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Procurement Practitioners Will Only Add Sustainable Value To An Organisation's Bottom-Line If They Understand The Environment in Which They Operate

This document discusses understanding the procurement environment. It covers several key topics: 1) The importance of understanding factors like political, economic, social, technological, legal, and environmental issues that can impact an organization. This includes analyzing the market, competition, supply/demand dynamics. 2) How supply and demand are influenced by price, substitutes, complements, tastes, advertising and other factors. Equilibrium is reached where supply and demand intersect. 3) How legal regulations like contracts and implied terms govern business agreements. Disputes should be resolved through arbitration if possible to avoid litigation. The overall message is that procurement professionals need a thorough understanding of their operating environment to add sustainable value through efficient purchasing.
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0% found this document useful (0 votes)
57 views85 pages

Procurement Practitioners Will Only Add Sustainable Value To An Organisation's Bottom-Line If They Understand The Environment in Which They Operate

This document discusses understanding the procurement environment. It covers several key topics: 1) The importance of understanding factors like political, economic, social, technological, legal, and environmental issues that can impact an organization. This includes analyzing the market, competition, supply/demand dynamics. 2) How supply and demand are influenced by price, substitutes, complements, tastes, advertising and other factors. Equilibrium is reached where supply and demand intersect. 3) How legal regulations like contracts and implied terms govern business agreements. Disputes should be resolved through arbitration if possible to avoid litigation. The overall message is that procurement professionals need a thorough understanding of their operating environment to add sustainable value through efficient purchasing.
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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CHAPTER 3

Understanding the Environment


Introduction
Procurement practitioners will only
add sustainable value to an
organisation’s bottom-line if they
understand the environment in which
they operate.
There is the need for
Procurement professionals to
understand the purchasing
environment in which they
operate, in their respective
organisations and industries.
The activities of Procurement
have a direct impact on the
overall performance of an
organisation as these activities
cut across the whole
organisation.
‘’a product well bought
is half sold", as is often
said.
The role of procurement is often described
as the purchasing of the goods and services:
at acceptable quality standards,
in quantities that meet the organisational
needs,
delivered at the time and place where
they are needed
to a price that is sustainable.
Under-specification or
over-specification of goods
and services can lead to an
organisation incurring
unnecessary costs.
Therefore, getting the
right quality of product
or service is
fundamental to
procurement’s role.
Finding the best fit for the above at
the lowest total cost of ownership
requires that Procurement
professionals understand the driving
factors within their purchasing
environment, which will bring about
efficiency and effectiveness of
procurement.
Ways to understand the purchasing environment

1 .Undertaking a market analysis


Negotiators need to be aware of the influences
that external factors have on their organisations,
and of the influences their organisations transmit
in the opposite direction.
To get a handle on external factors, group them in
the six categories indicated by the acronym
PESTLE.
•Political factors
•Economic factors
•Sociocultural factors
•Technological factors
•Legal factors
•Environmental factors (in
the sense of ‘green’issues)
The Political Environment embraces
New social pressures and the
Attitudes of the party which is in power at
the time,
Legislation that regulates the activities of
organisations.
the style of government adopted
(centralised or decentralised), etc.
The Economic Environment
includes such factors as
the level of industrial concentration,
fluctuations in the business cycle,
and the general level of economic
activity.
The Sociocultural Environment consists of
demographic environmental characteristics,
such as
geographical distribution
population density,
age and educational levels,
as well as the norms, customs and values of the
population within which the organisation
functions.
The Technological Environment
impacts on organisations in three
ways:
streamlining operations,
altering production methods, and
creating new products such as mobile
Smart phones, DVD players etc.
The legal environment is
considered later in the
chapter.
Laws, by-laws, rules ,
regulations etc
ENVIRONMENTAL FACTORS
Recent decades have seen an unprecedented upswing in public
concern over environmental issues.
Once any organization takes on an environmental stance, it is
likely that such attitudes will begin to spread along the supply
chain.
Similar commitments will be demanded from that
organization's suppliers, who in turn will pass on the
philosophy to their own suppliers.
Another area of critical concern
for purchasers is the general
competitive environment.
A key tool of analysis in this
context is Professor Michael
Porter’s five forces model
Porter holds that an industry is shaped by five
forces:
i. The extent of competitive rivalry within the
industry itself, and
four external forces:
threats from
ii. potential entrants,
iii. substitute products,
iv. suppliers’ bargaining powe
v. from buyers’ bargaining power
2. Supply and demand

