Table of Contents

1. A New Competitive Environment................................ 4

2. Why Purchasing Is Important.................................. 5
3. Language of Purchasing & Supply Chain Management............. 7
3.1. Purchasing and Supply Management ......................... 7
3.2. Supply Chains and Value Chains .......................... 10
3.3. Supply Chains Illustrated ............................... 13
3.4. The Supply Chain Umbrella ............................... 15
3.4.1. Purchasing .......................................... 15
3.4.2. Inbound Transportation .............................. 15
3.4.3. Quality Control ..................................... 15
3.4.4. Demand and Supply Planning .......................... 16
3.4.5. Receiving, Materials Handling, and Storage .......... 16
3.4.6. Materials or Inventory Control ...................... 16
3.4.7. Order Processing .................................... 16
3.4.8. Production Planning, Scheduling, and Control ........ 17
3.4.9. Warehousing/ Distribution ........................... 17
3.4.10. Shipping ........................................... 17
3.4.11. Outbound Transportation ............................ 17
3.4.12. Customer Service ................................... 17
4. Purchasing Objectives....................................... 18
4.1. Objective 1: Supply Continuity .......................... 18
4.2. Objective 2: Manage the Purchasing Process Efficiently and
Effectively ..................................................... 19
4.3. Objective 3: Develop Supply Base Management ............. 19
4.4. Objective 4: Develop Aligned Goals with Internal Functional
Stakeholders .................................................... 20
4.5. Objective 5: Support Organizational Goals and Objectives 20
4.6. Objective 6: Develop Integrated Purchasing Strategies That
Support Organizational Strategies ............................... 21
5. Purchasing Responsibilities................................. 21
5.1. Res 1 - Evaluate and Select Suppliers ................... 22
5.2. Res 2 - Review Specifications ........................... 22
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 5.3. Res 3 - Act as the Primary Contact with Suppliers ....... 22
5.4. Res 4 - Determine the Method of Awarding Purchase Contracts
................................................................ 23
6. The Purchasing Process...................................... 23
6.1. Forecast and Plan Requirement ........................... 25
6.2. Needs Clarification: Requisitioning ..................... 27
6.2.1. Purchase Requisitions/ Statement of Work ............ 27
6.2.2. Traveling Purchase Requisitions/ Bar Codes .......... 30
6.2.3. Forecasts and Customer Orders ....................... 30
6.2.4. Reorder Point System ................................ 31
6.2.5. Stock Checks ........................................ 31
6.2.6. Cross-Functional New-Product Development Teams ...... 32
6.2.7. Description ......................................... 32
6.3. Supplier Identification and Selection ................... 34
6.3.1. Bidding or Negotiating? ............................. 35
6.3.2. Request for Quotation ............................... 37
6.3.3. Specifications or Blueprints ........................ 37
6.3.4. Evaluate Suppliers .................................. 38
6.4. Approval, Contract, and Purchase Order Preparation ...... 39
6.4.1. Purchase Order ...................................... 40
6.4.2. Blanket Purchase Order .............................. 42
6.4.3. Material Purchase Release ........................... 44
6.4.4. Fixed-Price Contracts ............................... 45
6.5. Receipt and Inspection .................................. 46
6.5.1. Material Packing Slip ............................... 48
6.5.2. Bill of Lading ...................................... 48
6.5.3. Receiving Discrepancy Report ........................ 49
6.5.4. Just-in-Time Purchasing ............................. 49
6.6. Invoice Settlement and Payment .......................... 50
6.7. Records Maintenance ..................................... 50
6.8. Continuously Measure and Manage Supplier Performance .... 50
7. Types of Purchases.......................................... 51
7.1. Raw Materials ........................................... 51
2
7.2. Semifinished Products and Components .................... 52
7.3. Finished Products ....................................... 52
7.4. Maintenance, Repair, and Operating Items ................ 52
7.5. Production Support Items ................................ 53
7.6. Services ................................................ 53
7.7. Capital Equipment ....................................... 53
7.8. Transportation and Third-Party Purchasing ............... 54

3
CHAPTER 1 – PURCHASING OVERVIEW
1. A New Competitive Environment
The new millennium features increasing numbers of world-class
competitors, domestically and internationally, that are forcing
organizations to improve their internal processes to stay competitive.
Sophisticated customers, both industrial and consumer, no longer talk
about price increases—they demand price reductions! Information that
is available over the Internet will continue to alter the balance of
power between buyers and sellers. An abundance of competitors and
choices have conditioned customers to want higher quality, faster
delivery, and products and services tailored to their individual needs
at a lower total cost. If a company cannot meet these requirements,
the customer will find someone who is more accommodating.
Throughout the 1960s and 1970s, companies began to develop detailed
market strategies that focused on creating and capturing customer
loyalty. Before long, organizations also realized that this required
a strong engineering, design, and manufacturing function to support
these market requirements. Design engineers had to translate customer
requirements into product and service specifications, which then had
to be produced at a high level of quality at a reasonable cost. As the
demand for new products increased throughout the 1980s, organizations
had to become flexible and responsive to modify existing products,
services, and processes, or to develop new ones to meet ever-changing
customer needs.
As organizational capabilities improved further in the 1990s,
managers began to realize that material and service inputs from
suppliers had a major impact on their ability to meet customer needs.
This led to an increased focus on the supply base and the
responsibilities of purchasing. Managers also realized that producing
a quality product was not enough. Getting the right products and
services to customers at the right time, cost, place, condition, and
quantity constituted an entirely new type of challenge. More recently,
new technology has spawned a whole set of time-reducing information
technologies and logistics networks aimed at meeting these new
challenges. The availability of low-cost alternatives has led to
unprecedented shifts toward outsourcing and offshoring. The impact of
China as a major world competitor poses tremendous challenges for U.S.
firms in both the manufacturing and services sectors. Because the
services sector now accounts for over 70% of the Gross Domestic
Product, new strategies are required for effective supply management
in this sector.
4
 All these changes have made 21st-century organizations realize how
important it is to manage their supply base. They must be involved in
the management of (or at least take a serious interest in) the
suppliers that provide materials and services. They must also be
concerned with the network of downstream firms responsible for
delivery and aftermarket service of the product to the end customer.
From this realization emerged the concept of the supply chain and
supply chain management.
Several factors are driving an emphasis on supply chain management.
First, the cost and availability of information resources between
entities in the supply chain allow easy linkages that eliminate time
delays in the network. Second, the level of competition in both
domestic and international markets requires organizations to be fast,
agile, and flexible. Third, customer expectations and requirements are
becoming much more demanding. Fourth, the ability of an organization’s
supply chain to react rapidly to major disruptions in both supply and
downstream product or services will lessen the impact on lost sales.
As demands increase, organizations and their suppliers must be
responsive or face the prospect of losing market share. Competition
today is no longer between firms, it is between the supply chains of
those firms. The companies that configure the best supply chains will
be the market winners and gain competitive advantage.

2. Why Purchasing Is Important

As companies struggle to increase customer value by improving
performance, many companies are turning their attention to purchasing
and supply management. It does not take a financial genius to realize
the impact that suppliers can have on a firm’s total cost. Furthermore,
many features that make their way into final products originate with
suppliers. The supply base is an important part of the supply chain.
Supplier capabilities can help differentiate a producer’s final good
or service.
In the manufacturing sector the percentage of purchases to sales
averages 55%. This means that for every dollar of revenue collected
on goods and services sales, more than half goes back to suppliers.
It is not difficult to see why purchasing isclearly a major area for
cost savings. However, savings come in different forms; the
traditional approach is to bargain hard for price reductions. A newer
approach is to build relations with suppliers to jointly pull costs
out of the product or service.
A three-year study within the automobile industry studied the
extent to which major producers emphasized relationships. The results

5
showed a clear difference in the approach taken to managing suppliers.
When suppliers were asked to rate their automobile customers, the
Japanese transplants Toyota, Honda, and Nissan were all above the
median on their “Supplier Relations Working Index” score, whereas
Chrysler, Ford, and General Motors were rated below the median. This
says something about how suppliers perceive the dominant purchasing
philosophy of these large automobile companies. The 17-category index
measured key supplierrelationship parameters including relationship
development and communications. Out of a maximum score of 500, Toyota
was first with an index score of 399, while General Motors was last
with a score of 144. The superior management of supplier relationships
has helped give Japanese automobile producers a cost advantage over
Detroit’s Big Three.
Purchasing and supply management also has a major impact on product
and service quality. In many cases, companies are seeking to increase
the proportion of parts, components, and services they outsource in
order to concentrate on their own areas of specialization and
competence. This further increases the importance of the relationships
between purchasing, external suppliers, and quality.
The following example illustrates this important link between
supplier quality and product quality. Heparin is a main ingredient in
products for patients requiring dialysis and medicines that prevent
blood clots during surgery and thin the blood. Heparin has recently
come under suspicion in the deaths of four Americans and allergic
reactions from another 350 patients who obtained heparin from Baxter
International. Interestingly, more than half of the world’s heparin
comes from China. The recent deaths have highlighted the need to
control sourcing accountability. One of the key ingredients in the
process of making heparin is pulp extracted from pig intestines, which
is then heated in large vats. This key ingredient is widely sourced
in small, poorly regulated Chinese factories. For example, one Chinese
firm, Yuan Intestine and Casing Factory, also manufactures sausage
casings. Baxter buys its heparin from Scientific Protein. The
president of Scientific Protein says it can’t trace its supplies in
China as well as it can in the United States. The example illustrates
the importance of the supplier selection process and its role in the
entire supply chain, from raw material to finished product. This
example further illustrates how lapses in managing supplier quality
can potentially tarnish a firm’s reputation.
Purchasing, acting as the liaison between suppliers and engineers,
can also help improve product and process designs. For example,
companies that involve suppliers early, compared to companies that do
not involve suppliers, achieve an average 20% reduction in materials
6
cost, 20% improvement in material quality, and 20% reduction in product
development time. Development teams that include suppliers as members
also report they receive more improvement suggestions from suppliers
than teams that do not involve suppliers. Thus involving suppliers
early in the design process is a way purchasing can begin to add new
value and contribute to increasing their competitiveness.
Many executives will agree that a focus on effective purchasing has
become a critical way to gain competitive advantage. An indication of
this enhanced reputation and recognition is the higher salaries that
are being paid to purchasing professionals. The most recent Purchasing
magazine salary survey showed an average annual income of $84,611.
Interestingly, those with responsibility for sourcing services are
among the highest earners in the profession, with an average annual
compensation of $104,110. Purchasers who buy IT goods and services
make $101,104, and those purchasing logistics services are compensated
$97,802. Additionally, the survey found that purchasers continue to
make more when compared to their colleagues in other related fields,
such as logistics and engineering. Eighty percent of purchasing
executives made over $100,000, with bonuses averaging over 13% of base
salaries.

