may be running at or near capacity, making it
unable to produce the components or provide the services in-house. This
can happen when demand grows faster than anticipated or when expansion
strategies fail to meet demand. The firm buys parts or services to free up
capacity in the short term to focus on vital operations. Under some
circumstances, firms may even subcontracting vital components and/or
operations under very strict terms and conditions in order to meet demand.

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When managed properly, subcontracting is an effective means to expand
short-term capacity.
Lack of expertise: The firm may not have the necessary technology and
expertise to manufacture the item or provide the service. Maintaining long-
term technological knowhow and economical viability for non-core activities
may be affecting the firm’s ability to focus on core competencies. Suppliers
may hold the patent to the process or product in question, thus precluding
the make option, or the firm may not be able to meet environmental and
safety standards to manufacture the item.
Quality: Procured components or services may be superior in quality
because suppliers have better technology, know-how, know-who, process,
skilled labour and the advantage of economy of scale. Suppliers may be
investing more in research and development. Suppliers’ superior quality
may help firms stay on top of product and process technology, especially in
high-technology industries with rapid innovation.

Reasons for Making

An organization also makes its own materials, components, services and/or
equipment in-house for many reasons:
Protect proprietary technology: A major reason for the make option is to
protect proprietary technology. A firm may have developed an equipment,
product or process that needs to be protected for the sake of competitive
advantage. Firms may choose not to reveal the technology by asking
suppliers to make it, even if it is patented. An advantage of not revealing
the technology is to be able to surprise competitors and bring new products
to market ahead of competition, allowing the firm to charge a price
premium. For example, Intel is not likely to ask suppliers to manufacture
their CPU.
Non-competent supplier: If the suppliers do not have the technology or
capability to produce the required components or services, the firm may

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have no choice but to make an item or provide a service in-house, at least
for the short term. The firm may use supplier development strategies to
work with a new or existing supplier to produce the component or service in
the future as a long-term strategy.
Better quality control: If the firm is capable, the make option allows for
the most direct control over the design, process, labour and other inputs to
ensure that high-quality components or services are built or provided. The
firm may be so experienced and efficient in manufacturing the component
that suppliers are unable to meet its exact specifications and requirements.
On the other hand, suppliers may have better technology and processes to
produce better-quality components. Thus, the sourcing option ensuring a
higher quality level is a debatable question and must be investigated
thoroughly.
Using existing idle capacity: A short-term solution for a firm with excess
idle capacity is to use the excess capacity to make/do some of its
components/services. This strategy is valuable for firms that produce or
provide seasonal products/services. It avoids laying-off skilled workers and,
when business picks up, the capacity is readily available to meet demand.
Lower cost: If technology, capacity, and managerial and labour skills are
available, the make option may be more economical if large quantities of the
component are needed on a continuing basis. Although the make option has
a higher fixed cost due to capital investment, it has a lower variable cost
because it precludes suppliers’ profits. However, this is not a strategic
option in the long term, if the activities are not core-competencies of the
firm.

Benefits and Problems of outsourcing

The main benefits identified by organizations that have adopted outsourcing
are the freeing of management time and improvement in organizational
focus to concentrate on core business operations. Outsourcing also allows
access to world-class capabilities and makes capital funds available for core
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activities. Other benefits include reduced staff costs, increased flexibility,
reduction in staff management problems and improved cost certainty.
Outsourcing is not, however, without its problems. It can be a while before a
firm begins to benefit from any savings and in some cases, the whole
process is cost neutral. Some problems associated with outsourcing are as
follows:
1. Overdependence on suppliers
2. Lack of supplier flexibility
3. Communication with suppliers
4. Coordinating different suppliers
5. Lack of management skills to control suppliers
6. Quality of service at suppliers
7. Shallow expertise at suppliers
8. Poor staff training at suppliers
9. Unrealistic expectations of outsourcing providers due to over-
promising at the negotiations stage
10. Divergent interests of the firm and suppliers
11. Lack of commitment to the firm or industry
12. Cultural mismatches between firm and supplier organizations
13. Cost escalation
Procurement’s Role in Outsourcing
Procurement function should play a major role in make-or-buy decisions. On
the other hand, research indicates that Procurement has had relatively
moderate involvement in the outsourcing investigations in many firms.
Given the nature of the decision, Procurement should be heavily involved in
outsourcing as they can add value to the decision in the following ways:
1. Providing a comprehensive, competitive process
2. Identifying opportunities for outsourcing
3. Aiding in selection of sources
4. Identifying potential relationship issues

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 5. Developing and negotiating the contract
6. Monitoring and managing the relationship on an ongoing basis

The Sources of Information Regarding the Potential Suppliers.

1. Newspaper advertisements:
Newspapers columns are full of advertisements from various firms
indicating the items of stores which they manufacture, import, and stock or
specialize in.
2. Trade directories:
Directories are available which give classified information of suppliers
industry wise. Very detailed information is available there in regarding
names and addresses of manufacturers, their regional and branch offices,
their authorized agents and their range of products.
3. Catalogue, price lists etc:
Prices obtainable from catalogues and price lists are generally not final and
are subject to confirmation at the time of placing the order. Catalogues and
price lists should be properly classified and arranged to enable easy
reference. Either they could be kept according to commodity groups as such
as pipes and fittings, tools, alloy steel, abrasives, etc., or numbered serially
and covered with index cards or lists prepared according to commodity
groups.
4. Trade journals:
Most leading companies advertise in trade journals. Sometimes excellent
articles appear in them regarding specific industries. Valuable information
can be obtained from such journals.

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5. Salesmen:
Salesmen are excellent sources for supply and material information. Not
only are they usually well informed about the capabilities and features of
their own products, but they are also familiar with similar and competitive
products as well.
6. Telephone directories:
Telephone directories of large cities contain classified advertisements from
suppliers.
7. Exchange of information between similar companies:
If satisfactory trade relations are maintained, even one’s own competitors
will part with the information he has.
8. Trade exhibitions and fairs:
Visits to exhibitions and fairs should give valuable information regarding
potential suppliers. Such exhibitions and fairs are held industry wise and
also for specific purposes, e.g., import substitution. Some such exhibitions
are held regularly at specific intervals when available information can be
updated.
9. Personnel from other departments of the company:
Personnel from other departments of a firm can often provide purchasing
with helpful information about prospective suppliers. Through their
associations in professional organisations, civic associations, and social
groups, these employees often learn about outstanding suppliers.
10. Yellow pages:
Another commonly known directory is the classified yellow pages section of
telephone directories. This source of information is frequently of limited
value to industrial buyers because local telephone books list only local
companies.
However, buyers can readily obtain telephone books for all major cities from
the telephone company. The size and capability of companies are also

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difficult to determine, as management and financial data are normally not
included in the advertisements.
The yellow pages do, however, have the virtue of being well indexed. Also,
they can serve as a useful starting point if other sources have proved
fruitless, and if local sources are desired.

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SPECIFICATIONS AND QUALITY MANAGEMENT
One of the key functions of procurement is to specify and document
business requirements for supply. Specifications are one of the most
important elements of the purchasing process. The preparation of good
specifications is probably the most difficult function in the process.
Inadequate or poorly written specifications are the cause of many bidder
challenges and can considerably delay the purchasing process but if well
executed, supply specifications can provide value to other functional areas
within the organization.