Demand is the quantity of a good


which consumers want, and are
willing and able to pay for.
The main influences on the
demand for goods and services
are discussed below.
1. Price is probably the most significant
factor.
The higher the price, the less likely
people are to buy it.
In general, the more income people
earn, the more they will buy.
The demand for most goods increases as
income rises.
2. Substitutes
Two or more goods are defined as substitutes if
they are interchangeable in giving consumers
utility.
If the price of a substitute rises, demand for it will
probably fall, leading to an increase in demand for
the original product.
Conversely, if the price of a substitute falls, then
demand for the original product will also fall, as
people switch to the substitute.
3. COMPLEMENTS
Complements are goods which must be used
together.
For example, a compact disc player is no good
without any compact discs.
If the price of a complement rises, then
demand for the good in question will fall.
Conversely, if the price of a complement falls,
demand for the good will rise.
Demand is also influenced by
4. Taste/Preferences
5. Advertising and by
6. The quality of goods.
7. Expectations of consumers e.g. future
rise/price
8. Growth in population 9. government policy
10. Climatic condition
As we have seen, the quantity of a good
demanded by an individual depends on
many factors, one of the most important
being price.
A demand curve relates the price of a good
to the quantity of the good which a person,
or people, are willing and able to buy.
For most goods demand falls as price rises.
Supply is the quantity of a good which
suppliers (or a single supplier) are willing and
able to produce in a given period.
As with demand, the decision about how much
to supply depends on many factors, of which
one of the most important is
price.
the cost of production
The higher the price of the product,
the more the supplier will supply
because he will make a bigger profit.
In producing goods for sale, the
supplier will incur costs.
these must be covered if the
supplier is to stay in business.
The Level of Technology influences the
efficiency with which capital or machines
and labour can be used to produce goods.
Improved technology enables firms to
produce more with a given input of
resources, i.e. at the same cost, and can
thus be expected to increase the amount
that they are willing to supply at given
prices.
New entrants to the supply market
increase the supply of goods or services
in that market.

The availability of complements is also


important.
Many goods are linked to each other –
for example, cameras and Storage card.
A reduction in the price of
cameras will mean that more
cameras are supplied (at a lower
price); this increase in demand
will have a knock-on effect on the
supply of storage cards without
any change in their price.
•The quantity supplied of a good
depends on the price of the good
and, unlike demand, the supply rises
as price rises.
•Consumers want to pay as little as
possible, but suppliers want to
charge as much as possible.
The two sides of the market have
to compromise at some price
between these two extremes.
An equilibrium price is at the
point where demand and supply
intersect.
Price elasticity of demand is the
degree of sensitivity of demand for a
good to changes in the price of that
good.
Goods are described as ‘inelastic’ if the
quantity of them demanded is
relatively insensitive to the price
charged.
Typically such goods are basics, such as food, which
people put at the top of their spending priorities.

Conversely, demand is described as being ‘elastic’ where


the quantity of a good demanded is relatively sensitive
to a change in price.

The phrase ‘price elasticity of demand’ is a bit long


winded, so it is often shortened to ‘elasticity of demand’
or even PED.
Price elasticity is the proportionate
change in demand divided by the
proportionate change in the good’s
price.
Although mathematically this can be
defined in a number of ways, the
most common formula is as follows.
PED=PERCENTAGE CHANGE IN QUANTITY DD
PERCENTAGE CHANGE PRICE
When PED > 1 (ie price
elasticity of demand is greater
than 1), demand is relatively
elastic and the quantity
demanded is very responsive
to price changes;
When PED < 1 (i.e. price elasticity
of demand is less than 1),
demand is relatively inelastic and
the quantity demanded is not
very responsive to price changes.
Note that if demand is said to be
inelastic, this does not mean that
there will be no change in quantity
demanded when the price changes.
It means that the consequent
demand change will be
proportionately smaller than the
price change.
If demand does not
change at all after a
price change, demand
is said to be perfectly
inelastic.
Equally goods which have
many substitutes and which
represent a large proportion
of consumer’s expenditure
have an elastic demand.
3. The impact of legal regulations

The outcome of a successful


negotiation will invariably be a
supply agreement between
buyer and supplier.
This will form a contract
governed by legal rules
that have been
developed over many
centuries.
The agreement will
incorporate express terms
agreed upon by the parties
and specifically stated in the
written agreement.
However, it may also include
implied terms: Terms which a
court will assume to have
been incorporated into the
agreement even if they are
not specifically written down.
For example, the Sale of Goods
Act requires that certain terms are
always to be included in contracts
for the sale of goods, even if the
contract between the parties is
silent on the subject
The contract should also contain
terms governing action to be taken in
the event of a dispute.
It is usual for the parties to agree that
some kind of arbitration or mediation
will be undertaken, leaving litigation
in the courts as a last resort.
The Latin term caveat emptor
(‘let the buyer beware’) is the
legal principle that a buyer is
not protected in law for his
foolishness or negligence in
making a bad bargain.
If the buyer regrets the price
he paid, it is too late to look to
the courts for redress: he
should have been more careful
in entering into the contract.
Typical terms and
conditions agreed in a
supply contract include
the following:
1. The subject matter
of the contract: what
exactly the supplier is
to supply
2. The required
standard or quality of
the goods or services
3. The price to be paid
by the buyer, with
details of payment
dates, instalment
payments etc.
4. The delivery date(s)
5. The mechanisms for
measuring, inspecting
and agreeing quality
6. In some cases, the
damages to be payable
in the event of any
breach of contract
7.The means by which
disputes will be
resolved ( arbitration,
mediation etc. )
8. Any exclusion clauses, i.e.
clauses which limit the
extent of a party’s liability
in the event that things go
wrong
When a party to a contract is
found to be in breach of his
obligations, the other party can
usually claim a monetary
remedy in the form of
damages.
The purpose of this is to put the
injured party in the position he
would have been in but for the
breach. In other words, the
purpose of damages is to
compensate the injured party, not
to punish the party at fault.
4. Undertaking a risk assessment