3. Language of Purchasing & Supply Chain Management

Anyone who has written about purchasing and supply chain management
has defined the various terms associated with these concepts one way
or another, making confusion about the subjects a real possibility.
How, for example, is purchasing different from supply management? Are
supply chains and value chains the same? What is supply chain
management? What is an extended enterprise? It is essential to define
various terms before proceeding with this book.
3.1. Purchasing and Supply Management
We need to recognize the differences between purchasing and supply
management. Purchasing is a functional group (i.e., a formal entity
on the organizational chart) as well as a functional activity (i.e.,
buying goods and services). The purchasing group performs many
activities to ensure it delivers maximum value to the organization.
Examples include supplier identification and selection, buying,
negotiation and contracting, supply market research, supplier
measurement and improvement, and purchasing systems development.
Purchasing has been referred to as doing “the five rights”: getting
the right quality, in the right quantity, at the right time, for the
right price, from the right source. In this text we will interchange
the terms “purchasing” and “procurement.”

7
 Supply management is not just a new name for purchasing but a more
inclusive concept. We feel supply management is a strategic approach
to planning for and acquiring the organization’s current and future
needs through effectively managing the supply base, utilizing a
process orientation in conjunction with cross-functional teams (CFTs)
to achieve the organizational mission. Similar to our definition, the
Institute for Supply Management defines supply management as the
identification, acquisition, access, positioning, and management of
resources and related capabilities an organization needs or
potentially needs in the attainment of its strategic objectives.
Exhibit 1.1 depicts the key elements in our definition of supply
management.

Supply management requires pursuing strategic responsibilities, which

are those activities that have a major impact on longer-term
performance of the organization. These longer-term responsibilities
are not pursued in isolation, but should be aligned with the overall
mission and strategies of the organization. These strategies exclude

8
routine, simple, or day-to-day decisions that may be part of
traditional purchasing responsibilities. The routine ordering and
follow-up of basic operational supplies is not a strategic
responsibility. The development of the systems that enable internal
users to order routine supplies, however, is considerably more
important.
Supply management is a broader concept than purchasing. Supply
management is a progressive approach to managing the supply base that
differs from a traditional arm’s-length or adversarial approach with
sellers. It requires purchasing professionals to work directly with
those suppliers that are capable of providing world-class performance
and advantages to the buyer. Think of supply management as a
progressive and supercharged version of basic purchasing.
Supply management often takes a process approach to obtaining required
goods and services. We can describe supply management as the process
of identifying, evaluating, selecting, managing, and developing
suppliers to realize supply chain performance that is better than that
of competitors. We will interchange the terms “supply management” and
“strategic sourcing” throughout this book.
Supply management is cross-functional, meaning it involves purchasing,
engineering, supplier quality assurance, the supplier, and other
related functions working together as one team, early on, to further
mutual goals. Instead of adversarial relationships, which characterize
traditional purchasing, supply management features a long-term win-
win relationship between a buying company and specially selected
suppliers. Except for ownership, the supplier almost becomes an
extension of the buying company. Supply management also involves
concrete, on-site, and frequent help to suppliers in exchange for
dramatic and continuous performance improvements, including steady
price reductions. In short, supply management is a new way of
operating, involving internal operations and external suppliers to
achieve advances in cost management, product development, cycle times,
and total quality control.
Organizationally, leading and coordinating strategic supply management
activities has largely become the responsibility of the functional
group called purchasing. Practicing professionals often use the terms
“supply management” and “purchasing” interchangeably. Through the
above discussion we have sought to clarify some of the differences
while recognizing that good purchasing and supply management practices
can have significant impact on the organization’s overall performance.

9
 3.2. Supply Chains and Value Chains
Over time, researchers and practitioners have developed dozens of
definitions to describe supply chains and supply chain management. One
group of researchers has indicated that defining supply chain
management both as a philosophy and as a set of operational activities
creates confusion. These researchers break down the concept into three
areas and separate supply chain orientation from supply chains and
from supply chain management.
A supply chain orientation is a higher-level recognition of the
strategic value of managing operational activities and flows within
and across a supply chain. A supply chain is a set of three or more
organizations linked directly by one or more of the upstream or
downstream flows of products, services, finances, and information from
a source to a customer. Supply chain management, then, endorses a
supply chain orientation and involves proactively managing the two-
way movement and coordination of goods, services, information, and
funds (i.e., the various flows) from raw material through end user.
According to this definition, supply chain management requires the
coordination of activities and flows that extend across boundaries.
Organizations that endorse a supply chain orientation are likely to
emphasize supply chain management.
Regardless of the definition or supply chain perspective used, we
should recognize that supply chains are composed of interrelated
activities that are internal and external to a firm. These activities
are diverse in their scope; the participants who support them are
often located across geographic boundaries and often come from diverse
cultures.
Although many activities are part of supply chain management (which
a later section discusses), an improved perspective visualizes supply
chains as composed of processes rather than discrete, often poorly
aligned activities and tasks. A process consists of a set of
interrelated tasks or activities designed to achieve a specific
objective or outcome. New-product development (NPD), customer-order
fulfillment, supplier evaluation and selection, and demand and supply
planning are examples of critical organizational processes that are
part of supply chain management. Recent product recalls of consumer
products such as toys, peanut butter, and dog food have placed
increasing emphasis on a new supply chain concept: the reverse supply
chain; its goal is to rapidly identify and return these tainted
products back through the supply chain. Conceiving of supply chains
as a series of systematic processes makes sense for a number of
reasons. Almost by definition, processes usually move across

10
functional boundaries, which aligns well with a supply management and
supply chain orientation. Well-communicated processes also accelerate
learning as participants become familiar with a defined process.
Furthermore, formal supply chain processes can “build in” best
practices and knowledge that enhance the likelihood of success.
Perhaps most importantly, organizations can document, measure, and
improve their supply chain processes.
A question that often arises, and one that has no definite answer,
involves the difference between a value chain and a supply chain.
Michael Porter, who first articulated the value chain concept in the
1980s, argues that a firm’s value chain is composed of primary and
support activities that can lead to competitive advantage when
configured properly. Exhibit 1.2 presents a modified version of
Porter’s value chain model. This exhibit also defines some important
supply chain–related terms and places them in their proper context.

One way to think about the difference between a value chain and
supply chain is to conceptualize the supply chain as a subset of the
value chain. All personnel within an organization are part of a value
chain. The same is not true about supply chains. The primary
activities, or the horizontal flow across Exhibit 1.2, represent the
operational part of the value chain, or what some refer to as the
supply chain. At an organizational level, the value chain is broader
than the supply chain, because it includes all activities in the form
of primary and support activities. Furthermore, the original value
chain concept focused primarily on internal participants, whereas a
11
supply chain, by definition, is both internally and externally
focused.
To reflect current thinking, we must expand the original value
chain model, which focused primarily on internal participants, to
include suppliers and customers who reside well upstream and
downstream from the focal organization. Multiple levels of suppliers
and customers form the foundation for the extended value chain or the
extended enterprise concept, which states that success is a function
of effectively managing a linked group of firms past first-level
suppliers or customers. In fact, progressive firms understand that
managing cost, quality, and delivery requires attention to suppliers
that reside several tiers from the producer. The extended enterprise
concept recognizes explicitly that competition is no longer between
firms but rather between coordinated supply chains or networks of
firms.
Notice that Exhibit 1.2 identifies purchasing as a support
activity. This means that purchasing provides a service to internal
customers. Although purchasing is the central link with suppliers that
provide direct materials, which is the upstream or lefthand side of
Exhibit 1.2, purchasing can support the materials and service
requirements of any internal group. (Direct materials are those items
provided by suppliers and used directly during production or service
delivery.) Purchasing is becoming increasingly responsible for
sourcing indirect goods and services required by internal groups.
Examples of indirect items include personal computers, office and
janitorial supplies, health care contracts, transportation services,
advertising and media, and travel. Although indirect items are not
required for production, they are still vital to the effective running
of an organization. The right-hand side of the model illustrates the
customer, or downstream, portion of the supply chain. Because meeting
or exceeding customer expectations is the lifeblood of any
organization, it should become the focal point of supply chain
activities. Exhibit 1.2 presents a relatively straightforward and
linear view of the value and supply chain, which is often not the
case. First, the flows of materials, information, funds, and knowledge
across a supply chain are often fragmented and uncoordinated. The
“hand-off” points from one group to the next or from one organization
to the next usually provide opportunity for improvements. Second, the
value chain model shows suppliers linking with inbound logistics and
then operations. Although this is usually the case with direct
materials, indirect items and finished goods sourced externally can
result in suppliers delivering to any part of the supply chain.

12
 3.3. Supply Chains Illustrated
The increasing importance of supply chain management is forcing
organizations to rethink how their purchasing and sourcing strategies
fit with and support broader business and supply chain objectives.
Supply chains involve multiple organizations as we move toward the raw
material suppliers or downstream toward the ultimate customer. Simple
supply chains pull materials directly from their origin, process them,
package them, and ship them to consumers.
A good example of a simple supply chain involves cereal producers
(see Exhibit 1.3). A cereal company purchases the grain from a farmer
and processes it into cereal. The cereal company also purchases the
paperboard from a paper manufacturer, which purchased the trees to
make the paper, and labels from a label manufacturer, which purchased
semifinished label stock to make the labels. The cereal is then
packaged and sent to a distributor, which in turn ships the material
to a grocer, who then sells it to an end customer. Even for a simple
product such as cereal, the number of transactions and of material and
information flows can be considerable.

The supply chain for the cereal manufacturer features an extensive

distribution network that is involved in getting the packaged cereal
to the final customer. Within the downstream portion of the supply
chain, logistics managers are responsible for the actual movement of

13
materials between locations. One major part of logistics is
transportation management, involving the selection and management of
external carriers (trucking companies, airlines, railroads, shipping
companies) or the management of internal private fleets of carriers.
Distribution management involves the management of packaging, storing,
and handling of materials at receiving docks, warehouses, and retail
outlets.