Specifications
A specification has been defined as a statement of the attributes of a
product or service or a statement of needs to be satisfied in the supply of a
product or service.
It must be distinguished from standards. A standard is a specification
intended for recurrent use. Standards differ from specifications in that,
while every standard is a specification, not every specification is a standard.
The guiding principle of standardization is the elimination of unnecessary
variety.
Both specifications and standards aim to:
1. Define requirements thus encouraging all relevant stakeholders to
consider what they really need, whether what they think they need is
the only, most cost effective or most value-adding solution.
2. Communicate the requirements clearly to suppliers so that they can
plan to conform, and perhaps also use their expertise to come up with
innovative or lower cost solutions to the requirement problem i.e. you
get what you need
3. Provide a means of evaluating the quality or conformance of the goods
or services supplied, for acceptance(if conforming to specification) or
rejection (if non-conforming) and improvement planning

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A specification is often thought in terms of the “right product or service’ or
of the right quality’, but it may also include other aspects of the ‘five rights
of procurement’ in defining the requirement, including the quantity
required, and when and where delivery is required.

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A good Specification should………
 state the requirement clearly, concisely and logically in functional and
performance terms unless specific technical requirements are needed;
 state what the item or goods will be used for;
 contain enough information for offerors to decide and cost the goods
or services they will offer and at what level of quality;
 permit offered goods or services to be evaluated against defined
criteria by examination, trial, test or documentation;
 state the criteria for acceptance of goods or services by examination,
trial, test or documentation;
 provide equal opportunity for all potential suppliers to offer goods or
services which satisfies the needs of the user, including goods or
services incorporating alternative solutions;
 form the fundamental basis of the contract between buyer and seller;
 not over-specify requirements; and
 not contain features that directly or indirectly discriminate against
suppliers.

Types of Specifications:
The main categories of specification are conformance specifications (also
known as technical or design specifications) and performance
specifications (also known as functional specifications, output or outcome
specifications)
Performance (Functional) Specifications
These are specifications that define the function, duty or role of the goods
or services. It nominates what the goods or services are broadly required to
do. Functional specifications define the task or desired result by focusing on
what is to be achieved rather than how it is to be done. Performance
specifications define the purpose of the goods or services in terms of how
effectively it will perform, that is, in capability or performance terms.
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However, they do not describe the method of achieving the intended result.
This enables suppliers to provide solutions to defined problems.
Conformance (Technical Specifications)
These are specifications that define the technical and physical
characteristics and/or measurements of a product, such as physical aspects
(for example, dimensions, colour, and surface finish), design details,
material properties, energy requirements, processes, maintenance
requirements and operational requirements. They are used when functional
and performance characteristics are insufficient to define the requirement.
With a conformance specification, the buyer details exactly what the
required product, part or material must consist of. This may take the form
of an engineering drawing or blue print, a chemical formula or a sample of
the product to be duplicated. For example, a supplier may not know in
detail, or even at all, what function the product will play in the buyer’s
operations.
Advantages and Disadvantages of Specifications
The main advantages of claimed for using specifications are as follows:
 The process of drawing up specifications is a useful discipline. It
forces careful consideration of needs and possible alternative ways of
satisfying them. This can lead to other benefits such as innovation and
cost savings.
 If items are too be purchased from more than one source, the use of
conformance specifications (specifying exactly what is too be
supplied) may be essential to ensure uniformity
 Specifications provide useful criteria for measuring the quality and
acceptability of purchase once delivered.
 Specifications provide evidence, in the event of a dispute, as to what
the purchaser required (and the supplier agreed to provide) as part of
the contract.
The main disadvantages of using specifications are as follows:

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 Detailed specification is an expensive and time consuming process,
and almost uneconomic for routine and small value purchases.
 The costs of inspection and quality control are greater for complex
specifications and if simple specification is used (e.g. by a brand name
and model, for which conformance is easily established)
 Specifications can become too firmly embedded: they need to be
regularly reviewed, to ensure that the latest design decisions, and the
latest developments in the supply market, and the latest reassessment
of the business need is being taken into account.
 Specifications can create a temptation to over-specify, adding cost
( without necessarily adding value) and increasing stock variation and
proliferation (a widening range of items held, reflecting potentially
minor differences in specifications, rather than ‘rationalizing’ the
range of inventory by utilizing generic or already stocked items)

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Consequences of Poor Specifications
The of ineffective specification process are potentially costly for the
organization
 There may be misunderstandings with suppliers over requirements
and expectations (e.g. if the specification did not take into account
users’ needs), leading to internal conflict, resistance to use of the
product and loss of credibility for purchasing
 There are more likely to be quality defects in the goods supplied, and
these are costly in terms of lost time, scrapped goods, rework,
additional inspections and controls, etc. if defects reach the customer,
there may be additional serious consequences of lost customer loyalty,
lost business, the adjustment of complaints and so on.
 Poorly defined specifications may mean that, even if the procured
materials or services conform to specification, they may fail to
function as they should (or to meet the business need): the risk and
cost of such a failure is borne by the buyer.
 Goods and services may be over-specified: related to some ‘ideal
standard rather than a robust business case: without reference to
users’ actual needs, the cost of higher standards, or the added value
actually contributed by higher standards.

Methods of Description
The description of an item may take any one of a variety of methods or,
indeed, may be a combination of several different methods. The term
specification will be used in the narrower sense referring to one particular
method of description.
The methods of description include:
Specification by brand: A buyer may specify what it requires by means of
a brand name. if the company is familiar with a particular product on the
market, and it meets your criteria, it is simple to order the required quantity

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of that brand, usually supported by a particular model name or number.
Branded items will tend to be of good quality, simple, quick, cheap and easy
to administer.
The main disadvantages of specifying branded item are as follows:
a) The cost of a branded item may be higher than that of an unbranded
substitute.
b) The naming of a brand effectively results in a ‘closed specification’
which restricts the number of potential suppliers and deprives the
buyer of the possible advantage of a lower price or even of
improvements brought out by competitors.
Specification by Physical or Chemical Properties: Composition
specifications are equivalent of technical specifications for different types of
product, such as chemicals and manufactured materials (e.g. plastics),
engineering or construction. They specify the chemical or physical make-up
required. This may be particularly important where
 Certain physical properties (e.g. strength, flexibility, durability) are
important for safety and/or performance.
 Certain materials are restricted by law, regulation or codes of
practice, for health, safety or environmental reasons
Specification by sample: If the purchaser knows exactly what he wants,
because he already possesses an example of that item (e.g. produced by
another supplier) he can simply send a sample or prototype to the supplier,
requiring the supplier to duplicate the features and performance of the
sample. The advantage her is that the buyer relies on a sample provided by
supplier and that some samples can be used or tested to assess suitability,
prior to purchase.
Specification by standards: Standards are documents that stipulate or
recommend minimum levels of performance and quality of goods and
services. The buyer can simply specify that the supplies be compliant with a
given standard, or that the supplier’s processes be accredited under a given
standard scheme.

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Standards may related to various aspects of product quality such as
standard terms and symbols, item dimensions, performance or safety
requirements, code of practice and methods of testing among others.
NB: Purchasing staff need to be aware of the major trade, national and
international standards applicable to their industry and the items they buy
regularly.