The choice between


competitive bidding and
negotiation is not a
straightforward one.
And is not one that can
be taken once and for all
and thereafter applied to
every purchasing
transaction.
On the contrary – the
variety of purchasing
transactions suggests that
different approaches will be
necessary in different cases.
This idea is formalised
in the purchasing
product portfolio
devised by Peter Kraljic.
Kraljic’s approach is to
analyse the products
purchased by a buyer in
relation to two
characteristics:
1.Their supply risk (i.e.
the danger that the
product will be
unavailable when
needed).
Risk relates to the
likelihood for an
unexpected event in the
supply chains to disrupt
operations.
For instance, in important areas
of spend, such as tire suppliers
for an automotive are business
critical, and should a disruption
occur, the auto company is
likely itself to face substantial
problems.
The supplier suffers from a range of risks depending on
its geographic location, business model and supply
chain length.
If the vendor  is based in Canada, it is unlikely that
political uncertainty or logistical delay will impact upon
operations.
On the other hand, facilities based in the developing
world may be subject to legislative risk, political
upheaval and unreliable transportation routes.
All such risk factors have a bearing upon the buying
company.
Profitability describes the impact of a supply
item upon the bottom line.
For certain areas of spend, such as stationery,
supplies have only a negligible effect on profits.
In other categories, a single source of supply can
make or break a business.  
For Apple, a large proportion of its profits are
determined by Foxconn’s ability to manufacture
the scale of products required to a precise
specification.
2. The impact of the
purchasing function on
overall financial results.
This will be greater in the
case of products of high
value, or which are used in
large volume, and lower in
other cases.
This analysis is then
summarised by means of
a two-by-two grid (or
matrix): see below.
The use of Kraljic’s matrix implies
that we are able to evaluate the
supply risk relating to the different
items we purchase.
Risk management process,
consisting of five stages.
•Identify sources of potential
risk

•For each possible risk event,


determine its likelihood and its
impact
•Assess the overall
impact of all risk factors

•Investigate risk reduction


•Plan, control and
reduce risk
Non-critical items
These items are low risk and have a low impact upon organizational profitability.
The most commonly used example in this segment is office stationery.
Although important for employees to perform their duties, pens and paper do
not have a significant impact upon the business, nor does their absence
represent a serious threat.
For buyers, stationery is a nuisance. It clogs up time with peripheral concerns.
As such, the sourcing strategies deployed here focus on efficiency and reducing
administrative burden.
Techniques such as e-auctioning and catalogues are an excellent means to
redirect responsibilities either directly to suppliers or to internal customers that
are requisitioning the goods.
Leverage items
Where items have a high profitability, but a low risk factor, buyers possess the
balance of power in the relationship and leverage this strength to obtain greater
returns.
Traditionally, procurement professionals have exploited this status to lower
prices, but increasingly more advanced companies are looking to unlock the
innovative potential of their suppliers.
The market dynamics of this relationship rest upon an abundance of highly
commodified parts.
Suppliers can be easily substituted as their offerings are much the same.
The only limitation for buyers is perhaps over-playing their hand and forcing a
low-profit margin vendor into insolvency.
Bottleneck items
The flip side of leverage: risk is high, but
profitability is low. Here, the strength is in the
hands of the supplier.
The market consists of few suppliers that can
behave oligopolistically to force prices upward.
Procurement Leaders found that these suppliers
absorb more of buyers’ time compared to any
other segment.
The supplier relationship is demanding, even though they
have a limited impact upon company profitability. The market
structure forces buyers to accept an unfavourable deal.
The main strategy rests upon damage limitation.
Procurement must recognize that few opportunities will arise
from this category.
More creative buyers will seek to alter the terms of trade.
Innovative internal activities can redevelop product
requirements such that the material can be replaced with
another and preferably sourced from a leverage supplier.
Strategic items
Lastly, high supplier risk and high profit impact items cover strategic suppliers.
These are critical to the business.
These items only represent a handful of suppliers, but ensuring an effective and
predictable supplier relationship is key to the future of the buying company.
Managing such suppliers requires a diverse array of skills and can subsume a
significant proportion of executive time in sponsoring and directing the relationship.
Unlike the non-critical items, each contract is unique and focuses upon the shared
gains that equal partners enjoy in a collaborative relationship.
Strategic partners should look to innovative both product and process innovation
and in return they can expect long-term commitment from the buyer as well as
proactive development.

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