For products such as automobiles, which feature multiple products,

technologies, and processes, the supply chain becomes more
complicated. The materials, planning, and logistics supply chain for
an automotive company is shown in Exhibit 1.4, which illustrates the
complexity of the chain, spanning from automotive dealers back through
multiple levels or tiers of suppliers. The automotive company’s
supplier network includes the thousands of firms that provide items
14
ranging from raw materials, such as steel and plastics, to complex
assemblies and subassemblies, such as transmissions, brakes, and
engines.
Participants in a supply chain are willing to share such information
only when there is trust between members. Thus, the management of
relationships with other parties in the chain becomes paramount.
Organizations are effectively forming new types of relationships
(sometimes called “partnerships” or “alliances”) that require shared
resources. For instance, organizations may provide dedicated capacity,
specific information, technological capabilities, or even direct
financial support to other members of their supply chain so that the
entire chain can benefit.
3.4. The Supply Chain Umbrella
A large set of activities besides purchasing is part of supply
chain management. Each of these seemingly diverse activities has one
important feature in common— it is part of a network that will define
how efficiently and effectively goods and information flow across a
supply chain. Although the need to perform supply chain– related
activities has been present for many years, it is an organization’s
willingness to align, coordinate, integrate, and synchronize these
activities and flows that is relatively new. What are the activities
that are part of this concept called supply chain management?
3.4.1. Purchasing
Most organizations include purchasing as a major supply chain
activity. Because purchasing is the central focus of this book, there
is no need to provide more detail here.
3.4.2. Inbound Transportation
Larger organizations usually have a specialized traffic and
transportation function to manage the physical and informational links
between the supplier and the buyer.
For some organizations, transportation is the single largest
category of single costs, especially for highly diversified
organizations. Although a firm may have minimal common purchase
requirements among its operating units, there usually are
opportunities to coordinate the purchase of transportation services.
3.4.3. Quality Control
Quality control has taken on increased importance during the last
15 years. Almost all organizations recognize the importance of
supplier quality and the need to prevent, rather than simply detect,
quality problems. The emphasis has shifted from detecting defects at
15
the time of receipt or use to prevention early in the materialssourcing
process. Progressive organizations work directly with suppliers to
develop proper quality control procedures and processes.
3.4.4. Demand and Supply Planning
Demand planning identifies all the claims (or demand) on output.
This includes forecasts of anticipated demand, inventory adjustments,
orders taken but not filled, and spare-part and aftermarket
requirements. Supply planning is the process of taking demand data and
developing a supply, production, and logistics network capable of
satisfying demand requirements.
3.4.5. Receiving, Materials Handling, and Storage
All inbound material must be physically received as it moves from
a supplier to a purchaser. In a non-just-in-time environment, material
must also be stored or staged. Receiving, materials handling, and
storage are usually part of the materials management function because
of the need to control the physical processing and handling of
inventory. Receipts from users indicating that services have been
performed are also run through receiving to trigger invoice payment.
3.4.6. Materials or Inventory Control
The terms “materials control” and “inventory control” are sometimes
used interchangeably. Within some organizations, however, these terms
have different meanings. The materials control group is often
responsible for determining the appropriate quantity to order based
on projected demand and then managing materials releases to suppliers.
This includes generating the materials release, contacting a supplier
directly concerning changes, and monitoring the status of inbound
shipments. Materials control activities are sometimes the
responsibility of the purchasing department, particularly in smaller
organizations.
The inventory control group is often responsible for determining
the inventory level of finished goods required to support customer
requirements, which emphasizes the physical distribution (i.e.,
outbound or downstream) side of the supply chain. Integrated supply
chain management requires that the materials and inventory control
groups coordinate their efforts to ensure a smooth and uninterrupted
flow to customers.
3.4.7. Order Processing
Order processing helps ensure that customers receive material when
and where they require it. Problems with order processing have involved
accepting orders before determining if adequate production capacity

16
is available, not coordinating order processing with order scheduling,
and using internal production dates rather than the customer’s
preferred date to schedule the order. Order processing is an important
part of supply chain management—it represents a link between the
producer and the external customer.
3.4.8. Production Planning, Scheduling, and Control
These activities involve determining a time-phased schedule of
production, developing short-term production schedules, and
controlling work-in-process production.
The production plan often relies on forecasts from marketing to
estimate the volume of materials that are required over the near term.
Because operations is responsible for carrying out the production plan
and meeting customer order due dates, order processing, production
planning, and operations must work together closely.
3.4.9. Warehousing/ Distribution
Before a product heads to the customer, it may be stored for a
period in a warehouse or distribution center. This is particularly
true for companies that produce according to a forecast in anticipation
of future sales. Increasingly, as companies attempt to make a product
only after receiving a customer order, this part of the supply chain
may become less important.
3.4.10. Shipping
This activity involves physically getting a product ready for
distribution to the customer. This requires packing to prevent damage,
completing any special labeling requirements, completing the required
shipping documents, and/or arranging transportation with an approved
carrier. For obvious reasons, shipping and outbound transportation
must work together closely.
3.4.11. Outbound Transportation
Fewer organizations “own” the transportation link to their
customers, compared with just a few years ago. Increasingly, full-
service transportation providers are designing and managing entire
distribution networks for their clients.
3.4.12. Customer Service
Customer service includes a wide set of activities that attempt to
keep a customer satisfied with a product or service. The three primary
elements of customer service are pre-transaction, transaction, and
post-transaction activities.

17
4. Purchasing Objectives
A world-class purchasing staff must continuously work to improve
the efficiency and effectiveness of what we call the purchasing
process. This is the process used to identify user requirements,
evaluate the need effectively and efficiently, identify suppliers,
ensure payment occurs promptly, ascertain that the need was
effectively met, and drive continuous improvement. The challenges in
ensuring that this process occurs effectively and efficiently are the
theme of this chapter. Until an organization can streamline the day-
to-day purchasing process, it will continually delay implementing
other important strategic activities that help their organization
become more competitive.
The objectives of a world-class purchasing organization move far
beyond the traditional belief that purchasing’s primary role is to
obtain goods and services in response to internal needs. To understand
how this role is changing, we must understand what purchasing is all
about, starting with the primary objectives of a world-class
purchasing organization.
4.1. Objective 1: Supply Continuity
Purchasing must perform a number of activities to satisfy the
operational requirements of internal customers, which is the
traditional role of the purchasing function. More often than not,
purchasing supports the needs of operations through the purchase of
raw materials, components, subassemblies, repair and maintenance
items, and services. Purchasing may also support the requirements of
physical distribution centers responsible for storing and delivering
replacement parts or finished products to end customers. Purchasing
also supports engineering and technical groups, particularly during
new-product development and outsourcing of key processes.
With the dramatic increase in outsourcing, enterprises are relying
increasingly on external suppliers to provide not just materials and
products, but information technology, services, and design activities.
As a greater proportion of the responsibility for managing key business
processes shifts to suppliers, purchasing must support this strategy
by providing an uninterrupted flow of high-quality goods and services
that internal customers require. Supporting this flow requires
purchasing to do the following:
1. Buy products and services at the right price
2. Buy them from the right source
3. Buy them at the right specification that meets users’ needs

18
 4. Buy them in the right quantity
5. Arrange for delivery at the right time
6. Require delivery to the right internal customer
Purchasing must be responsive to the materials and support needs
of its internal users (sometimes also called internal customers).
Failing to respond to the needs of internal customers will diminish
the confidence these users have in purchasing, and they may try to
negotiate contracts themselves (a practice known as backdoor buying).
4.2. Objective 2: Manage the Purchasing Process
Efficiently and Effectively
Purchasing must manage its internal operations efficiently and
effectively, by performing the following:
• Determining staffing levels
• Developing and adhering to administrative budgets
• Providing professional training and growth opportunities for
employees
• Introducing procure to pay systems that lead to improved spending
visibility, efficient invoicing and payment, and user satisfaction
Purchasing management has limited resources available to manage the
purchasing process and must continuously work toward improved
utilization of these resources. Limited resources include employees
working within the department, budgeted funds, time, information, and
knowledge. Organizations are therefore constantly looking for people
who have developed the skills necessary to deal with the wide variety
of tasks faced by purchasing. Procurement people must be focused on
continuously improving transactional-level work through efficient
purchasing systems that keep suppliers satisfied, which makes life
easier for internal users.
4.3. Objective 3: Develop Supply Base Management
One of the most important objectives of the purchasing function is
the selection, development, and maintenance of supply, a process that
is sometimes described as supply base management. Purchasing must keep
abreast of current conditions in supply markets to ensure that
purchasing (1) selects suppliers that are competitive, (2) identifies
new suppliers that have the potential for excellent performance and
develops closer relationships with these suppliers, (3) improves
existing suppliers, and (4) develops new suppliers that are not
competitive. In so doing, purchasing can select and manage a supply

19
base capable of providing performance advantages in product cost,
quality, technology, delivery, and new-product development.
Supply base management requires that purchasing pursue better
relationships with external suppliers and develop reliable, high-
quality supply sources. This objective also requires that purchasing
work directly with suppliers to improve existing capabilities and
develop new capabilities. A good part of this text focuses on how
purchasing can effectively meet this objective
4.4. Objective 4: Develop Aligned Goals with Internal
Functional Stakeholders
U.S. industry has traditionally maintained organizational
structures that have resulted in limited cross-functional interaction
and cross-boundary communication. During the 1990s, the need for
closer relationships between functions became clear. Purchasing must
communicate closely with other functional groups, which are
purchasing’s internal customers. These are sometimes called
stakeholders, in that they have a significant stake in the
effectiveness of purchasing performance! If a supplier’s components
are defective and causing problems for manufacturing, then purchasing
must work closely with the supplier to improve its quality. Similarly,
marketing may spend a great deal on advertising and promotion, so
purchasing must ensure that the pricing is competitive and that
service-level agreements are being met. In order to achieve this
objective, purchasing must develop positive relationships and interact
closely with other functional groups, including marketing,
manufacturing, engineering, technology, and finance.
4.5. Objective 5: Support Organizational Goals and
Objectives
Perhaps the single most important purchasing objective is to
support organizational goals and objectives. Although this sounds
easy, it is not always the case that purchasing goals match
organizational goals. This objective implies that purchasing can
directly affect (positively or negatively) total performance and that
purchasing must concern themselves with organizational directives. For
example, let’s assume an organization has an objective of reducing the
amount of inventory across its supply chain. Purchasing can work with
suppliers to deliver smaller quantities more frequently, leading to
inventory reductions. Such policies will show up as improved
performance on the firm’s balance sheet and income statements. In so
doing, purchasing can be recognized as a strategic asset that provides
a powerful competitive advantage in the marketplace.