Service Specifications
A service may be defined as ‘any activity or benefit that one party can offer
to another that is essentially intangible and does not result in ownership of
anything’ (Kotler). Some obvious examples include call centre, cleaning,
transport & logistics, IT services, advertising, security services, catering,
training, & consultancy among others.
Why Services are Different?
Services and/or service elements present buyers with problems additional
to those that arise in purchasing materials or manufactured goods, when it
comes to specifying requirements. This can be well understood by looking
at the characteristics of both services and goods.
 Goods are tangible: they can be inspected, measured, weighed and
tested to check quality and compliance with specification. Services
are intangible: specification of service levels and subsequently
checking whether or how far they have been achieved presents
difficulties. For instance, determining ‘how clean is clean? How long
should it take to repair a computer e.tc.
 Goods emerging from a manufacturing process generally have a high
degree of uniformity, which also simplifies their evaluation. Services
are variable because every instance of a service provision is unique,
because the personnel and circumstances are different. It is hard to
standardize requirements.
 Goods can be produced, purchased and stored in advance of a need,
for later consumption. Services and inseparable and perishable,
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 provided in ‘real time’ they can’t be provided first and consumed later.
E.g. transport, accommodation and catering services are only relevant
when they are needed. It is important therefore to include time of
provision so that the supplier can schedule accordingly.
 Goods can often be used somewhere, once purchased. Many services
can only be performed in particular locations (e.g. accommodation
provided at hotel premises). The service specifications may therefore
need to include explicit understanding about where the service is to
be provided, the access required and related issues (such as
confidentiality if suppliers are working on the buyers premises)
 Goods are usually purchased for more or less immediate use, such as
incorporation in a larger product, or onward sale. A service may be
purchased for a long period during which requirements may change
from the original specification.

NB: The process of preparing and developing a comprehensive service

specification must take into account a range of considerations and these
include:
 Commercial
 Technical and infrastructure
 Consumer expectations
 Regulatory
 Ethical
 Consumer choice and experience
 Service outcome

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Role of Purchasing in Specification Development
The primary purpose of procurement is to contribute to the profitability of
the organization by obtaining the best-quality products or services in terms
of fitness for use at the least possible total cost. From the procurement
perspective, the purpose of specifying requirements is to provide the
information that the supplier requires in order to reliably meet the
organization’s expectations.
Procurement professional are in good position to make significant
contributions to the specifications process through:
 supply market awareness: the availability of standard or generic items
(for variety reduction), the availability of capable suppliers, the
possibility of alternative suppliers and solutions ( especially if
expensive branded products are requisitioned), market prices, supply
market risk factors, availability issues etc.
 Supplier contacts, to discuss potential solutions in advance of
specification, or to introduce pre-qualified suppliers to the design
team (early supplier involvement), which may in turn improve
technical specification.
 Awareness of commercial aspects of purchases, e.g. the need to
include requirements for just-in-time (low inventory) supply or
supplier stockholding, response time, maintenance cover, spares
availability, warranty periods and user training in the specification.
 Awareness of legal aspects of purchases, e.g. the need to comply with
national and international standards, and regulations on health and
safety, environmental protection and (in the public sector)
procurement methods.
 Purchasing disciplines, for variety reduction, value analysis, cost
reduction and so on. The buyer should be ready to discuss real needs
of the user, and to question desired performance levels or tolerances,

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 to pursue gains in these areas. The greatest scope for cost reduction
is at the design and specification stage.

QUALITY
For purchasing purposes, quality can be broadly defined as fitness for
purpose. It is the totality of an item’s characteristics which make it suitable
to satisfy a department’s/agency’s stated or implied needs (ISO 8402-1986).
In manufacturing, quality is a measure of excellence or a state of being free
from defects, deficiencies and significant variations. Quality can cover
attributes such as reliability, performance, standard of workmanship,
conformance of design and economic and perceived value.
Including quality requirements into a specification is one of the methods of
managing the risks associated with the goods and services required by a
department/agency. The aim is to remove, transfer or minimize these risks
before the goods or services are acquired. The seriousness of these risks
depends on the likelihood and consequences of something going wrong with
either the acquired goods or services or with the purchase

TOTAL QUALITY MANAGEMENT

Total Quality Management (TQM) is the optimization and integration of all
the functions and processes of a business in order to provide for excited
customers through a process of continuous improvement.
Objectives of TQM:
 Process improvement
 Defect prevention
 Measuring system capacity
 Developing improvement checklist and check forms
 Helping teams make better decisions
 Developing operational definitions

PRINCIPLES OF TOTAL QUALITY MANAGEMENT;

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In order to exceed customer expectations, an organization must embrace
the following principles:
 Customer Centric Approach – Consumers are the ultimate judge to
determine whether products or services are of superior quality or not.
No matter how many resources are pooled in training employees,
upgrading machines and computers, incorporating quality design
process and standards, bringing new technology, etc.; at the end of
the day, it is the customers who have the final say in judging your
company. Companies must remember to implement TQM across all
fronts keeping in mind the customers.
 Employee Involvement – Ensuring total employee involvement in
achieving goals and business objectives will lead to employee
empowerment and active participation from the employees in decision
making and addressing quality related problems. Employee
empowerment and involvement can be increased by making the
workspace more open and devoid of fear.
 Continuous Improvement – A major component of TQM is continual
improvement. Continual improvement will lead to improved and
higher quality processes. Continual improvement will ensure
companies will find new ways and techniques in producing better
quality products, production, be more competitive, as well as exceed
customer expectations.
 Strategic Approach to Improvement – Businesses must adopt a
strategic approach towards quality improvement to achieve their
goals, vision, and mission. A strategic plan is very necessary to ensure
quality becomes the core aspect of all business processes.
 Integrated System – Businesses comprise of various departments
with different functionality purposes. These functionalities are
interconnected with various horizontal processes TQM focuses on.
Everyone in the company should have a thorough understanding of

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 the quality policies, standards, objectives, and important processes. It
is very important to promote a quality work culture as it helps to
achieve excellence and surpass customer expectations. An integrated
system ensures continual improvement and helps companies achieve a
competitive edge.
 Decision Making – Data from the performance measurement of
processes indicates the current health of the company. For efficient
TQM, companies must collect and analyze data to improve quality,
decision making accuracy, and forecasts. The decision making must be
statistically and situational based in order to avoid any room for
emotional based decisions.
 Communications – Communication plays a crucial role in TQM as it
helps to motivate employees and improve their morale during routine
daily operations. Employees need to be involved as much as possible
in the day to day operations and decision making process to really
give them a sense of empowerment. This creates the environment of
success and unity and helps drive the results the TQM process can
achieve.

COSTS OF QUALITY
Quality has many other costs, which can be divided into two categories. The
first category consists of costs necessary for achieving high quality, which
are called quality control costs. These are of two types:
i) Prevention costs
ii) Appraisal costs.
The second category consists of the cost consequences of poor quality,
which are called quality failure costs. These include:
i) External failure costs
ii) Internal failure costs
Prevention costs

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Are all costs incurred in the process of preventing poor quality from
occurring? They include;
 Quality planning costs, such as the costs of developing and
implementing a quality plan.
 The costs of product and process design, from collecting customer
information to designing processes that achieve conformance to
specifications.
 Employee training in quality measurement is included as part of this
cost,
 The costs of maintaining records of information and data related to
quality.
Appraisal costs
Are incurred in the process of uncovering defects. They include;
 The cost of quality inspections, product testing, and performing audits
to make sure that quality standards are being met.
 Costs of worker time spent measuring quality.
 Cost of equipment used for quality appraisal.
Internal failure costs
Are associated with discovering poor product quality before the product
reaches the customer site. One type of internal failure cost is rework, which
is the cost of correcting the defective item. Sometimes the item is so
defective that it cannot be corrected and must be thrown away. This is
called scrap, and its costs include all the material, labor, and machine cost
spent in producing the defective product.
Other types of internal failure costs include the cost of machine downtime
due to failures in the process.
External failure costs: Are associated with quality problems that occur at
the customer site. These costs can be particularly damaging because
customer faith and loyalty can be difficult to regain. They include everything
from customer complaints, product returns, and repairs, to warranty claims,
recalls, and even litigation costs resulting from product liability issues. A
final component of this cost is lost sales and lost customers.

