What is Purchase Management?

Pur­chase man­age­ment is the planned and con­trolled buy­ing of the mate­ri­als, parts, equip­ment and ser­vices an organ­i­sa­tion needs. The clas­sic def­i­n­i­tion says its job is to obtain the right mate­r­ial, of the right qual­ity, in the right quan­tity, at the right time, from the right source, at the right price. It is not sim­ply "buy­ing some­thing"; it is a sequence of deci­sions and doc­u­ments that starts with a need and ends only when the goods are received, checked, paid for and recorded.

The topic mat­ters because no fac­tory, hos­pi­tal, col­lege or shop can deliver any­thing until its inputs arrive. In most man­u­fac­tur­ing firms bought-in mate­ri­als are a large share of total cost, so a small sav­ing in pur­chas­ing goes straight to profit, and a small mis­take (late steel, poor flour, too few boxes) can stop pro­duc­tion, dam­age qual­ity and upset cus­tomers.

Why pur­chase man­age­ment is impor­tant

Every organ­i­sa­tion depends on pur­chas­ing in some way:

• A fac­tory needs raw mate­ri­als, com­po­nents, spare parts, tools and pack­ag­ing mate­ri­als.
• A hos­pi­tal needs med­i­cines, sur­gi­cal items, med­ical equip­ment and clean­ing sup­plies.
• A col­lege needs com­put­ers, fur­ni­ture, sta­tionery and main­te­nance mate­ri­als.

If pur­chas­ing is poor, pro­duc­tion may stop, qual­ity may suf­fer, costs may rise, deliv­er­ies may be delayed and cus­tomers may become unhappy. Good pur­chas­ing, on the other hand, sup­ports smooth oper­a­tions, keeps money from being locked up in excess stock, and builds depend­able sup­plier rela­tion­ships.

A sim­ple exam­ple

Sup­pose a bak­ery makes cakes and bis­cuits from flour, sugar, but­ter and eggs, and packs them in boxes. If it buys poor-qual­ity flour, too much sugar, too few boxes, and receives some items late, then prod­uct qual­ity falls, money is blocked in excess sugar, pro­duc­tion is delayed, and some cus­tomer orders can­not be com­pleted. Care­ful buy­ing avoids all four prob­lems; that care­ful buy­ing is pur­chase man­age­ment.

Objec­tives of pur­chase man­age­ment

The cen­tral objec­tive is to ensure the timely avail­abil­ity of mate­ri­als of suit­able qual­ity at the low­est total cost. To achieve this, the pur­chase func­tion bal­ances qual­ity, cost, time, quan­tity and sup­plier reli­a­bil­ity. The cheap­est pur­chase is there­fore not always the best pur­chase. Sup­port­ing objec­tives include:

• main­tain­ing con­ti­nu­ity of sup­ply so that pro­duc­tion never stops for want of mate­r­ial;
• keep­ing invest­ment in inven­tory as low as is safe;
• devel­op­ing reli­able sup­pli­ers and good long-term rela­tion­ships;
• stan­dar­d­is­ing items where pos­si­ble to reduce vari­ety;
• keep­ing hon­est, trans­par­ent records that can be audited;
• watch­ing mar­ket trends so that price rises and short­ages are antic­i­pated.

The six "rights" of pur­chas­ing

The six rights are the eas­i­est way to remem­ber what pur­chas­ing tries to achieve.

Some text­books add a sev­enth right, the right place (deliv­ery to the cor­rect plant or store), and a few also men­tion the right mode of trans­port.

Scope and func­tions of pur­chase man­age­ment

The scope of pur­chas­ing cov­ers iden­ti­fy­ing the need, find­ing and select­ing sup­pli­ers, obtain­ing and com­par­ing quo­ta­tions, nego­ti­at­ing price and terms, plac­ing the order, fol­low­ing up deliv­ery, check­ing qual­ity, receiv­ing goods, approv­ing pay­ment and main­tain­ing records. The main func­tions are described below.

Iden­ti­fy­ing mate­r­ial require­ments

The organ­i­sa­tion must first know what is needed, how much and by when. This infor­ma­tion comes from the pro­duc­tion, stores, main­te­nance and project depart­ments. If the require­ment itself is wrong, the whole pur­chase goes wrong.

Search­ing for sup­pli­ers

Pos­si­ble sup­pli­ers are found through exist­ing sup­plier lists, mar­ket sur­veys, web­sites, cat­a­logues, adver­tise­ments, ref­er­ences and ten­ders.

Select­ing sup­pli­ers

Sup­pli­ers are com­pared on price, qual­ity, deliv­ery record, rep­u­ta­tion, lead time and ser­vice sup­port. Choos­ing the sup­plier is one of the most impor­tant pur­chas­ing deci­sions, and it is cov­ered in depth under ven­dor selec­tion and ven­dor rat­ing.