20
 4.6. Objective 6: Develop Integrated Purchasing
Strategies That Support Organizational Strategies
Far too often the purchasing function fails to develop strategies
and plans that align with or support organizational strategies or the
plans of other business functions. There are a number of reasons why
purchasing may fail to integrate their plans with company plans. First,
purchasing personnel have not historically participated in senior-
level corporate planning meetings, because they were often viewed as
providing a tactical support function. Second, executive management
has often been slow to recognize the benefits that a world-class
purchasing function can provide. As these two conditions are rapidly
changing, purchasing is being integrated within the strategic planning
process in multiple industries. A purchasing department actively
involved within the corporate planning process can provide supply
market intelligence that contributes to strategic planning. Effective
supply market intelligence involves the following:
• Monitoring supply markets and trends (e.g., material price
increases, shortages, changes in suppliers) and interpreting the
impact of these trends on company strategies
• Identifying the critical materials and services required to
support company strategies in key performance areas, particularly
during new-product development
• Developing supply options and contingency plans that support
company plans
• Supporting the organization’s need for a diverse and globally
competitive supply base

5. Purchasing Responsibilities
Functional groups carry out certain duties on behalf of the
organization. We refer to this as a function’s responsibility or span
of control. Purchasing must have the legitimate authority to make
decisions that fall within their span of control. Span of control is
established through senior management policies and support. Although
internal customers influence many important decisions, final authority
for certain matters must ultimately be assigned to the purchasing
department. This section details those decision areas that are
rightfully part of purchasing’s operating authority in most
organizations.

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 5.1. Res 1 - Evaluate and Select Suppliers
Perhaps the most important duty of purchasing is the right to
evaluate and select suppliers—this is what purchasing personnel are
trained to do. It is important to retain this right to avoid maverick
buying and selling—a situation that occurs when sellers contact and
attempt to sell directly to end users (purchasing’s internal
customers). Of course, this right does not mean that purchasing should
not request assistance when identifying or evaluating potential
suppliers. Engineering, for example, can support supplier selection
by evaluating supplier product and process performance capabilities.
The right to evaluate and select suppliers also does not mean that
sales representatives are not allowed to talk with non-purchasing
personnel. However, non-purchasing personnel cannot make commitments
to the seller or enter into contractual agreements without
purchasing’s involvement. A trend that is affecting purchasing’s right
to select suppliers is the use of sourcing teams with purchasing and
non-purchasing representation. The selection decision in sourcing
teams requires that the members reach a consensus in selecting
suppliers.
5.2. Res 2 - Review Specifications
The authority to review material specifications is also within
purchasing’s span of control, although engineering sometimes disputes
this right. Purchasing personnel work hard to develop knowledge and
expertise about a wide variety of materials but must also make this
knowledge work to an organization’s benefit. The right to question
allows purchasing to review specifications where required. For
example, purchasing may question whether a lower-cost material can
still meet an engineer’s stress tolerances. The right to question
material specifications also helps avoid developing material
specifications that only a user’s favorite supplier can satisfy. A
review of different requisitions may also reveal that different users
actually require the same material. By combining purchase
requirements, purchasing can often achieve a lower total cost.
5.3. Res 3 - Act as the Primary Contact with Suppliers
Purchasing departments historically have maintained a policy that
suppliers have contact only with purchasing personnel. Although this
makes sense from a control standpoint, some firms today are beginning
to relax this policy. Today, we recognize that purchasing must act as
the primary contact with suppliers, but that other functions should
be able to interact directly with suppliers as needed. Involving
multiple people enables the communication process between internal
customers, purchasing, sales, and the suppliers’ internal functions
22
to be more efficient and accurate. Although purchasing must retain the
right to be the primary contact with suppliers, involving other people
can improve the transfer of information and knowledge between buying
and selling organizations.
5.4. Res 4 - Determine the Method of Awarding Purchase
Contracts
An important area of control is that purchasing has the right to
determine how to award purchase contracts. Will purchasing award a
contract based on competitive bidding, negotiation, or a combination
of the two approaches? If purchasing takes a competitive bidding
approach, how many suppliers will it request to bid? Purchasing should
also lead or coordinate negotiations with suppliers. Again, this does
not mean that purchasing should not use personnel from other functions
to support the negotiation process. It means that purchasing retains
the right to control the overall process, act as an agent to commit
an organization to a legal agreement, and negotiate a purchase price.

6. The Purchasing Process

In this section, we examine in detail the purchasing process, which
includes all the steps that must be completed when someone within the
organization requires some product, material, or service. As stated
in the chapter introduction, purchasing is a process made up of all
activities associated with identifying needs, locating and selecting
suppliers, negotiating terms, and following up to ensure supplier
performance.
These activities, or steps, are highlighted in Exhibit 2.1; this
is often referred to as the procure to pay cycle. This term includes
all of the steps required, from the initial identification of
requirements, to the procurement/purchasing of the item, through the
receipt of the goods, and finally, to the payment of the supplier once
the goods are received.
There are two things to keep in mind as we describe the purchasing
process. First, how much effort a company spends on these activities
will differ greatly from one situation to the next. The purchasing
process leading to a $30 billion contract for military jets is very
different from that for a routine purchase of office supplies!
Second, as you look at the steps in the procure to pay cycle shown
in Exhibit 2.1, recognize that companies can often gain a competitive
advantage by performing these activities better than their
competitors. Many organizations, for example, use information systems
to automate routine purchase order preparation, whereas others use

23
sourcing management teams to improve the outcome of supplier
evaluation and selection efforts.
This section presents the purchasing process as a cycle consisting
of six major stages:
1. Forecast and plan requirement
2. Need clarification (requisition)
3. Supplier identification/selection
4. Contract/purchase order generation
5. Receipt of material or service and documents
6. Settlement, payment, and measurement of performance

These stages may vary in different organizations, depending on

whether purchasing is sourcing a new or a repetitively purchased item,
and also whether there is a detailed approval process for purchases
that exceed a specific dollar amount. New item require that purchasing
spend much more time up front evaluating potential sources. Repeat
items usually have approved sources already available. Exhibit 2.1
illustrates a typical purchasing process used in many enterprises,
with some typical contingency elements shown.

24
 The process flow shown in Exhibit 2.1 is often called the procure
to pay process, as it documents all of the stages from the initiation
of a need, through to the payment element. A document flow accompanies
the movement of orders and material throughout the procure to pay
process. Historically, preparing and managing the proper purchasing
documents has been a time-consuming process. Most firms have
streamlined the document flow process to reduce the paperwork and
handling required for each purchase. The suite of tools used to achieve
efficiency in purchasing transactions is broadly defined as e-
procurement. Companies are using e-procurement tools to manage the
flow of documents by (1) automating the document generation process
and (2) electronically transmitting purchase documents to suppliers.
The benefits of electronically generating and transmitting
purchasing-related documents include the following:
1. A virtual elimination of paperwork and paperwork handling
2. A reduction in the time between need recognition and the release
and receipt
of an order
3. Improved communication both within the company and with
suppliers
4. A reduction in errors
5. A reduction in overhead costs in the purchasing area
6. A reduction in the time spent by purchasing personnel on
processing purchase orders and invoices, and more time spent on
strategic value-added purchasing activities
The electronic documents often used in the process are represented
in Exhibit 2.1 by boxes, which we shall now discuss.
6.1. Forecast and Plan Requirement
The purchasing cycle begins with the identification of a need (a
requirement). In most cases, procurement personnel have an annual or
biannual planning process,whereby they will review the spending
pattern for the organization (through a spend analysis, discussed
later in the chapter), and prepare a forecast of what will be
purchased. In some cases, there may be a whole set of new requirements
that have not been planned for (such as for new product introductions).
In such cases, purchasing personnel meet with internal customers to
discuss their needs for the coming year. In many firms today,
purchasing is the primary vehicle for obtaining external inputs
(products or services) from suppliers, so that means that purchasing
personnel have to work with a large number of internal customers,
25
which will often include marketing, operations, finance, information
technology, and other internal customers. Through a structured
dialogue, purchasing will understand and plan for what these customers
will be buying and translate this into a forecast that is shared with
suppliers.
A projected need may take the form of a component (e.g., a set of
fasteners), raw material (e.g., resins), subassembly (e.g., a motor),
or even a completely finished item (e.g., a computer). In other cases,
the need may be a service, such as the need to contract with an ad
agency for a new marketing campaign, or a food service to provide
lunches at the company cafeteria. Because purchasing is responsible
for acquiring products and services for the entire organization, the
information flows between the purchasing function and other areas of
the organization can be extensive.
Of course, not all needs can be forecasted ahead of time. There are
situations that arise when an internal customer has a need that comes
up suddenly, which is not planned for and for which there is no pre-
existing supplier identified to provide the product or service
required. Such needs are often handled through a spot buy approach,
which is also discussed within the context of the P2P process. For
example, marketing may need to purchase a set of pens and cups for a
special promotion and may alert purchasing on sudden notice of this
need. If it was not planned for, then purchasing must work with
marketing to quickly identify a supplier to provide these products on
short notice at the lowest possible cost with an acceptable level of
quality and delivery time.
When creating a forecast for a needed product or service, internal
customers may not always be able to express exactly what it is they
will need at a single point in time. For example, a chemical plant
maintenance group may say that they will need replacement parts for
their equipment, but they might not be able to provide details on the
exact nature of the specific parts they will need, nor the exact time
they will need them. In such cases, purchasing may negotiate agreements
with distributors of parts that can provide a whole different set of
products that can meet that need. In other cases, an internal customer
may say that they need to work with a specific service provider for
temp services, consulting services, or software programming, but they
cannot express exactly what type of service they will need in advance.
Purchasing will then go off and attempt to secure a contract with
predefined costs for different classes of workers who can provide
these services on short notice.

26
 6.2. Needs Clarification: Requisitioning
At some point, however, internal customers identify their need for
a product or service and communicate to purchasing exactly what it is
they need and when it is required.
Internal users communicate their needs to purchasing in a variety
of ways including purchase requisitions from internal users, forecasts
and customer orders, routine reordering systems, stock checks, and
material requirements identified during newproduct development. Let’s
take a closer look at these electronic (or paper) documents that
communicate internal customer requirements to purchasing.
6.2.1. Purchase Requisitions/ Statement of Work
The most common method of informing purchasing of material needs
is through a purchase requisition. (An example is shown in Exhibit
2.2.) Users may also transmit their needs by phone, by word of mouth,
or through a computer-generated method.

27
 Although there are a variety of purchase requisition formats, every
requisition should contain the following:
• Description of required material or service
• Quantity and date required
• Estimated unit cost
• Operating account to be charged
• Date of requisition (this starts the tracking cycle)
• Date required
• Authorized signature
Although varieties of formats exist, at a minimum a purchase
requisition should include a detailed description of the material or
service, the quantity, date required, estimated cost, and
authorization. This form of communication for a specific need is called
a requisition. A requisition is an electronic or paper form that
provides some critical information about the need. A typical
requisition will provide a description of the product (e.g., a valve),
the material and color (brass, red valve), the quantity required (20
red brass valves), the intended purpose (20 red brass valves to be
used in a maintenance project for equipment XYZ), and the required
date for delivery (three weeks).
Sometimes a service is required. For instance, marketing may want
to purchase an advertising campaign, R&D may need a clinical trial,
or human resources may need to print a brochure. In this case, the
user will complete a statement of work (SOW) that specifies the work
that is to be completed, when it is needed, and what type of service
provider is required.
A standard purchase requisition or SOW is used most often for
routine, noncomplex items that are increasingly being transmitted
through online requisitioning systems linking users with purchasing.
An online requisition system is an internal system designed primarily
to save time through efficient communication and tracking of material
requests. Users should use these systems only if they require
purchasing involvement. It is possible that users have access to other
systems that will allow them to purchase an item directly from a
supplier, such as a corporate procurement card. In that case
requisitions forwarded to purchasing are unnecessary.
There are wide differences across organizations in the quality and
use of electronic purchase requisition systems. A system that simply
requires users to submit to purchasing what they require for electronic
transmission is similar to electronic mail. This type of system
28
provides little added value except to speed the request to purchasing.
Conversely, one system studied was so complex that users were afraid
to use it. They bypassed online requisitioning and relied instead on
the phone or intracompany mail.