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Companies that consider quality important invest heavily in prevention and
appraisal costs in order to prevent internal and external failure costs. The
earlier defects are found, the less costly they are to correct. For example,
detecting and correcting defects during product design and product
production is considerably less expensive
TQM Tools
 Quality Improvement Teams; these are small groups of employees who
work on solving specific problems related to quality and productivity,
often with stated targets for improvement.
 Benchmarking; this is the process of identifying the best practices and
approaches by comparing productivity in specific areas within ones'
own company to other organizations both within and outside the
industry.
 Statistical process control; this is a statistical technique that uses
periodic random samples taken during actual production to determine
whether acceptable quality levels are being met or whether
production should be stopped in order to take remedial action.
 Commitment; In order for the Eye on the Future Model to be a
success, each member in an organisation must be committed to the
change process.
 Training; Training must be a part of the organization’s succession
planning. In today's business environment any training which is less
than visionary will not help the organization meet its' future goals and
objectives.

QUALITY ASSURANCE AND QUALITY CONTROL

Quality assurance means managing business processes in such a way that
both the supplier and the customer are satisfied with the quality and
consistency of the goods or services being produced/supplied. Quality
Assurance is process oriented and focuses on defect prevention, while
quality control is product oriented and focuses on defect identification.
Thus,
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Quality assurance (QA) refers to the overall management system which
includes the organization, planning, data collection, quality control,
documentation, evaluation, and reporting activities of your group. QA
provides the information you need to ascertain the quality of your data and
whether it meets the requirements of your project. QA ensures that your
data will meet defined standards of quality with a stated level of confidence.
Quality control (QC) refers to the routine technical activities whose purpose
is, essentially, error control. Since errors can occur in either the field, the
laboratory or in the office, QC must be part of each of these functions. QC
should include both internal and external measures.

Together, QA and QC help you produce data of known quality, enhance the
credibility of your group in reporting monitoring results, and ultimately save
time and money. However, a good QA/QC program is only successful if
everyone consents to follow it and if all project components are available in
writing. The Quality Assurance Project Plan (QAPP) is the written record of
your QA/QC program.

The benefits that businesses should derive from a properly implemented QA

System are:
(i) Improving customer satisfaction
(ii) Improving efficiency
(iii) Improving effectiveness
(iv) Reducing rework and waste
(v) Creating a well-planned business
(vi) Adding credibility to the business
(vii) Enabling the business to compete on an equal basis with larger
businesses.

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Negotiations & Inventory Management
Introduction
The process, by which agreements are reached, by parties with different
and potentially divergent interests, is a complex one. Every one negotiates,
in a sense, every day, as they engage in the give-and-take required to get
what they want in interactions with other people. But the kind of
negotiations engaged in by procurement professionals have legal, financial
and business consequences, and must therefore be undertaken in a
systematic, intentional and skilled manner.

Commercial negotiation

What is negotiation?
Negotiation in the procurement and supply context is defined by Burt,
Dobler and Starling (World class supply management) as; a process of
planning, reviewing and analyzing used by a buyer and seller to reach
acceptable agreements and compromises (which) include all aspects of the
business transaction, not just price.
Alternative definitions proposed by Lysons &Farrington, include the
following.

 The process whereby two or more parties decide what each will give
and take in an exchange between them. Rubin Brown-highlighting the
interactive bargaining nature of negotiation: the exchange of valued
currencies between interdependent parties.

 Any form of verbal communication in which the participants seek to

exploit the relative competitive advantages and needs to achieve
explicit or implicit objectives within the overall purpose of seeking to
resolve problems that are barriers to agreement. (Lyson)-highlighting
the potentially competitive nature of a process, in which participants
have own business needs and objectives.

As a student of purchasing, you would probably associate negotiation with

commercial negotiations of price and other contract terms (delivery, quality,
quantity e.t.c). However, negotiation gurus Fisher, Ury et al point out that:

Negotiation is a fact of life….everyone negotiates something every

day…a person negotiates with his spouse about where to go for
dinner….negotiation is a basic means of getting what you want from
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 others. It is a back and forth communication designed to reach an
agreement when you and the other side have some interests that are
shared and others that are opposed.(Fisher & Ury, Getting to Yes).

In this wider context, negotiation may be defined broadly as: A process

whereby two parties come together to confer, in a situation in which there is
some divergence or conflict of interests between them, with a view to
concluding a jointly acceptable agreement.

Gennard & Judge (Employee Relation) define this process as one of:

 Purposeful persuasion: whereby each party tries to persuade the

other to accept its case, see its view point or comply with its wishes
and

 Constructive compromise: whereby both parties accept the need to

move close to each other’s positions, identifying the areas of common
ground where there is room for concessions to be made.

In this broader sense, negotiation can be seen as an interpersonal problem-

solving technique, enabling parties to meet their own needs (as far as
possible) in a conflict of interest, without damaging ongoing relations
between them.

In this sense, negotiation is important not just in the development of

commercial agreements with external suppliers, but in the management of
activities and relationships within workforces and teams, and in the
management of issues and interests with organizational or project
stakeholders. In any business relationship, a procurement professional may
need to negotiate:

 What objectives will be set and given priority( given the potentially
differing needs of stakeholders) in making plans and managing
projects

 Mutually acceptable terms and conditions of work and working

together: relevant to internal( team and employer-employee) and
external ( supplier-customer) relationships

 Approaches to conflicts and problems that may arise in the course of

the work: differences of values, expectations, interests, priorities or
schedules; competition for scarce resources; and so on.

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In commercial contexts, negotiation is applicable where there is
disagreement or potential disagreement between suppliers and buyers. A
good buyer will be sensitive to potential areas of conflicts and will seek to
resolve these before they arise by ensuring that the terms and conditions
applicable to the purchase provide for such contingencies. (Lysons)

In an ideal world from the buyer’s point of view, all of the materials and
services required by a business would be freely available at cheap rates and
low risk. From a supplier’s point of view, the ideal world be one in which it
could charge as much as it liked for its goods and services. Somewhere
between the two extremes businesses must find common ground, and this is
essentially the purpose of commercial negotiation.

Alternative ways of establishing agreements

Despite the focus on negotiation, you should be aware that negotiation is

not the only approach to getting what you want from others or reaching
agreement with suppliers and stakeholders.

One major alternative for example, is competitive bidding , in which the

suppliers are asked to make a firm bid on terms and prices against
specification, and the buyer chooses the best(most advantageous) offer.
While this is a fair and efficient mechanism(and compulsory for these
reasons in public sector), negotiation may be preferred to competitive
bidding in situations where production costs are difficult to estimate
accurately, price is not the only important variable, or there are likely to be
changes to the specification as the contract progresses.

Bailey et al (Purchasing Principles & Management) suggest other

alternative approaches to reaching agreement.

 Persuasion: encourage the other side to accept the merits of your

case, with no concessions made on your side.

 Giving in (or accommodating): accept the other side’s case without

requiring it to make concessions.

 Coercion: insist that the other side meets your demands, ‘or else’

 Problem solving: work together to remove the divergence in goals or

interest, so that there is no need to negotiate.

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Lewicki, Saunders, Barry & Minton (Negotiation; and essentials of
negotiation) suggest that negotiation should be avoided if;

 one can achieve the objective without negotiating.

 the objective is not worth the time and effort of negotiating

 we have compelling alternatives to negotiating (e.g. a very strong

alternative to a negotiated agreement)

 we risk losing too much by negotiating

 the other party acts in bad faith or unethically

 waiting (doing nothing) may improve our position.

Strategic and tactical negotiation

Buyer-supplier relationship may require negotiation at two levels: strategic

and tactical. Strategic negotiation is carried out less frequently and at a
higher level, usually by senior management teams from both parties. It
addresses long-range issues involving the direction and objective of long
term supply chain relationships: the nature of the collaboration, the source
of competitive advantage to be sought, the mutual strategic benefits of
developing and so on. It is about the ‘ends’; what should we be doing
together, and what do we each want to get out of it?

