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Every organization, whether it is a manufacturer, wholesaler, or retailer, buys

materials, services, and supplies to support operations. Historically, purchasing
has been perceived as a clerical or low-level managerial activity charged with
responsibility to execute and process orders initiated elsewhere in the
organization. The role of purchasing was to obtain the desired resource at the
lowest possible purhase price from a supplier. This traditional view of purchasing
has changed substantially in the past several decades. The modern focus is on
total spend and the development of relationships between buyers and sellers. As
a result, procurement has been elevated to a strategic activity.
Procurement Perspectives
The evolving focus on procurement as a key organizational capability has
stimulated a new perspective regarding its role in supply chain management. The
emphasis has shifted from adversarial, transaction-focused negotiation with
suppliers to ensuring that the firm to effective procurement strategy are
identified below.
1. Continuous Supply
Stockouts of raw materials or component parts can shut down or force a change
in production plans, resulting unexpected cost. Downtime due to production
stoppage increases operating costs and may result in an inability to provide
finished goods as promised to customers. One of the core objectives of
procurement is to ensure that a continuous supply of materials, parts, and
components is available to maintain manufacturing operations.
2. Minimize Inventory Investment
In the past, downtime due to material shortages was minimized by maintaining
large investments of materials and components to protect against potential
disruption in supply. However, maintaining inventory is expensive and requires
scarce capital. One goal of procurement is to maintain supply continuity with the
minimum inventory investment possible. This requires balancing the costs of
carrying material against the possibility of a production stoppage.
3. Quality Improvement
Procurement is critical to the quality requirements discussed earlier in this
chapter. The quality of finished goods and services is dependent upon the quality
of the materials and components used. Both a firm and its suppliers need to be
jointly committed to a continuous quality improvement initiative.
4. Supplier Development
In the final analysis, successful procurement depends on locating or developing
suppliers, analyzing their capabilities, and selecting and working with those
suppliers to achieve continuous improvement. Developing good supply
relationships with firms that are committed to the buying organization's success
is critical in supplier development. It is important to develop close relationships
with those suppliers in order to share information and resources to achieve better

Total Cost of Ownership

Total Cost of Ownership (TCO) is an estimate of the total costs of goods, services
or construction works over the whole of their life. It is the combination of the
purchase price plus all other costs you will incur, less any income you receive.
Why is TCO important?
The procurement principles encourage us to make balanced procurement
decisions. This includes getting the best value for money. It means accounting for
all costs and benefits over the lifetime of the goods or services. Part of good
procurement is achieving the right price. Best value for money is the lowest
whole-of-life cost. This involves identifying the initial purchase price and
estimating all future costs and returns. A procurement decision based on the
initial purchase price only, rather than the total costs over the whole-of-life, could
fail to recognise the real costs to your agency.
How is TCO measured and how does it affect negotiation?
First, let us identify the four elements of cost and demonstrate the impact of each
on TCO.
The four elements of cost are: Quality, Service, Delivery, and Price (QSDP )
TCO =the sum of the cost elements in QSDP, or
TCO = Quality + Service + Delivery + Price
Several facts about TCO must be recognized and appreciated to conduct an
effective negotiation:
1. Each element of QSDP has an impact on the TCO
2. The importance of each element varies with the product or service being
3. The relative weight of each element depends upon our assessment of the TCO
impact on our business.
4. The identity and weight of each element is an ongoing part of the continuous
negotiation process.
Effective PROCUREMENT STRATEGY to support supply chain operation
requires a much closer working relationship between buyers and sellers
than was traditionally practiced
3 types of strategy: (1) Volume Consolidation; (2) Supplier Operational
Integration; (3) Value Management
Reduction of the numbers of supplier, accompanied by rigorous supplier
screening, selection and certification program
It allows buyers to negotiate strongly to the supplier for business
Allow the supplier to obtain larger economies of scale in its internal
The next stage occur when the buyers and seller integrate their processes
and activities in an attempt to achieve substantial performance
improvement in the supply chain