Exhibit 2.3 provides further details regarding how a purchase

requisition is approved, converted into a purchase order, and
ultimately prepared for delivery and payment. Although the user may
suggest a supplier, purchasing has final selection authority. For
routine, off-the-shelf items, the requisition may contain all the
information that purchasing requires. However, for technically complex
or nonstandard items, purchasing may require additional information
or specifications with the requisition. Examples of such
specifications include the grade of material, method of manufacture,
and detailed measurements and tolerances. Purchasing may send an
acknowledgment of the receipt of the purchase requisition to the
requestor. This acknowledgment often takes the form of a confirming
order requisition. The acknowledgment may be a separate form notifying
the user that purchasing has received and is processing the

29
requisition, or it may be a copy of the original requisition. The
confirmation verifies the accuracy of the user’s material request.
6.2.2. Traveling Purchase Requisitions/ Bar Codes
Material needs are also communicated through a traveling purchase
requisition—a form consisting of a printed card or a bar code with
information about whom the item is purchased from. This method is used
primarily for very small companies that have not automated their
purchasing or inventory management processes. Information on the card
or the database entry associated with the bar code can include the
following:
• Description of item
• List of approved suppliers
• Prices paid to suppliers
• Reorder point
• Record of usage
A traveling requisition can be helpful because it can conserve time
when reordering routine materials and supplies. When stock levels
reach a specified reorder point, an employee notifies purchasing by
forwarding the traveling requisition maintained with the inventory,
or by electronically scanning the bar code into the ordering system.
The employee notes the current stock level and desired delivery date.
To eliminate the need to research information, the traveling
requisition includes information required by a buyer to process an
order. This system saves time because it provides information for the
item on the card (or in the database) that otherwise would require
research by a buyer. For example, the traveling requisition can include
a list of approved suppliers, prices, a history of usage and ordering,
and lead-time information.
Historical ordering information is noted directly on the record
over a period of time. As inventory systems continue to become
computerized (even at smaller companies), traveling requisitions are
used less frequently. With an automated system, clerks simply enter
the order requirement and the system generates a purchase requisition
or automatically places an order.
6.2.3. Forecasts and Customer Orders
Customer orders can trigger a need for material requirements,
particularly when changes to existing products require new components.
Customer orders can also signal the need to obtain existing materials.
As companies increasingly customize products to meet the needs of
individual customers, purchasing must be ready to support new material
30
requirements. Market forecasts can also signal the need for material.
An increasing product forecast, for example, may signal the need for
additional or new material. If a supplier is already selected to
provide that material, then an automated ordering system such as a
material requirements planning (MRP) system may forward the material
request to suppliers automatically.
6.2.4. Reorder Point System
A reorder point system is a widely used way to identify purchase
needs. Such a system uses information regarding order quantity and
demand forecasts unique to each item or part number maintained in
inventory. Each item in a reorder point system, which is usually
computerized, has a predetermined order point and order quantity. When
inventory is depleted to a given level, the system notifies the
materials control department (or the buyer, in some organizations) to
issue a request to a supplier for inventory replenishment. This signal
might be a blinking light on a screen, a message sent to the materials
control department’s e-mail address, or a computer report.
Most reorder point systems are automated using predetermined
ordering parameters (such as an economic order quantity, which
considers inventory holding and ordering costs). Electronic systems
(such as material requirements planning systems) can instantly
calculate reorder point parameters. Most systems can also calculate
the cost tradeoffs between inventory holding costs, ordering costs,
and forecast demand requirements. Reorder point systems are used for
production and nonproduction items.
An automated reorder point system efficiently identifies purchase
requirements. This type of system can routinely provide visibility to
current inventory levels and requirements of thousands of part
numbers. The reorder point system is the most common method for
transmitting routine material order requests today, particularly for
companies that maintain spare-part distribution centers.
6.2.5. Stock Checks
Stock checks (or cycle counts) involve the physical checking of
inventory to verify that system records (also called the record on
hand, or ROH) match actual on-hand inventory levels—also called the
physical on-hand (POH) levels. If the physical inventory for an item
is below the system amount, an adjustment to that part’s record can
trigger a reorder request for additional inventory. Why might physical
inventory be less than what the computerized system indicates should
be on hand? Placing material in an incorrect location, damage that is
not properly recorded, theft, and short shipments from the supplier
that receiving did not notice all can contribute to the POH being less
31
than the ROH. For example, at one major hardware retailer, missing
inventory on the shelf may be located in another area of the store,
or may simply be missing because of a problem with the incorrect item
being entered into the system.
Smaller firms that rely on standard, easy-to-obtain items often use
stock checks to determine material ordering requirements. In this
environment, the stock check consists of physically visiting a part
location to determine if there is enough inventory to satisfy user
requirements. No purchase reorder is necessary if there is enough
inventory to cover expected requirements.
6.2.6. Cross-Functional New-Product Development Teams
When users contact purchasing with a specific need, we say that
purchasing is operating in a reactive manner. When purchasing works
directly with internal customers to anticipate future requirements,
such as during new-product development, purchasing is being proactive.
What does it mean to anticipate a requirement? If purchasing is part
of new-product development teams, then the opportunity exists to see
product designs at early stages of the process. Purchasing can begin
to identify potential suppliers for expected requirements rather than
reacting to an engineering requirement at a later date. Anticipating
requirements can contribute to faster product development cycle times
and better supplier evaluation and selection. As firms continue to be
forced to reduce the time required to develop new products, cross-
functional interaction will increasingly be the means through which
organizations identify, and hopefully anticipate, material
requirements in the purchasing process cycle.
However the need is clarified, the point here is that a requisition
document is completed by a requisitioner. A requisitioner is someone
who is authorized by purchasing to complete the needs clarification
process. In some cases, the person who expresses the need can also be
the requisitioner. This occurs in cases where the supplier has already
been qualified, and the individual who has the need can go to a
supplier’s online catalog, order the product or service directly
(e.g., through Amazon), and pay for the item using a company purchasing
credit card. In such cases, the item is typically low cost, and it is
not worth the expense and trouble of completing an entire requisition
and going through the entire P2P cycle.
6.2.7. Description
Within the requisitioning process, it is important to include a
description of what is to be sourced. Why? If the time is not spent
to describe the product or service, purchasing will have no idea of
what to go out and purchase! How purchasing accomplishes this will
32
differ dramatically from one situation to the next. There are a variety
of methods for communicating the user’s requirements. Description by
market grade or industry standard might be the best choice for standard
items, where the requirements are well understood and there is common
agreement between supply chain partners about what certain terms mean.
Description by brand is used when a product or service is proprietary,
or when there is a perceived advantage to using a particular supplier’s
products or services. A builder of residential communities, for
example, might tell the purchasing staff to purchase R21 insulation,
an industry standard, for walls, and to buy finish-grade lumber, a
market grade, for the trim and fireplace mantels. In addition, it
might also specify brands such as Georgia-Pacific’s Catawba® hardboard
siding, Kohler® faucets, and TruGreen-Chemlawn® lawn treatment for all
the homes. As you can see, brand names, market grades, and industry
standards provide purchasing with an effective and accurate shortcut
for relaying the user’s needs to potential suppliers.
More detailed and expensive methods of description will be needed
when the items or services to be purchased are more complex, when
standards do not exist, or when the user’s needs are harder to
communicate. Three common methods include description by
specification, description by performance characteristics, and
prototypes or samples.
In some cases, an organization may need to provide very detailed
descriptions of the characteristics of an item or service. We refer
to such efforts as description by specification. Specifications can
cover such characteristics as the materials used, the manufacturing
or service steps required, and even the physical dimensions of the
product. Consider one extreme example: the special heat shield tiles
used on NASA’s space shuttles. Each tile has a unique shape and
location on the space shuttle. Furthermore, each shield must be able
to protect the space shuttle from heat generated by re-entry into the
Earth’s atmosphere. In providing a description of these tiles, NASA
almost certainly includes specifications regarding the exact
dimensions of the tiles and the composite materials to be used in
making them. Such information might be relayed in the form of detailed
blueprints and supporting documentation. Furthermore, NASA likely
specifies the precise manufacturing steps and quality checks to be
performed during the manufacture of the tiles.
In contrast, description by performance characteristics focuses
attention on the outcomes the customer wants, not on the precise
configuration of the product or service. The assumption is that the
supplier will know the best way to meet the customer’s needs. A company
purchasing hundreds of PCs from Dell Computer might demand (1) 24-hour
33
support available by computer or phone, and (2) 48-hour turn-around
time on defective units. How Dell chooses to meet these performance
characteristics is its choice.
Firms often develop prototypes or samples to share with their
suppliers. Prototypes can provide critical information on the look or
feel of a product or service. Such information is often difficult to
convey in drawings or written descriptions. Note that prototypes or
samples are not limited to physical products. An excellent example is
a prototype information system that a company might share with
potential software vendors. The prototype may include sample output
screens and reports. Through the prototype, the company can give its
software vendors a clearer idea of how the company expects its users
to interact with the system.
6.3. Supplier Identification and Selection
Once the need and the description of the need are identified, one
of two things can happen: (1) The need is fulfilled by a supplier that
has an existing contractual relationship with the buying company. (2)
The need is fulfilled by a new supplier that is not currently qualified
to provide products and services to the firm.
In the first case, the P2P process moves quite smoothly. Through
the need forecasting process, purchasing personnel have already
identified which suppliers will be used to source the need, and they
have already taken steps to evaluate and prequalify the supplier.
Qualification is important, as the purchasing firm must ascertain that
the supplier meets several criteria and evaluate whether it is
qualified to do business and meet the needs of their internal customers
in a satisfactory manner. This evaluation process is described in some
detail in the next chapter.
In the second case, where a supplier is not identified, or when the
internal customer requests that the need be fulfilled by a specific
supplier of their choosing, purchasing face a more difficult
challenge. Because there is no existing contract with the supplier,
they may balk at approving the need fulfillment from this supplier.
When internal customers purchase directly from nonqualified suppliers
and try to bypass purchasing in the process, this is known as maverick
spending. That is, customers are acting as a maverick, in that they
do not wish to use suppliers already deemed by purchasing as qualified
to fulfill the need. Although some level of maverick spending is always
going to occur in an organization, there are significant risks that
can occur when it reaches high proportions. We will discuss some of
these risks later in the chapter.