At this level, negotiation tends to be collaborative or integrative in style,

because both parties are seeking mutual commitment, aligned objectives,
joint problem solving, mutual gain and equitable gain sharing in the
relationship. The building of trust and cooperation, and open dialogue about
issues and objectives, will be a priority. Examples of a strategic negotiation
might include negotiation of a joint venture or partnership agreement; the
formulation of supply chain management strategies; or an agreement to co-
invest in research and development or systems integration.

Tactical negotiation is carried out more frequently and at a lower level,

usually by functional or cross-functional teams from both parties. It
addresses short range issues involving operations, resource allocation,
performance and risk management and gain sharing within a tactical
( potentially short term or arm’s length relationship-and at the day-to-day
management level of a strategic relationship. It is about ‘means’; who does

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what, who pays for what and when, what are the obligations and rights of
each party.

At this level, negotiation tends to be more adversarial and competitive or

distributive in style, because both parties are seeking to maximize their own
organization’s share of the value gains, and minimize their own
organization’s share of the risks, within the relationship. Less attention may
be paid to relationship development (within the bounds of ethical and
professional behavior), where the relationship is purely tactical or
transactional. The focus may be an opportunistic, short-term gains (e.g.
forcing lower prices or favorable terms). Examples of a tactical negotiation
might include negotiation of prices and terms on a supply contract;
negotiation of service levels, incentives and penalties; negotiation of
solutions to problems and disputes; and so on.

Negotiation in the sourcing process

Burt, Dobler & Starling note that supply management professionals

typically play one of two distinct roles in negotiation, depending on the type
and value of the purchase.

 Acting as the company’s sole negotiator (for low-value, non- critical

items) with the sales negotiator of the supplier. This is not limited to
periodic formal contract negotiations; informal negotiations occur on
a daily basis, as suppliers adjust their catalogue prices or offer new
product lines, and as purchasers seek information about discounts or
‘deals’ available for different volume orders.

 Acting as a team leader of a cross-functional negotiating team (for

high-value, technically complex or strategic contracts, and for the
development of long-term supply relationship agreement). The other
members of the team are typically relevant technical experts (from
design, engineering, finance and so on), and the procurement
specialist may take the lead as the most skilled negotiator, with the
firmest grasp of commercial and contractual aspects of the
agreement.

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The Sourcing Process
Negotiation may also be used throughout a standard sourcing cycle for a
given item or service.

Define the need

specification

Identify the need Develop contract

requisition or terms
bill of materials

Contract/supplier Source the market

management monitor,
Identify potential
review & maintain
suppliers
performance
Appraise
Award the contract
suppliers

Negotiate best value Invite quotation or

tenders

Analyse quotations and

select most promising
supplier

Identifying and describing the need

Dobler et al note that in the broadest sense, negotiation begins with the
origin of a firm’s requirements for specific materials or services… the
ultimate in purchasing value is possible only if design, production or
operations, supply management, and marketing are able to reconcile their
differing views with respect to specifications or statement of works’.

Needs are commonly identified via purchase requisition from a user

department, a stock replenishment requisition from inventory control, or a
new product design specification. Negotiation may be a result of

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procurement’s role in challenging user-identified requirements to ensure
that they commercially sound and add value. For example:

 A non-standard or variant requisition may be challenged as to

whether a more cost effective generic item, a standard item, or an
item already in stock, would be equally effective in fulfilling the
requirement. This may be resisted by users with a technical
orientation, and procurement specialists may have to negotiate for
agreement with a more commercially appropriate, cost saving
solution.

 A systematic exercise of value analysis (or, at product design and

development stage, value engineering) may be used to ensure that all
aspects of a product add value, and to eradicate waste. This may
involve a complex cross-functional negotiation of value definitions,
essential and desirable features, priorities and objectives.

 Where purchasers and or suppliers are involved in the specification of

a product (early procurement involvement or early supplier
involvement), there may similarly be negotiation around objectives,
priorities, methods, the sharing of risk and cost and so on.
Negotiation may even be required in order to secure the involvement
of purchasers and /or suppliers in the development process.

Similar approaches will be used in negotiating with internal customers and

stakeholders as with external suppliers-with one crucial difference. While
an external negotiation may not have a successful outcome-the parties may
simply not be able to reach agreement-this is not an option with internal
negotiations. There is no acceptable ‘walk away’ option.

Specification also affects negotiation because the more ‘open’, or less

perspective, the specification, the more leeway there is for the negotiating
team to negotiate a total package of value: better or more innovation
solutions, lower total cost of ownership, quality improvements and so on –
not just ‘lowest price to conform to specification’.

Appraising and selecting suppliers

There are a number of different approaches to letting a purchase contract,

depending on the type of purchase and company policy. The organization
may already have negotiated a framework agreement or standing contract
with a supplier, to meet a requirement of a certain type. In such a case, the
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requirement will simply be notified to the pre-contracted supplier by a
purchase or call-off order, on the pre-agreed terms. Alternatively, buyers
may be authorized to make purchases up to a certain value from the
catalogues of pre-approved suppliers; catalogue purchasing is often used
for low-value purchases and routine supply replenishments, for example.

There may be only one available supplier, or the organization may already
have negotiated a preferred supplier or sole supplier agreement with a
dependable supply partner. In such a case, the buyer may simply seek to
negotiate a contract with the preferred or designated supplier.

The organization may send an ‘enquiry’ to one or more shortlisted suppliers,

in the form of a request for quotation (RFQ), a request for information (RFI)
or Request for Proposal(RFP). Such enquiries will typically set out the
details of the requirement: the contact details of the purchaser, the quantity
and description of goods and services required the required place and date
of delivery, and the buyer’s standard terms and conditions of business. It
will then invite the supplier(s) to submit a proposal and price for the job.
These may be evaluated:

 As a basis for negotiation of price and other terms with the supplier(s)

 On a non-negotiated competitive tender basis: potential suppliers are

issued with an invitation to tender (ITT), or an invitation or bid for a
contract, with the buyer intending to choose the best proposal or the
lowest lowest-price offer.

Negotiation may be necessary in situations where the terms of sale include

many and varied clauses, or if the buyer suspects that the quoted price is
unreasonably high. Other common situations in which negotiation will be
appropriate include the following:

 Contracts for the procurement of capital goods

 Projects with a large element of uncertainty in the eventual cost

 Costs where the purchaser contributes expertise, materials and so on

 Contracts with a learning curve, so that productivity, costs and

performance will vary over time

 Outsourcing agreements and contracts for services.

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In direct contract negotiation with suppliers, the buyers’ main objective
may be (Dobler et al):

 To obtain a fair and reasonable price for the quantity and quality of
goods specified

 To exert control over the manner in which the contract is performed

 To persuade the supplier to give maximum cooperation to the buyer’s

company

 To develop a sound and continuing relationship with competent

suppliers.

Where a relationship is ongoing, one particular issue may have to the

fore, but more often there are multiple objectives, especially in
negotiations with a new supplier or potential supplier.

Inventory Management
Inventory management is the process of efficiently overseeing the constant
flow of units into and out of an existing inventory. This process usually
involves controlling the transfer in of units in order to prevent the inventory
from becoming too high, or dwindling to levels that could put the operation
of the company into jeopardy. Competent inventory management also seeks
to control the costs associated with the inventory, both from the perspective
of the total value of the goods included and the tax burden generated by the
cumulative value of the inventory.
Inventory control is concerned with minimizing the total cost of inventory.
The three main factors in inventory control decision-making process are:
 The cost of holding the stock (e.g., based on the interest rate).
 The cost of placing an order (e.g., for row material stocks) or the set-
up cost of production.
 The cost of shortage, i.e., what is lost if the stock is insufficient to
meet all demand.