It aims to achieve cost reduction, cut waste and develop a relationship that
allows both buyer and seller to achieve mutual improvements

Value management
Achieving operational integration with suppliers creates the opportunity for value
management. Value management is an even more intense aspect of supplier
integration, going beyond a focus on buyer-seller operations to a more
comprehensive and sustainable relationship. Value engineering, reduced
complexity, and early supplier involvement in new product design represent
some of the ways procurement can work with suppliers to reduce TCO.
Value engineering is a concept that involves closely examining material and
component requirements at the early stage of product design to ensure that a
balance of lower total cost and quality is incorporated into new product design.
FIGURE 4.2 Flexibility and Cost of Design Changes






Cost of
Design changes

Flexibility in design


Figure 4.2 shows how early supplier involvement can be critical in achieving cost
reductions. As a firms new product development process proceeds from idea
generation through the various stages to commercialization, the companys
flexibility in making design changes decreases. Design changes are easily

accommodated in the early stages, but by the time prototypes have been
developed, a design change becomes difficult and expensive. The earlier a
supplier is involved in the design process, the more likely an organization is to
capitalize on that suppliers knowledge and capabilities.
Clearly, value management extends beyond procurement in an organization and
requires cooperation between numerous participants, both internal and external.
Teams representing procurement, engineering, manufacturing, marketing and
logistics as well as key supplier personnel jointly seek solutions to lower total
cost; improve performance, or improved accommodation of customer

E-Commerce and Procurement

The explosion in technology and information system is having a major on impact
on the procurement activity of most organization. Much of the actual day-to-day
work in procurement has traditionally been accomplished manually with
significant amounts of paperwork, resulting in slow processes subject to
considerable human error. Applying technology to procurement has considerable
potential to speed the process, reduce errors and lower acquisition cost.
Probably the most common technology used in procurement in Electronic Data
Interchange (EDI). EDI involves the electronic transmission of data between a firm
and its suppliers. This allows two or more companies to obtain and provide timely
and accurate information. Using EDI there are many types of data being directly
transmitted, including purchases requisitions, purchase orders, purchases order
knowledge, order status, advanced shipment notification and tracking and tracing
information. The explosion in EDI usage is a direct recognition of associated
benefits, including standardization of data, more accurate information, and more
timely information, shortening of lead times with associated reductions in
inventories and reduced TCOs.
Another procurement application of electronic commerce is the development of
electronic catalogs. In fact, making information available about products and who
can supply with their common base of suppliers. In the auto industry, General
Motors, Ford, and DaimlerChrysler, each of which had initially formed separate
trading networks, established a joint online buying exchange. The auto
companies allows their suppliers to view requirements for parts and supplies,
look at technical specifications, and even have a limited view of planned
production schedules. Since the auto manufactures in many instances deal with
common sources, the suppliers can better plan their own production and delivery
requirements by having access to information concerning all of their customers
available from a single location.
The potential volume of procurement activity through buying exchanges is
enormous. Exchanges have been developed in the aircraft parts industry,
chemicals, steel building products, food distribution and even retailing. However,
there is a potential downside. Many suppliers fear that the exchanges will

become a mechanism that ultimately will reinforce past practice of buyers to

focus strictly on purchase price. If buyers post their requirements and needs on
the internet primarily of the purpose of soliciting bids from alternative suppliers,
or use the technology to have suppliers enter into an auctioning process, some
fear many of advances in supplier integration and value management will suffer.
In a supply chain management context, the link between a company and its
external suppliers is critical. It provides for the integration of materials and
resources from outside the organization into internal operations. Procurement is
charged with the responsibility of ensuring that this transition is accomplished as
efficiently and as effectively as possible. Much of the concern in procurement is
focused on the logical interface between the organization and its supply base.
Ultimately, the purpose of procurement is to integrate material flow in
accordance with requirements. Its the job of logistics to efficiently move
purchases to the desired location.