34
 Maverick spending is acceptable when there is little risk
associated with the purchase. For example, if someone needs to purchase
a box of copy paper, there is little risk when an internal customer
goes to the local Staples store and purchases a box using the company
procurement card. In fact, purchasing will often encourage them to do
so, as this does not represent a productive use of their time in
managing these types of expenses. However, when high levels of maverick
spending occur repeatedly throughout the company, it can result in
major lost opportunities to control cost and also expose the firm to
undue risk and loss of control over the purchasing process.
Let’s assume for the moment that a qualified supplier is able to
provide the product or service, and that the supplier has been through
the evaluation process. For some items, firms may maintain a list of
preferred suppliers that receive the first opportunity for new
business. A preferred supplier has demonstrated its performance
capabilities through previous purchase contracts and therefore
receives preference during the supplier selection process. By
maintaining a preferred supplier list, purchasing personnel can
quickly identify suppliers with proven performance capabilities.
In cases when there is not a preferred supplier available,
purchasing must get involved in selecting a supplier to fulfill that
need.
Final supplier selection occurs once purchasing completes the
activities required during the supplier evaluation process. Selecting
suppliers is perhaps one of the most important activities performed
by companies. Errors made during this part of the purchasing cycle can
be damaging and long-lasting. Competitive bidding and negotiation are
two methods commonly used for final supplier selection when there is
not a preferred supplier.
6.3.1. Bidding or Negotiating?
Identifying potential suppliers is different from reaching a
contract or agreement with suppliers. Competitive bidding and
negotiation are two methods commonly used when selecting a supplier.
Competitive bidding in private industry involves a request for bids
from suppliers with whom the buyer is willing to do business. This
process is typically initiated when the purchasing manager sends a
request for quotation (RFQ) form to the supplier. The objective is to
award business to the most qualified bidder. Purchasers often evaluate
the bids based on price. If the lowest bidder does not receive the
purchase contract, the buyer has an obligation to inform that supplier
why it did not receive the contract. Competitive bidding is effective
under certain conditions:
35
 • Volume is high enough to justify this method of business.
• The specifications or requirements are clear to the seller. The
seller must know or have the ability to estimate accurately the cost
of producing the item.
• The marketplace is competitive, which means it has an adequate
number of qualified sellers that want the business.
• Buyers ask for bids only from technically qualified suppliers
that want the contract, which in turn means they will price
competitively.
• Adequate time is available for suppliers to evaluate the requests
for quotation.
• The buyer does not have a preferred supplier for that item. If a
preferred supplier exists, the buyer may simply choose to negotiate
the final details of the purchase contract with that supplier.
Buyers use competitive bidding when price is a dominant criterion
and the required item (or service) has straightforward material
specifications. In addition, competitive bidding is often used in the
defense industry and for large projects (e.g., construction projects
and information system development). If major nonprice variables
exist, then the buyer and seller usually enter into direct negotiation.
Competitive bidding can also be used to narrow the list of suppliers
before entering contract negotiation.
Negotiation is logical when competitive bidding is not an
appropriate method for supplier selection. Face-to-face negotiation
is the best approach in the following cases:
• When any of the previously mentioned criteria for competitive
bidding are missing. For example, the item may be a new or technically
complex item with only vague specifications.
• When the purchase requires agreement about a wide range of
performance factors, such as price, quality, delivery, risk sharing,
and product support.
• When the buyer requires early supplier involvement.
• When the supplier cannot determine risks and costs.
• When the supplier requires a long period of time to develop and
produce the items purchased. This often makes estimating purchase
costs on the part of the supplier difficult.
As firms continue to develop closer relationships with selected
suppliers, the negotiation process becomes one of reaching agreement
on items in a cooperative mode. One thing is certain: The process that

36
buyers use to select suppliers can vary widely depending on the
required item and the relationship that a buyer has with its suppliers.
For some items, a buyer may know which supplier to use before the
development of final material specifications. For standard items, the
competitive bid process will remain an efficient method to purchase
relatively straightforward requirements. The bid process can also
reduce the list of potential suppliers before a buyer begins time-
consuming and costly negotiation.
After bids have been received or the negotiation has taken place,
the sourcing team will select a supplier and then move on to authorize
the purchase through the purchase approval process.
6.3.2. Request for Quotation
If the requisition requests an item for a higher dollar amount with
no existing supplier, then purchasing may obtain quotes or bids from
potential suppliers. Purchasing forwards a request for quotation to
suppliers inviting them to submit a bid for a purchase contract.
Exhibit 2.4 presents an example of a request for quotation form.
The form provides space for the information that suppliers require
to develop an accurate quotation, including the description of the
item, quantity required, date needed, delivery location, and whether
the buyer will consider substitute offers. Purchasing can also
indicate the date by which it must receive the supplier’s quotation.
The supplier completes the form by providing name, contact person,
unit cost, net amount, and any appropriate payment terms. The supplier
then forwards the request for quotation to the buyer for comparison
against other quotations. The normal practice is for a buyer to request
at least three quotations. Purchasing evaluates the quotations and
selects the supplier most qualified to provide the item.
6.3.3. Specifications or Blueprints
If the requested item is complex or requires an untested or new
production process, purchasing can include additional information or
attachments to assist the supplier. This might include detailed
blueprints, samples, or technical drawings. In addition, buyers can
use requests for quotation as a preliminary approach to determine if
a potential supplier even has the capability to produce a new or
technically complex item. A buyer must identify suppliers with the
required production capability before requesting detailed competitive
bids. Further quotation and evaluation can then occur to identify the
best supplier.

37
 If the purchase contract requires negotiation between the buyer and
seller (rather than competitive bidding), purchasing sends a request
for proposal (RFP) to a supplier. In many firms, RFQs and RFPs are
synonymous. However, in the latter case, the item’s complexity
requires that a number of issues besides price need to be included in
the supplier’s response.
6.3.4. Evaluate Suppliers
As shown in Exhibit 2.1, when the size of the purchase dictates
that a detailed evaluation is required for a new purchase, supplier
evaluation may be required. The potential evaluation of suppliers
begins after determining that a purchase need exists (or is likely to
exist) and the development of material specifications occurs. For
routine or standard product requirements with established or selected
suppliers, further supplier evaluation and selection is not necessary,
and the approval process may be generated. However, potential sources
38
for new items, especially those of a complex nature, require thorough
investigation to be sure that purchasing evaluate only qualified
suppliers.
The source evaluation process requires the development of a list
of potential suppliers. This list may be generated from a variety of
sources, including market representatives, known suppliers,
information databases, and trade journals. For some items, companies
may maintain a list of preferred suppliers that receive the first
opportunity for new business. A preferred supplier has demonstrated
capability through past performance. Relying on a list of preferred
suppliers can reduce the time and resources required for evaluating
and selecting suppliers.
Buyers use different performance criteria when evaluating potential
suppliers. These criteria are likely to include a supplier’s
capabilities and past performance in product design, commitment to
quality, management capability and commitment, technical ability, cost
performance, delivery performance, and the ability to develop process
and product technology. These factors are weighted in the supplier
evaluation process. Specific examples of such weighting schemes appear
in Chapter 8 on supplier evaluation. Final evaluation often requires
visits to supplier plants and facilities. Because the resources to
conduct such visits are limited, the purchaser must take great care
in deciding which suppliers to visit.
In recent years, firms have also begun to utilize an electronic
competitive bidding tool called a reverse auction or an e-auction.
These mechanisms work exactly like an auction, but in reverse. That
is, the buyer identifies potential qualified suppliers to go online
to a specific website at a designated time and bid to get the business.
In such cases, the lowest bid will often occur as suppliers see what
other suppliers are bidding for the business and, in an effort to win
the contract, bid it lower. Although they are somewhat ruthless,
reverse auctions have been found to drive costs much lower when there
is adequate competition in a market.
6.4. Approval, Contract, and Purchase Order
Preparation
After the supplier is selected or a requisition for a standard item
is received, purchasing grant an approval to purchase the product or
service. This is accomplished through several different approaches,
depending on the type of system in place.

39
 6.4.1. Purchase Order
The drafting of a purchase order, sometimes called a purchase
agreement, takes place after supplier selection is complete.
Purchasing must take great care when wording a purchase agreement
because it is a legally binding document. Almost all purchase orders
include on the reverse side of the agreement the standard legal
conditions that the order (i.e., the contract) is subject to. The
purchase order details critical information about the purchase:
quantity, material specification, quality requirements, price,
delivery date, method of delivery, ship-to address, purchase order
number, and order due date. This information, plus the name and address
of the purchasing company, appears on the front side of the order.
Exhibit 2.5 on p. 59 presents an example of a purchase order, and
Exhibit 2.6 illustrates a typical set of conditions and instructions.

40
 Companies with an older paper system have a cumbersome process (see
Exhibit 2.3). Approximately seven to nine copies typically accompany
the purchase order. In computerized environments, a file containing a
copy of the PO is sent to each department’s computer mailbox. The
supplier receives the original copy of the purchase order along with
a file copy. The supplier signs the original and sends it back to the
buyer. This acknowledges that the supplier has received the purchase
order and agrees with its contents. In legal terms, the transmittal
of the purchase order constitutes a contractual offer, whereas the
acknowledgment by the supplier constitutes a contractual acceptance.
Offer and acceptance are two critical elements of a legally binding
agreement.
Purchasing forwards a copy of the purchase order (either
electronically or manually) to accounting (accounts payable), the
requesting department, receiving, and traffic. Purchasing usually
keeps several copies for its records. There are good reasons for
41
allowing other departments to view purchase orders and incoming
receipts:
• The accounting department gains visibility to future accounts
payable obligations. It also has an order against which to match a
receipt for payment when the material arrives.
• The purchase order provides the requesting department with an
order number to include in its records.
• The requestor can refer to the purchase order number when
inquiring into the status of an order.
• Receiving has a record of the order to match against the receipt
of the material. Receiving also can use outstanding purchase orders
to help forecast its inbound workload.
• Traffic becomes aware of inbound delivery requirements and can
make arrangements with carriers or use the company’s own vehicles to
schedule material delivery.
• Purchasing use their copies of the purchase order for follow-up
and monitoring open orders.
• Orders remain active in all departments until the buying company
acknowledges receipt of the order and that it meets quantity and
quality requirements.
Note that firms are increasingly using computerized databases to
perform these processes and are moving toward a paperless office.
6.4.2. Blanket Purchase Order
For an item or group of items ordered repetitively from a supplier,
purchasing may issue a blanket purchase order—an open order, usually
effective for one year, covering repeated purchases of an item or
family of items. Exhibit 2.7 provides an example of such a form.
Blanket orders eliminate the need to issue a purchase order whenever
there is a need for material. After a buyer establishes a blanket
order with a supplier, the ordering of an item simply requires a
routine order release. The buyer and seller have already negotiated
or agreed upon the terms of the purchase contract. With a blanket
purchase order, the release of material becomes a routine matter
between the buyer and seller.