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Major Buying Issues

Organizational Buying Behaviour

Every firm, regardless of its organizational characteristics, must procure
the materials, supplies, equipment, and services necessary to operate the
business successfully. In terms of the value chain, this is ‘procurement’ and
concerns; sourcing the process inputs, ensuring specifications meet
requirements, managing availabilities, and costs and capabilities.
Customers in the business market, such as commercial firms, governments,
and not-for-profit institutions, buy goods and services in order to produce
other goods and services for their own customers”.
However, business-to-business buying situation can be categorised into one
of the following:
 New task. In the new-task buying situation, the problem or need is
perceived by organisational decision makers as totally different from
previous experiences; therefore a significant amount of information is
required for decision makers to explore alternative ways of solving the
problem and to search for alternative suppliers.
 Straight re-buy. Where there is a continuing or recurring requirement,
buyers have substantial experience in dealing with the need, and they
require little or no new information. Evaluation of new alternative
solutions is unnecessary and unlikely to yield appreciable improvements.
 Modified re-buy. In the modified re-buy situation, organisational decision
makers feel that significant benefits may be derived from a revaluation of
alternatives. The buyers have experience in satisfying the continuing or
recurring requirement, but they believe it worthwhile to seek additional
information and perhaps to consider alternative solutions”.
Centralised Vs Decentralised
Organisational buying processes may be centralised or decentralised.

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 A centralised buying process exists where the purchasing of company
inputs is controlled exclusively by one group or department within the
organisation. The advantages of centralised purchasing include:
 Purchases are made in large volumes, leading to economies of scale.
 The ability to use a highly specialised group of staff to maximise the
possibility of making favourable purchase decisions.
 The ability to maximise purchasing efficiency through task-specific
technology.
 policies and procedures are easy to standardise and implement facilitating standardisation,
variety reduction and better value for money and minimising ‘maverick’ purchasing. Staff
training and development would be better organised.
 Consolidation of requirements: higher volumes could lead to savings based on economies of
scale.
 Location: If units are in different places, distance may hamper supply coordination.
Consistency is easier because of the single location.
 Supply market structure: if there is only a small number of suppliers a centralised
coordinated approach could facilitate a better negotiating position.
 Expertise required: expertise for buying the products and services required may suggest a
specialist buyer for each and a centralised approach. It could lead to a ‘category management’
approach.
 Customer demands: Different customers may dictate which products must be purchased,
obstructing efforts aimed at coordination.

Disadvantages include:
 Inability to cater for large widely dispersed markets.
 Goal confusion, where the goals of the purchasing department a
contrary to those of other departments.
 Lack of exposure to other organisational departments may lead to
an inability to grasp their perspectives. That is, knowledge
management may be difficult in this situation.
 A decentralised buying process is one that is dispersed between different
areas of the business, each being responsible for a discrete product line.
Advantages of this method include:
 Local responsibility: important where units are a long distance away from a central
location and/or where each unit’s requirements are specific.

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  Knowledge of the local environment, culture and customer needs might give benefits
to local suppliers and the local economy.
 Skills development of buyers in each unit as there may be an element of local
purchasing if only for MRO items and facilities management.
 Better communication and coordination between procurement and operating
departments,
 Customer focus: buyers are ‘closer’ to internal and external customers developing
understanding of user needs and problems.
 Quicker response to operational and user needs, environmental changes and problems
by local buyers close to the scene of operations.
 Smaller purchase quantities: sacrificing economies of scale, but reducing costs and
risks of holding inventory.
 Accountability: divisional managers can be held accountable for performance only if
they have genuine control over operations.
 Freeing central procurement units to focus on higher-level, value-adding tasks

Disadvantages include:
 Lesser ability to gain economies of scale.
 Less-specialised staff.
 Large costs involvement.
 A hybrid between each of these two methods is a way that organisations
with groups of similar customers as well as groups of dissimilar
customers can manage their purchasing activities effectively.
Smaller companies tend to have centralised buying processes.
Organisations that use the ‘product platform’ technique also are capable of
having highly centralised buying functions. Organisations with diverse
customer groups usually benefit from decentralised purchasing, however,
this method usually proves to be costly.

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Capital Buying (Procurement)

Capital equipment has been defined as one of the subclass of the fixed asset
category that includes industrial and office machinery and tools,
transportation equipment, furniture and others. As such, these items are
properly chargeable to a capital account rather than to expense. There are
alternative terms such as ‘capital good’, ‘capital assets’ and ‘capital
expenditure’, which can be defined as follows:
Capital goods: Capital in the form of fixed assets used to produce
goods, such as plant and equipment.
Capital assets: Assets, tangible and intangible, used to generate
revenues on cost savings by providing production, distribution or
service capabilities for more than one year.
Capital expenditure: An expenditure on acquisition of tangible
productive assets, which yield continuous service beyond the
accounting period in which they are bought.
TYPES OF CAPITAL EQUIPMENTS
Capital equipment can be generalized into six types:
1. Buildings (permanent constructions)
2. Installation equipment (plant, machinery and equipment used
directly in producing goods and services)
3. Accessory equipment (major equipment used to facilitate the
production of goods and services or to enhance the operations of
organization, e.g., transport vehicles for staff)
4. Operating equipment (semi-durable minor equipment that is
movable and used in, but not generally essential to, the production
of goods and services, e.g., goggles)
5. Tools and instruments (semi-durable or durable portable minor
equipment required and associated with the production of goods and
services, e.g., timing devices)

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 6. Furnishing and fittings (all goods and materials employed to fit
buildings for organizational purposes, e.g., carpets)

DIFFERENCENCES IN THE PROCUREMENT OF CAPITAL EQUIPMENTS

1. Non-recurring procurement
Capital equipment procurements do not occur with regular frequency. A
production machine, for example, may remain in use for 10 to 15 years.
Even furniture may last over 5 years. Another unique feature of most capital
equipment procurements is the lead-time requirement. While some types of
capital equipment are standard, off-the-shelf products, many are not. Much
production machinery and even some tools are built to operate under
specific conditions peculiar to each buyer’s operation.
2. Nature and size of expenditure
An expenditure of company funds for capital equipment is an investment. If
procured wisely and operated efficiently, capital equipment generates profit
for its owner. Because it exerts a direct influence on the costs of production,
the selection of major capital equipment is a matter of significant concern to
top management.
Although capital equipment prices cover a wide range, the procurement of
most major equipment involves the expenditure of a substantial sum of
money. However, the procurement price for a piece of equipment is
frequently overshadowed in importance by other elements of cost. Since a
machine is often used for ten years or more, total costs of operation and
maintenance during its lifetime may far exceed its initial cost. Hence, the
total life cost of a machine, relative to its productivity, is the cost factor of
primary importance. Estimating operating and maintenance costs, which
will be incurred in future years, is not easy. Frequently, these costs vary
from year to year. Consequently, discussions involving the choice between
several alternative machines often centre on the probable accuracy of
specific cost estimates.