Nego­ti­at­ing price and terms

The buyer may nego­ti­ate price, trans­port terms, pay­ment terms, dis­counts, deliv­ery dates and replace­ment terms. Good nego­ti­a­tion con­trols cost with­out harm­ing qual­ity.

Plac­ing the pur­chase order

A pur­chase order is the for­mal doc­u­ment that tells the sup­plier what item is needed, how much, at what price, when it must be deliv­ered and where it should be sent. Once accepted, it forms a legal con­tract.

Fol­low-up and expe­dit­ing

Sup­pli­ers some­times slip. The pur­chase depart­ment fol­lows up open orders, and chases urgent ones (expe­dit­ing), so that mate­ri­als arrive on time.

Receiv­ing and inspec­tion

On arrival, goods are checked for quan­tity, qual­ity, dam­age and con­for­mity to spec­i­fi­ca­tion, so that wrong or defec­tive mate­r­ial does not enter stock.

Record keep­ing

Records of sup­pli­ers, orders, quo­ta­tions, prices, deliv­ery per­for­mance and pay­ments sup­port future deci­sions, ven­dor rat­ing and audit.

The pur­chase pro­ce­dure

The pur­chase pro­ce­dure is the step-by-step rou­tine fol­lowed for each pur­chase. A typ­i­cal sequence is shown below.

1. Receive the pur­chase req­ui­si­tion.
2. Check the need and the spec­i­fi­ca­tion.
3. Iden­tify pos­si­ble sup­pli­ers.
4. Invite quo­ta­tions or ten­ders.
5. Com­pare the offers on total cost, not just price.
6. Select the sup­plier and nego­ti­ate terms.
7. Issue the pur­chase order.
8. Fol­low up deliv­ery.
9. Receive and inspect the goods.
10. Check the invoice against the order and the goods received note, then approve pay­ment.
11. Main­tain pur­chase records.

Key doc­u­ments

Match­ing the pur­chase order, the goods received note and the invoice before pay­ing is called three-way match­ing; it pre­vents pay­ment for goods that were never ordered or never received.

Worked exam­ple: com­par­ing quo­ta­tions on total cost

Sup­pose a bak­ery needs 1,000 kg of flour a month and receives three quo­ta­tions. From past records it expects some flour to be rejected, and each rejected kilo­gram costs it ₹40 (the flour itself plus han­dling and lost bak­ing time).

Step 1: pur­chase price. P: 1,000 × ₹30 = ₹30,000. Q: 1,000 × ₹31 = ₹31,000. R: 1,000 × ₹32 = ₹32,000.

Step 2: add freight. P: ₹30,000 + ₹2,000 = ₹32,000. Q: ₹31,000 + ₹1,000 = ₹32,000. R: ₹32,000 + ₹0 = ₹32,000.

Step 3: cost of rejec­tions. P: 5% of 1,000 = 50 kg × ₹40 = ₹2,000. Q: 20 kg × ₹40 = ₹800. R: 10 kg × ₹40 = ₹400.

Step 4: total landed cost. P = ₹34,000; Q = ₹32,800; R = ₹32,400.

Deci­sion: Sup­plier R, with the high­est quoted price, is actu­ally the cheap­est by ₹1,600 a month com­pared with P. This is why pur­chas­ing looks at total cost of acqui­si­tion, not the price on the quo­ta­tion.

How much to buy and when to reorder

Decid­ing the right quan­tity and the right time links pur­chas­ing with inven­tory con­trol. Two stan­dard tools are the eco­nomic order quan­tity (EOQ), first set out by Har­ris, and the reorder level.

Eco­nomic order quan­tity

EOQ is the order size that min­imises the sum of annual order­ing cost and annual hold­ing cost:

$$\displaystyle EOQ = \sqrt{\frac{2DS}{H}}$$

where $D$ is annual demand, $S$ is the cost of plac­ing one order and $H$ is the cost of hold­ing one unit for a year.

Con­tin­u­ing the bak­ery exam­ple, sup­pose annual demand is $D = 12{,}000$ kg, each order costs ₹500 to place and receive, and hold­ing one kilo­gram for a year costs ₹3 (10% of the ₹30 price).

$$\displaystyle EOQ = \sqrt{\frac{2 \times 12{,}000 \times 500}{3}} = \sqrt{4{,}000{,}000} = 2{,}000 \text{ kg}$$

Num­ber of orders a year = 12,000 ÷ 2,000 = 6. Annual order­ing cost = 6 × ₹500 = ₹3,000. Aver­age stock = 2,000 ÷ 2 = 1,000 kg, so annual hold­ing cost = 1,000 × ₹3 = ₹3,000. Total = ₹6,000. At the EOQ the two costs are equal, which is a quick check that the answer is right.