42
 Almost all firms establish blanket purchase orders with their
suppliers. In fact, blanket orders have historically been the
preferred method for making the purchasing process more efficient and
user friendly. Buyers usually prefer a purchase order for initial
purchases or a one-time purchase, which purchasing professionals may
also call a “spot buy.” Blanket purchase orders are common for
production items ordered on a regular basis or for the routine supplies
required to operate. A maintenance supplies distributor, for example,
may have a purchase order covering hundreds of items. It is not unusual
for the buyer or seller to modify a purchase order to reflect new
prices, new quantity discount schedules, or the adding or deleting of
items.
The blanket purchase order is similar to the purchase order in
general content and is distributed to the same departments that receive
a copy of a purchase order. The major difference between a purchase

43
order and a blanket purchase order is the delivery date and the
receiving department. This information on the blanket order remains
open because it often differs from order to order.
When negotiating a blanket purchase order, the buyer and supplier
evaluate the anticipated demand over time for an item or family of
items. The two parties agree on the terms of an agreement, including
quantity discounts, required quality levels, delivery lead times, and
any other important terms or conditions. The blanket purchase order
remains in effect during the time specified on the agreement. This
time period is often, but not always, six months to a year. Longer-
term agreements covering several years are becoming increasingly
common with U.S. firms. Most buyers reserve the right to cancel the
blanket order at any time, particularly in the event of poor supplier
performance. This requires an escape clause that allows the buyer to
terminate the contract in the event of persistently poor quality,
delivery problems, and so on.
6.4.3. Material Purchase Release
Buyers use material purchase releases to order items covered by
blanket purchase orders. Purchasing specifies the required part
number(s), quantity, unit price, required receipt date, using
department, ship-to address, and method of shipment and forwards this
to the supplier. Purchasing forwards copies of this form to the
supplier, accounting, receiving, and traffic. Purchasing retains
several copies for its records. The copy to the supplier serves as a
notification of a required item or items. Accounting receives a copy
so it can match the quantity received against the quantity ordered for
payment purposes. Receiving must have visibility of incoming orders
so it can compare ordered quantities with received quantities. As with
other forms, this part of the process is increasingly becoming
electronic.
Different types of material releases exist. Organizations often use
the material release as a means to provide visibility to the supplier
about forecasted material requirements as well as actual material
requirements. One U.S. automobile producer provides suppliers with an
18-month forecast for replacement parts. The first three months of the
release are actual orders. The remaining nine months represent
forecasted requirements that help the supplier plan.
In other cases, a more detailed contract is required above and
beyond a simple purchase order. A contract is typically required if
the size of the purchase exceeds a predetermined monetary value (e.g.,
$1,000), or if there are risks associated with doing business with a
supplier where the potential for conflict and problems is not
44
negotiated prior to the purchase. Because purchasing professionals buy
products and services as a career, it is not surprising that they deal
regularly with contracts. It is therefore critical that purchasing
managers understand the underlying legal aspects of business
transactions and develop the skills to manage those contracts and
agreements on a day-to-day basis.
Once a contract has been negotiated and signed, the real work
begins. From the moment of signing, it is the purchasing manager’s
responsibility to ensure that all of the terms and conditions of the
agreement are fulfilled. If the terms and conditions of a contract are
breached, purchasing personnel are also responsible for resolving the
conflict. In a perfect world, there would be no need for a contract,
and all deals would be sealed with a handshake. However, contracts are
an important part of managing buyer-supplier relationships as they
explicitly define the roles and responsibilities of both parties, as
well as how conflicts will be resolved if they occur (which they almost
always do).
Purchasing contracts can be classified into different categories
based on their characteristics and purpose. Almost all purchasing
contracts are based on some form of pricing mechanism and can be
categorized as a variation on two basic types: fixedprice and cost-
based contracts.
6.4.4. Fixed-Price Contracts
6.4.4.1. Firm Fixed Price
The most basic contractual pricing mechanism is called a firm fixed
price. In this type of purchase contract, the price stated in the
agreement does not change, regardless of fluctuations in general
overall economic conditions, industry competition, levels of supply,
market prices, or other environmental changes. This contract price can
be obtained through a number of pricing mechanisms: price quotations,
supplier responses to the buying organization’s requests for proposal,
negotiations, and other methods. Fixed-price contracts are the
simplest and easiest for purchasing to manage because there is no need
for extensive auditing or additional input from the purchasing side.
If market prices for a purchased good or service rise above the
stated contract price, the seller bears the brunt of the financial
loss. However, if the market price falls below the stated contract
price because of outside factors such as competition, changes in
technology, or raw material prices, the purchaser assumes the risk or
financial loss. If there is a high level of uncertainty from the
supplying organization’s point of view regarding its ability to make
a reasonable profit under competitive fixed-price conditions, then the
45
supplier may add to its price to cover potential increases in
component, raw material, or labor prices. If the supplier increases
its contract price in anticipation of rising costs, and the anticipated
conditions do not occur, then the purchaser has paid too high a price
for the good or service. For this reason, it is very important for the
purchasing organization to adequately understand existing market
conditions prior to signing a fixed-price contract to prevent
contingency pricing from adversely affecting the total cost of the
purchase over the life of the contract.
6.4.4.2. Cost-Based Contracts
Cost-based contracts are appropriate for situations in which there
is a risk that a large contingency fee might be included using a fixed-
price contract. Cost-based contracts typically represent a lower level
of risk of economic loss for suppliers, but they can also result in
lower overall costs to the purchaser through careful contract
management. It is important for the purchaser to include contractual
terms and conditions that require the supplier to carefully monitor
and control costs. The two parties to the agreement must agree on what
costs are to be included in the calculation of the price of the goods
or services procured.
Cost-based contracts are generally applicable when the goods or
services procured are expensive, complex, and important to the
purchasing party or when there is a high degree of uncertainty
regarding labor and material costs. Cost-based contracts are generally
less favorable to the purchasing party because the threat of financial
risk is transferred from the seller to the buyer. There is also a low
incentive for the supplier to strive to improve its operations and
lower its costs (and hence the price to the purchaser). In fact there
is an incentive, at least in the short run, for suppliers to be
inefficient in cost-based contracts because they are rewarded with
higher prices.
6.5. Receipt and Inspection
This phase of the purchasing cycle involves the physical
transmittal of purchase requirements (see Exhibit 2.1 with further
details in Exhibit 2.8). This should be a fairly routine, although not
necessarily the most efficient, part of the purchasing cycle. Some
organizations transmit orders electronically, whereas others send
material releases through the mail or by fax. Purchasing or materials
planning must minimize the time required to release and receive
material.

46
 Electronic data interchange (EDI), which involves the electronic
transfer of purchase documents between the buyer and seller, can help
shorten order cycle time. EDI transactions, particularly through the
Internet, will increase over the next several years. Also, better
relationships with suppliers can support a just-in-time (JIT) ordering
system. In some companies, once a contract is negotiated, internal end
users may be directly responsible for releasing material orders
covered under the terms of the contract, and purchasing personnel are
no longer involved until the contract is renewed. Exhibit 2.9 on p.
66 shows the trend in how organizations are moving toward automating
the different portions of the procurement process.

47
 Purchasing or a materials control group must monitor the status of
open purchase orders. There may be times when a purchaser has to
expedite an order or work with a supplier to avoid a delayed shipment.
A buyer can minimize order follow-up by selecting only the best
suppliers and developing stable forecasting and efficient ordering
systems. The receiving process should also be made as efficient as
possible by using bar code technology to receive and place supplier
deliveries in inventory.
The shipping and receiving processes require several other
important documents that also can be electronic, including the
material packing slip, the bill of lading, and the receiving
discrepancy report.
6.5.1. Material Packing Slip
The material packing slip, which the supplier provides, details the
contents of a shipment. It contains the description and quantity of
the items in a shipment. It also references a specific purchase order
and material release number for tracking and auditing purposes. A
packing slip is a critical document when receiving material at a
buyer’s facility. The receiving clerk uses the packing slip to compare
the supplier packing slip quantity against the actual physical receipt
quantity. Furthermore, the packing slip quantity should match the
material release quantity. The comparison between material release
quantity and packing slip quantity is critical. It determines if
suppliers have over- or undershipped.
6.5.2. Bill of Lading
Transportation carriers use a bill of lading to record the quantity
of goods delivered to a facility. For example, the bill of lading may
state that ABC carrier delivered three boxes to a buyer on a certain
date. This prevents the purchaser from stating aweek later that it
received only two boxes. The bill of lading details only the number
of boxes or containers delivered. Detailing the actual contents of
each container is the supplier’s responsibility; that information
appears on the packing slip.
The bill of lading helps protect the carrier against wrongful
allegations that the carrier somehow damaged, lost, or otherwise
tampered with a shipment. This document does not necessarily protect
the carrier against charges of concealed damage, however. A user may
discover concealed damages after opening a shipping container.
Responsibility for concealed damage is often difficult to establish.
The receiving company may blame the carrier. The carrier may blame the
supplier or maintain that the damage occurred after delivery of the
material. The supplier may maintain total innocence and implicate the
48
carrier. While all this goes on, the buyer must reorder the material
as a rush order. This can affect customer service or commitments.
6.5.3. Receiving Discrepancy Report
A receiving discrepancy report details any shipping or receiving
discrepancies noted by the receiving department. It is often the job
of purchasing or material control to investigate and resolve material
discrepancies. Material discrepancies usually result from incorrect
quantity shipments. They can also result from receiving an incorrect
part number or a part number incorrectly labeled.
6.5.4. Just-in-Time Purchasing
Just-in-time purchasing and manufacturing allows firms to eliminate
most receiving forms. Honda of America, for example, assumes that if
its production line does not shut down it must have received its
scheduled shipments from its suppliers. The accounts payable
department makes payment unless informed otherwise. Honda’s JIT system
eliminates the need for packing slips and inbound material inspection.
The system also eliminates the need to examine, file, and forward
multiple copies of each packing slip to various departments. If a
receipt does not arrive on time or is not damage free, Honda realizes
this within minutes. With this system, no news means the shipment
arrived and is production ready.
Someone (typically purchasing or materials personnel) must monitor
the status of open purchase orders. There may be times when the buying
firm has to expedite an order or work with a supplier to avoid a delay
in a shipment. A company can minimize order follow-up by selecting
only the best suppliers and developing internally stable forecasting
and ordering systems. When the order for a physical good arrives at
the buyer’s location, it is received and inspected to ensure that the
right quantity was shipped and that it was not damaged in transit.
Assuming that the product or service was delivered on time, it will
be entered into the company’s purchasing transaction system. Physical
products delivered by suppliers then become part of the company’s
working inventory.
In the case of services, the buyer must ensure that the service is
being performed according to the terms and conditions stated in the
purchase order. For services, the user will typically sign off on a
supplier time sheet or other document to signal purchasing that the
service was delivered as promised, on time, and according to the
conditions stated in the initial SOW. That may mean checking with the
actual users within the organization who requested the service in the
first place and ensuring that all is going as planned. Deviations from