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Typically, the general supply capabilities of capital equipment producers do
not adjust quickly to changes in levels of demand. Thus, because capital
equipment procurements are made infrequently and can often be
postponed, producers of capital equipment frequently find themselves in a
‘feast or famine’ type of business. For instance, when a buyer’s business is
good, it needs additional equipment to satisfy customers’ burgeoning
demands. However, other buyers could also be in the same situation when
the market is up. The buyer will find capital equipment prices rising in a
market of short supply.
3. Consideration in source selection
When procuring capital equipment, selection of a supplier is governed
largely by four general considerations:
a. Operating characteristics: This is by far the most influential factor in
selecting the supplier for particular capital equipment. Once the user and
engineering personnel have clearly established the function the equipment
is to perform, design and operating capability are crucial in selecting the
specific equipment to be procured.
The challenge is that design and operating features for a given type of
equipment can differ significantly among the equipment available from
different suppliers. For this reason, the number of suppliers capable of
meeting every aspect of a buyer’s operating requirements, no more no less,
is frequently limited. This is one reason why Procurement usually finds its
freedom of sourcing and selecting capital equipment limited as compared
with buying production materials and supplies.
b. Engineering features: Closely related to the equipment’s operating
characteristics are its engineering features. These features must be
compatible with the buyer’s existing equipment, process, plant-layout,
established standards if applicable, e.g., physical size and mounting
dimensions, flexibility, power requirements, maintenance, safety features,
pollution characteristics, etc. The general questions to be answered are:

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How does this piece of equipment fit in with the existing operation? Will
many costly modifications be involved in adapting the equipment to the
existing system?
c. Economic analysis: After acceptable equipments have been identified, a
thorough evaluation of their relative merits is undertaken. The task is a
complicated one. An analysis of the major operating alternatives includes a
comparative economic analysis of the potential new equipment, and a
comparison of each with the alternative of using the existing equipment
now in operation. In all cases, the analysis of equipment must relate its total
expected life cost to its total expected productivity. A payback analysis is
then often used to determine the number of year’s equipment requires to
pay for itself from additional earnings generated by its increased level of
operation efficiency, which is a useful measure for evaluating a potential
procurement in light of the buying firm’s liquidity position.
The economic analysis is a critical portion of the formal proposal justifying
the need for additional equipment to be prepared for top management.
Although the proposal must consist of more than the economic analysis, a
complete quantitative analysis showing the potential profitability of the
various alternatives should constitute a major section of such a proposal.
d. Qualitative considerations: Certain qualitative factors concerning
potential suppliers are important in making any procurement. However, not
all the factors important in selecting sources for production materials weigh
as heavily in selecting sources for capital equipment. Capital equipment
procurements require a different type of cooperative relationship between
the buyer and the seller. It is important, initially, that a supplier be willing to
work with the buyer’s technical personnel to ensure a good fit of equipment
to operating needs. After the procurement, the buyer may need help with
installation, start-up, adjustments and so on. In fact, adjustment or
calibration may be a continuing need, depending on the type of equipment
and the buyer’s in-house capability.

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At some future date, the buyer may also require a warranty adjustment.
Especially important is an assessment of the supplier’s policy and
cooperativeness with respect to the supply of replacement parts and service
for the equipment, particularly later when the equipment is superseded by a
new model. These types of factors represent one group of qualitative
considerations that a buyer considers in making a capital equipment
procurement decision, with each individual case posing its own unique
requirements.
Another group of qualitative considerations are those indicating a supplier’s
ability to produce reliable equipment that performs in accordance with
specifications. This implies the definite need for an assessment of the
supplier’s technical and production capabilities. As the situation demands, a
good buyer uses various approaches and personnel in making such an
assessment, including plant visits and technical discussions with the
supplier’s personnel. However, buyers should not overlook the simple
technique of investigating a supplier’s reputation among present customers.
This is an invaluable source of information that is easy to tap.
Generally speaking, qualitative considerations do not play a primary role in
the selection of a supplier for capital equipment. They are usually
considered in the final analysis, after the major factors have been weighed.
The qualitative factors are the straws that tip the balance one way or the
other for the several potential suppliers who rank high on combined
technical and economic considerations.
Procurement’s role in capital equipment procurement
At this point, we can conclude that Procurement function plays a distinctly
different role in the acquisition of capital equipment than it does in the
acquisition of production materials and supplies. In the procurement of
capital equipment, the Procurement function acts to a great extent in a
service capacity as a gatherer of information, a process coordinator, a

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procurement consultant to management and finally a contract
administrator.
1. Source of information
No department is in a better position than Procurement to keep abreast of
the general developments occurring in major equipment industries.
Through daily contact with both salespeople and current trade literature,
alert buyers pick up considerable information of value to operating
department management. In large firms, one buyer may specialize solely in
capital equipment procurement. A good Procurement function makes a
point of regularly relaying information concerning new developments in the
capital equipment area to appropriate operating executives.
Once a requisition has been initiated, it is Procurement’s responsibility to
locate competent suppliers and secure the information required by the user
in making a preliminary analysis. Suppose the quality control manager
wants to buy an expensive microscope. With his or her knowledge of the
market, the capital equipment buyer can easily obtain the basic data needed
for analysis. Moreover, a good buyer should be able to arrange a side-by-
side display or demonstration of major competitive models so that quality
control personnel can test and compare them.
2. Liaison service
During investigation of various manufacturers’ equipment, an operating
manager frequently finds it advantageous to discuss technical details with a
manufacturer’s representative. A customary and sound practice is for the
appropriate buyer to act as a liaison in arranging meetings between
potential suppliers and operating departments. As a rule, the capital
equipment buyer should sit in on these meetings, or at least be kept
informed of significant developments. It is his or her responsibility to ensure
that no premature commitments are made by line departments; likewise,
the buyer must at all times be aware of the current status of all negotiations
if he or she is to function effectively in the buyer’s role.

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3. Requirement description development and bids
One of the advantages of formally establishing a buying team is the fact that
more cooperative action usually is generated in attacking the buying
problem. This can be extremely useful in development of the equipment
requirement descriptions, particularly when the buyer is genuinely involved.
As a part of this involvement, when requirement descriptions are nearing
completion and invitations for bid are to be issued, a good buyer should also
function in the role of an informal auditor. Although technical requirements
predominate, the buyer should make every effort to see that specifications
are written as functional as possible. Most users hold biases for and against
specific types of equipment. Every effort should be made to exclude such
personal biases from the requirement descriptions. The nature of many
capital equipment requirements limits the number of possible suppliers in
the first place. This number should not be further reduced by arbitrarily
excluding types or make of equipment on the grounds of prejudice alone.
To function effectively in this role, the buyer should have participated in
most of the technical discussions between the firm’s line personnel and the
various suppliers/manufacturers, and he or she must have a basic
understanding of the significance of the technical problems involved. The
buyer’s job is still one of challenging questionable requirement description
inclusions. Ironically, however, a buyer’s success in this endeavour depends
less on technical knowledge than on skill in understanding and dealing with
people. In the realm of technical matters, the buyer is at a disadvantage
because he or she is dealing with professionals in this area. Therefore, the
long-range approach should focus on an attempt to gain the cooperation of
technical managers. The buyer must persuade them that unbiased
functional requirement descriptions serve the firm’s best interests.
Once specifications are completed, the buyer is responsible for arranging
comparison demonstrations and for securing bids from a reasonable
number of qualified suppliers.