Lead time and reorder level

Lead time is the gap between plac­ing an order and receiv­ing the mate­r­ial. If an order goes out on the 1st and arrives on the 6th, the lead time is 5 days. Long or uncer­tain lead times make pur­chas­ing harder because stock must last longer while the order is on its way.

The reorder level tells the buyer when to order:

$$\text{Reorder level} = \text{daily usage} \times \text{lead time} + \text{safety stock}$$

If the bak­ery uses 40 kg a day, the lead time is 5 days and it keeps 100 kg as safety stock, the reorder level is $40 \times 5 + 100 = 300$ kg. When stock falls to 300 kg, a new order for 2,000 kg is placed.

Meth­ods of pur­chas­ing

Organ­i­sa­tions choose a buy­ing method to suit the item, the amount of money involved and the mar­ket.

Other meth­ods often listed are hand-to-mouth buy­ing (only for imme­di­ate needs, use­ful when prices are falling or the item is rarely used), rate or run­ning con­tracts (prices fixed for a period, orders placed as needed) and e-pro­cure­ment through online por­tals and reverse auc­tions.

Sup­plier selec­tion and ven­dor rat­ing

A good sup­plier strength­ens the whole oper­a­tion; a poor one dam­ages it. Selec­tion should weigh qual­ity con­sis­tency, cost com­pet­i­tive­ness, deliv­ery speed and reli­a­bil­ity, loca­tion, ser­vice sup­port, finan­cial sta­bil­ity and com­mu­ni­ca­tion. A sup­plier should never be cho­sen for low price alone, because poor qual­ity or late deliv­ery can cre­ate far big­ger losses, as the worked exam­ple shows.

Ven­dor rat­ing eval­u­ates sup­pli­ers after busi­ness begins, usu­ally on qual­ity, price, deliv­ery, ser­vice and lead time. It tells the buyer which sup­pli­ers deliver on time, which give good qual­ity, and which should be con­tin­ued or dropped.

Pur­chas­ing, pro­duc­tion and cost con­trol

Pur­chas­ing directly sup­ports pro­duc­tion. When mate­ri­als are not bought prop­erly, machines stop, work­ers wait, out­put falls and cus­tomer orders are delayed. Pur­chas­ing also affects many cost ele­ments beyond price: freight, taxes, stor­age, han­dling, short­age cost and the cost of qual­ity fail­ures. The pur­chase depart­men­t's aim is to lower total cost, not just the item price; cheap mate­r­ial that fails inspec­tion usu­ally ends up cost­ing more.

Cen­tralised and decen­tralised pur­chas­ing

Many large firms use a mix: high-value, com­mon items are bought cen­trally, while small or urgent local needs are bought by the branch.

Ethics in pur­chas­ing

Because pur­chas­ing spends the organ­i­sa­tion's money, it is exposed to favouritism, bribes, buy­ing with­out com­par­i­son, hid­ing sup­plier infor­ma­tion and poor doc­u­men­ta­tion. A sound sys­tem builds in trans­parency, proper doc­u­men­ta­tion, fair treat­ment of sup­pli­ers, approval lim­its, sep­a­ra­tion of duties (the per­son who orders should not also approve pay­ment) and clear account­abil­ity.

Prob­lems in pur­chase man­age­ment

• sud­den price rises and mar­ket short­ages;
• unre­li­able sup­pli­ers, delayed deliv­er­ies and trans­port prob­lems;
• poor-qual­ity mate­ri­als and wrong quan­ti­ties received;
• poor inter­nal com­mu­ni­ca­tion and weak demand esti­mates.

These call for con­tin­u­ous fol­low-up, backup sup­pli­ers and close links with pro­duc­tion and stores plan­ning.

Qual­i­ties of a good pur­chas­ing man­ager

Pur­chas­ing is both a tech­ni­cal and a com­mer­cial job, so a good pur­chase man­ager needs mar­ket knowl­edge, nego­ti­a­tion skill, cost aware­ness, hon­esty, com­mu­ni­ca­tion skill, record-keep­ing abil­ity, tech­ni­cal under­stand­ing of mate­ri­als and sound judge­ment.

Pur­chas­ing and pro­cure­ment

The two words are often used inter­change­ably, but pur­chas­ing usu­ally means the buy­ing trans­ac­tion itself, while pro­cure­ment is broader: need iden­ti­fi­ca­tion, sup­plier search, nego­ti­a­tion, pur­chas­ing, fol­low-up, receipt and pay­ment coor­di­na­tion. Pur­chas­ing is one major part of pro­cure­ment.