49
the statement of work must be noted and passed on to the supplier,
which in some cases may require modifications to the original PO or
contracted SOW (often called a change notice when this occurs).
6.6. Invoice Settlement and Payment
Once the item or service is delivered, the buying firm will issue
an authorization for payment to the supplier. Payment is then made
through the organization’s accounts payable department. This is
increasingly being accomplished through electronic means. Suppliers
are more often being paid through electronic funds transfer (EFT),
which is the automatic transfer of payment from the buyer’s bank
account to the supplier’s bank account. More and more organizations
are moving to integrated systems where all purchase orders, receipts,
and payments are made electronically.
6.7. Records Maintenance
After the product or service has been delivered and the supplier
paid, a record of critical events associated with the purchase is
entered into a supplier performance database. The supplier performance
database accumulates critical performance data over an extended
period, helping purchasing identify trends or patterns in supplier
performance.
Why is it important to capture the transaction-level data
associated with all purchasing processes? This answer is discussed in
the next section. Specifically, from time to time the firm must
identify opportunities for savings through a process known as a spend
analysis. Spend analysis becomes a critical input into building
sourcing strategies—the topic of the next section.
6.8. Continuously Measure and Manage Supplier
Performance
One way to identify the best suppliers is to track performance
after awarding a contract. Supplier measurement and management is a
key part of the purchasing cycle. As shown in Exhibit 2.1, buyers
should not assume that the purchasing cycle ends with the receipt of
an ordered item or the selection of a supplier. Continuous measurement
is necessary to identify improvement opportunities or supplier
nonperformance. A later chapter discusses purchasing measurement and
evaluation tools. This section simply summarizes the key points about
this phase of the purchasing cycle.
A desired outcome from performance measurement is improved supplier
performance. If no formal evaluation takes place, a buyer has little
insight into supplier performance over time, and tracking any

50
performance improvement that results from supplier development efforts
is not possible. Without a measurement and evaluation system, a buyer
lacks the quantitative data necessary to support future purchase
decisions.
A major issue when evaluating supplier performance is the frequency
of evaluation and feedback. For example, should a buyer receive a
supplier quality performance report on a daily, weekly, monthly, or
quarterly basis? Although most firms recognize the need to notify
suppliers immediately when a problem arises, there is little consensus
about the frequency for conducting routine or scheduled supplier
evaluations. For many firms, this overall evaluation may occur only
one or two times a year. Regardless of the reporting frequency,
supplier performance measurement is an important part of the
purchasing process cycle.

7. Types of Purchases
Organizations buy many different goods and services. All purchases
represent a tradeoff between what an organization can make itself
versus what it must buy externally. For many items, the make-or-buy
decision is actually quite simple. Few firms could manufacture their
own production equipment, computers, or pencils. However, all firms
require these items to support continued operations. The challenge is
deciding which suppliers offer the best opportunity for items an
organization must purchase externally. The following sections outline
the variety of goods and services a typical purchasing department is
responsible for buying. Please note that for each category,
organizations should establish measures that track the amount of goods
in physical inventory.
7.1. Raw Materials
The raw materials purchase category includes items such as
petroleum, coal, and lumber, and metals such as copper and zinc. It
can also include agricultural raw materials such as soybeans and
cotton. A key characteristic of a raw material is a lack of processing
by the supplier into a newly formed product. Any processing that occurs
makes the raw material saleable. For example, copper requires refining
to remove impurities from the metal. Another key characteristic is
that raw materials are not of equal quality. Different types of coal,
for example, can differ by sulfur content. Raw materials often receive
a grade indicating the quality level. This allows raw materials
purchases based on the required grade.

51
 7.2. Semifinished Products and Components
Semifinished products and components include all the items
purchased from suppliers required to support an organization’s final
production. This includes singlepart number components, subassemblies,
assemblies, subsystems, and systems. Semifinished products and
components purchased by an automobile producer include tires, seat
assemblies, wheel bearings, and car frames.
Managing the purchase of semifinished components is a critical
purchasing responsibility because components affect product quality
and cost. Hewlett-Packard buys its laser jet printer engines, which
are a critical part of the finished product, from Canon. HP must manage
the purchase of these engines carefully and work closely with the
supplier. Outsourcing product requirements increases the burden on
purchasing to select qualified suppliers, not only for basic
components, but also for complex assemblies and systems.
7.3. Finished Products
All organizations purchase finished items from external suppliers
for internal use. This category also includes purchased items that
require no major processing before resale to the end customers. An
organization may market under its own brand name an item produced by
another manufacturer. Why would a company purchase finished items for
resale? Some companies have excellent design capability but have
outsourced all production capability or capacity. Examples include
IBM, HewlettPackard, Sun, Cisco, General Motors (Geo), and others. The
purchase of finished products also allows a company to offer a full
range of products. Purchasing (or engineering) must work closely with
the producer of a finished product to develop material specifications.
Even though the buying company does not produce the final product, it
must make sure the product meets the technical and quality
specifications demanded by engineering and the end customer.
7.4. Maintenance, Repair, and Operating Items
Maintenance, repair, and operating (MRO) items include anything
that does not go directly into an organization’s product. However,
these items are essential for running a business. This includes spare
machine parts, office and computer supplies, and cleaning supplies.
The way these items are typically dispersed throughout an organization
makes monitoring MRO inventory difficult. The only way that most
purchasing departments know when to order MRO inventory is when a user
forwards a purchase requisition. Because all departments and locations
use MRO items, a typical purchasing department can receive thousands

52
of small-volume purchase requisitions. Some purchasers refer to MRO
items as nuisance items.
Historically, most organizations have paid minimal attention to MRO
items. Consequently, (1) they have not tracked their MRO inventory
investment with the same concern with which they track production
buying, (2) they have too many MRO suppliers, and (3) they commit a
disproportionate amount of time to small orders. With the development
of computerized inventory systems and the realization that MRO
purchase dollar volume is often quite high, firms have begun to take
an active interest in controlling MRO inventory. At FedEx, an agreement
with Staples allows purchasing to be free of the burden of tracking
office supply requests. Instead, Staples provides a website listing
all supplies with prices; users can point and click on the items they
need, and the supplier will deliver to the user’s location the next
business day.
7.5. Production Support Items
Production support items include the materials required to pack and
ship final products, such as pallets, boxes, master shipping
containers, tape, bags, wrapping, inserts, and other packaging
material. Production support items directly support an organization’s
production operation; this is a key distinction separating production
support and MRO items.
7.6. Services
All firms rely on external contractors for certain activities or
services. An organization may hire a lawn care service to maintain the
grounds around a facility or a heating and cooling specialist to handle
repairs that the maintenance staff cannot perform. Other common
services include machine repair, snow removal, data entry,
consultants, and the management of cafeteria services. Like MRO items,
the purchase of services occurs throughout an organization. Therefore,
there has been a tendency to pay limited attention to them and to
manage the service purchases at the facility or department level. A
study by AT&T several years ago revealed that the company was spending
over a billion dollars a year on consultants. As with any purchase
category, careful and specialized attention can result in achieving
the best service at the lowest total cost. More and more, companies
are negotiating longer-term contracts with service providers just as
they would with other high-dollar purchase categories.
7.7. Capital Equipment
Capital equipment purchasing involves buying assets intended for
use over one year. There are several categories of capital equipment
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purchases. The first includes standard general equipment that involves
no special design requirements. Examples include general-purpose
material-handling equipment, computer systems, and furniture. A second
category includes capital equipment designed specifically to meet the
requirements of the purchaser. Examples include specialized production
machinery, new manufacturing plants, specialized machine tools, and
power-generating equipment. The purchase of these latter items
requires close technical involvement between the buyer and seller.
Several features separate capital equipment purchases from other
purchases. First, capital equipment purchases do not occur with
regular frequency. A production machine, for example, may remain in
use for 10 to 20 years. A new plant or power substation may remain in
operation over 30 years. Even office furniture may last over 10 years.
A second feature is that capital equipment investment requires large
sums of money. This can range from several thousand dollars to hundreds
of millions of dollars. High-dollar contracts will require finance and
executive approvals. For accounting purposes, most capital equipment
is depreciable over the life of the item. Finally, capital equipment
purchasing is highly sensitive to general economic conditions.
Buyers can rarely switch suppliers in the middle of a large-scale
project or dispose of capital equipment after delivery because of
dissatisfaction. Furthermore, the relationship between the buyer and
supplier may last many years, so the buyer should also consider the
supplier’s ability to service the equipment. The consequences of
selecting a poorly qualified supplier of capital equipment can last
for many years. The reverse is also true. The benefit of selecting a
highly qualified capital equipment provider can last many years.
7.8. Transportation and Third-Party Purchasing
Transportation is a specialized and important type of service
buying. Few purchasing departments involved themselves with
transportation issues before the early 1980s. However, legislation
passed during the late 1970s and early 1980s deregulated the air,
trucking, and railroad industries. This legislation allowed buyers to
negotiate service agreements and rate discounts directly with
individual transportation carriers. Previously, the U.S. government,
through the Interstate Commerce Commission, established the rate
(referred to as a tariff) that a transportation carrier charged. It
was common for suppliers to arrange shipment to a purchaser and simply
include the transportation cost as part of the purchase cost.
Purchasing personnel have become involved with transportation
buying and the management of inbound and outbound material flows. It
is now common for purchasing personnel to evaluate and select logistics
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providers the same way they evaluate and select suppliers of production
items. Buyers are also selecting suppliers that are capable of
providing coordinated transportation and logistics services for an
entire company, including warehousing, packaging, and even assembly.
Because many carriers now provide service throughout the United
States, a buyer can rely on fewer transportation carriers. The cost
savings available from controlling and managing logistics are
significant.

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