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4. Qualitative analysis
Some suppliers are more qualified than others. The degree of qualification
should be considered carefully by the review team in deciding which
equipment to procure. Procurement department normally gathers and
analyses such information for the team. The buyer must first determine,
usually with engineering assistance, the level of a supplier’s technical and
production capabilities. This is of utmost importance.
Second, the buyer must assess the supplier’s capability and willingness to
provide any engineering service required during the installation and start-
up of the new equipment. This is an extremely important financial
consideration when complex, expensive equipment is involved. Closely
related to this factor is the necessity of training operators and what service
the supplier is willing to provide in this area.
Another important consideration is the reliability of a supplier in standing
behind its guarantees. Once the equipment is installed, unexpected
problems beyond the buying firm’s control sometimes add significantly to
the total cost of equipment. Finally, what is the supplier’s policy on
providing replacement parts? When the equipment is superseded by a new
model, what will be the availability of obsolete parts?
In practice, unfortunately, such considerations frequently play a minor role
in the initial selection of equipment, only to assume major proportions at a
later date. It is the Procurement function’s responsibility to evaluate
potential suppliers in light of these qualitative factors and to bring
significant considerations of this kind before the evaluating team for
adequate appraisal. After the equipment is procured, the wise buyer works
closely with the maintenance department in keeping and interpreting
historical records of equipment performance. Data of this kind are valuable
in making similar future analyses.
5. Bid tabulation and economic analysis

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When bids are received, the buyer tabulates them and makes any
adjustments necessary so they can be interpreted on a comparable basis by
the team responsible for the final recommendation.
The finance department frequently assumes responsibility for conducting
the total profitability study. However, once management has selected the
types of analysis to be used, the Procurement function might more
effectively prepare, interpret and present the complete package of price,
cost and profitability for the team’s consideration. This needs to be done
since the buyer has a complete understanding of the total cost situation
from his or her involvement in the preceding technical discussions till the
requirement descriptions preparation.
6. Negotiation, contract preparation and administration
After top management has approved a proposal for the procurement capital
equipment, the buyer assumes his or her customary responsibility for
negotiating the final price, delivery and related terms of contract. The
purchase order or contract should be written with particular care,
specifying the responsibility of both parties for equipment performance and
post-sale activities. Acceptance testing and inspection methods, acceptance
timing, equipment specifications and performance standards and guarantee
conditions should be clearly stated. Similarly, supplier responsibility for
post-sale service pertaining to installation, start-up, operator training,
maintenance checks and replacement parts should be spelled out clearly so
that there is no question about what is expected.
In the event that Procurement involves a lengthy manufacturing period, a
special follow-up and expediting program should be developed. This may
call for periodic plant visits and in-process inspection of the work.
Responsibility for monitoring this activity often rests with the Procurement
function.
Viewing the situation in total, procurement’s role in the acquisition of
capital equipment assumes a considerably greater staff orientation and a

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lesser decision-making orientation than is customary in the procurement of
standard production materials and supplies.

The used equipment market

A buyer is by no means restricted to the procurement of new capital
equipment. Procurement of used equipment, in fact, constitutes an
important percentage of total equipment sales.
A buyer may consider buying used equipment for several reasons:
a. The cost of used equipment is substantially less than that of new
equipment. Analysis of payback or return on investment may
well reveal that a piece of used equipment is a better buy than
new equipment. Even if this is not the case, a firm’s financial
position may dictate the procurement of lower-priced option.
b. Used equipment is frequently more quickly available than new
equipment. In some situations, availability may override all
other considerations.
c. Used equipment adequately satisfies the buying firm’s need, in
which case there is no point in buying new equipment. In cases
where operating requirements are not severe, used equipment
in sound operating condition frequently provides economical
service for many years. In the event that equipment is needed
for standby or peak-capacity operation, or for use on a short-
lived project, more often than not used equipment can satisfy
the need adequately.
A great deal of used equipment is available and can be commonly procured
from used equipment dealers, directly from the owner, brokers or auctions.
Used equipment may be sold in as-seen condition or rebuilt or
reconditioned. With rebuilt used equipment, the equipment will usually have
been stripped down and built up again from the base. Worn or broken parts
will have been replaced and worn surfaces reground and realigned to meet
the original tolerances. The rebuilt equipment will also have been

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thoroughly tested and will carry a limited warranty. Reconditioned
equipment will not have been as thoroughly overhauled as rebuilt
equipment. They will, nevertheless, have been cleaned and had all broken
or worn parts replaced and been repainted to look like new. However, the
guarantee or warranty may be less inclusive than for rebuilt equipment.
So, when does it make more sense to buy new capital equipment? In
addition, when does it make more sense to buy used equipment?
Consolidating some of the points discussed earlier, various aspects of new
and used equipment can be compared.

New equipment Used equipment

1. Low maintenance cost. 1. High maintenance cost. Short

Warranty period from warranty period or warranty period
manufacturer. expired.

2. Up-to-date technology. 2. Could be outdated technology.

3. Straightforward purchasing. 3. Thorough investigations and tests are

Require fewer tests and required to ensure the functionality and
investigations. reliability.

4. Availability of spare parts. 4. May not get all the spare parts
required.

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Factors to consider when buying new and used equipment
Advantages Disadvantages
Lower purchase cost. Faster return Shorter life span.
on investment.
Shorter lead time to acquire. Shorter warranty period.
Eliminate the teething problems Lower productivity.
associated with new equipment.
Maintenance record could be Need for thorough investigation of
available for inspection and maintenance history. Higher
reference. maintenance cost.

Advantages and disadvantages of used equipment

New equipment should be Used equipment should be
considered considered
When longer warranty period is For usage in pilot run or test run.
required.
When efficiency is the priority. When budget is the constraint.
When longer life is expected. For short term usage.
When less maintenance is expected. When maintenance is anticipated.
When spare parts are not available. When spare parts are available.
When tax exemption or government When the government does not offer
grant is available. incentives.
When used equipment available are When the used equipment could be
outdated in technology. upgraded to the latest technology.

Lease Vs. Buy (MUST READ OR RESEARCH ABOUT)

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References
Lysons K, Farrington B, (2006) Purchasing and Supply Chain
Management, 7th ed, FT Prentice Hall
Dempsey O, (editor) (2006), Operational Supply Management, IIPMM
Recommended Reading
Burt D, Dobler D, Starling S, (2003) World Class Supply Management:
The Key to Supply Chain Management 7thed, McGraw Hill/Irwin
Baily P, Farmer D, Jessop D, (2005) Purchasing Principles and
Management 9thed, Trans-Atlantic Publications Inc.
Waller, (2003) Operations Management: A Supply Chain Approach, 2 nd
Ed, Thompson Learning
Volman, Berry, Whybark, Jacobs, (2004) Manufacturing Planning and
Control for Supply Chain Management, 5th Ed, McGraw Hill
Beach, R., A.P. Muhlemann, D.H.R. Price, A. Paterson, and J.A.Sharp.
“Manufacturing Operations and Strategic Flexibility: Survey and Cases,”
International Journal of Operations and Production Management, 20, 1,
2000, 7–30.
Berry, W.L., and M.C. Cooper. “Manufacturing Flexibility: Methods for
Measuring the Impact of Product Variety on Performance in Process
Industries,” Journal of Operations
Management, 17, 1999, 163–178.
Chase. R.B., N.J., Aquilano, and F.B. Jacob. Operations Management
for a Competitive Advantage, Ninth Edition, McGraw-Hill Irwin, 2001.
Copacino, William C., and Jonathan L.S. Byrnes. “How to Become a
Supply Chain Master,” Supply Chain Management Review, September–
October, 2001, 24–35.
Dennis, Michael J., and Ajit Kambil. “Service Management: Building
Profits After the Sale,” Supply Chain Management Review, January–
February, 2003, 42–48.
Galbraith, J.K. The Affluent Society. Boston: Houghton Mifflin,1958.
Klassen, R.D., and D.C. Whybarl. “Environmental Management in
Operations: The Selection of Environmental Technologies,” Decision
Sciences, 30, 3, 1999, 601–631.
Koste, L.L., and M.K. Malhotra. “Trade-offs Among the Elements of
Flexibility: A Comparison from the Automotive Industry,” Omega, 28, 2000,
693–710.
Skinner, W. Manufacturing in the Corporate Strategy. New York: John
Wiley & Sons, 1978.
Skinner, W. “Manufacturing Strategy on the ‘S’ Curve,” Production and
Operations Management, Spring, 1996, 3–14.

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