Exam-ready sum­mary

Pur­chase man­age­ment is the process of obtain­ing the right mate­ri­als, of the right qual­ity, in the right quan­tity, at the right time, from the right source and at the right price. It ensures smooth pro­duc­tion, cost con­trol, timely deliv­ery and good sup­plier coor­di­na­tion. Its func­tions include iden­ti­fy­ing needs, select­ing sup­pli­ers, obtain­ing quo­ta­tions, nego­ti­at­ing, issu­ing pur­chase orders, fol­low­ing up, receiv­ing and inspect­ing mate­ri­als, and keep­ing records. Com­mon meth­ods are open ten­der, lim­ited ten­der, sin­gle and mul­ti­ple sourc­ing, sched­uled buy­ing, spec­u­la­tive buy­ing and just-in-time pur­chas­ing. Deci­sions should be based on total cost of acqui­si­tion rather than quoted price.

Key terms

Pur­chase req­ui­si­tion

An inter­nal request from a depart­ment ask­ing the pur­chase depart­ment to buy a stated item and quan­tity.

Pur­chase order

The for­mal order sent to a sup­plier stat­ing item, quan­tity, price, deliv­ery date and place.

Quo­ta­tion

A sup­pli­er's offer giv­ing price, deliv­ery time and pay­ment terms.

Lead time

The time between plac­ing an order and receiv­ing the mate­r­ial.

Landed cost

The full cost of get­ting mate­r­ial into use: price plus freight, duties, han­dling and the cost of rejects.

Eco­nomic order quan­tity

The order size that min­imises total annual order­ing and hold­ing cost.

Reorder level

The stock level at which a new order should be placed.

Expe­dit­ing

Chas­ing a sup­plier to speed up an order that is late or urgent.

Three-way match­ing

Check­ing the pur­chase order, goods received note and invoice agree before pay­ment.

Com­mon ques­tions

What are the objec­tives of pur­chase man­age­ment?

To ensure unin­ter­rupted sup­ply of mate­ri­als of suit­able qual­ity at the low­est total cost, keep inven­tory invest­ment low, develop reli­able sup­pli­ers, stan­dard­ise items where pos­si­ble and main­tain trans­par­ent records.

Why is the low­est quo­ta­tion not always accepted?

Because freight, rejec­tions, delays and poor ser­vice add cost. In the worked exam­ple the ₹30 quo­ta­tion led to a landed cost of ₹34,000, while the ₹32 quo­ta­tion cost only ₹32,400.

What is the dif­fer­ence between cen­tralised and decen­tralised pur­chas­ing?

In cen­tralised pur­chas­ing one depart­ment buys for the whole organ­i­sa­tion, gain­ing con­trol and bulk dis­counts; in decen­tralised pur­chas­ing each unit buys for itself, gain­ing speed and flex­i­bil­ity at the cost of con­trol and bar­gain­ing power.

What is the dif­fer­ence between sched­uled buy­ing and spec­u­la­tive buy­ing?

Sched­uled buy­ing fixes one con­tract with deliv­er­ies spread over time to reduce stor­age. Spec­u­la­tive buy­ing pur­chases more than cur­rent need because prices are expected to rise, which risks losses if prices fall.

What is the dif­fer­ence between a pur­chase req­ui­si­tion and a pur­chase order?

A req­ui­si­tion is an inter­nal request to the pur­chase depart­ment; a pur­chase order is the exter­nal, legally bind­ing doc­u­ment sent to the sup­plier after the source has been cho­sen.

How does lead time affect pur­chas­ing?

The longer the lead time, the more stock is needed to cover usage while an order is on its way, so the reorder level rises. Uncer­tain lead times also call for extra safety stock.

Ref­er­ences

1. Chary, S. N. Pro­duc­tion and Oper­a­tions Man­age­ment. McGraw-Hill Edu­ca­tion (India).
2. Steven­son, W. J. Oper­a­tions Man­age­ment. McGraw-Hill Edu­ca­tion.
3. Heizer, J., Ren­der, B. and Mun­son, C. Oper­a­tions Man­age­ment: Sus­tain­abil­ity and Sup­ply Chain Man­age­ment. Pear­son.
4. Bedi, K. Pro­duc­tion and Oper­a­tions Man­age­ment. Oxford Uni­ver­sity Press.
5. Har­ris, F. W. (1913) "How Many Parts to Make at Once". Fac­tory, The Mag­a­zine of Man­age­ment, 10(2), 135–136.

Related read­ing

• Sup­ply Chain Man­age­ment in Oper­a­tions Man­age­ment
• Ven­dor Selec­tion and Ven­dor Rat­ing
• Stores Man­age­ment in Oper­a­tions Man­age­ment