PURCHASING AND SUPPLY CHAIN MANAGEMENT

DEFINITIONS AND CLARIFICATION

PURCHASING

Purchasing is the act of buying the goods and services that a company needs to operate and/or manufacture products.

Many people are ignorant of what purchasing is all about. “Purchasing” is the term used in industries, commerce, public corporations to denote the act of and the financial responsibility for procuring material, supplies and services. It simply describes the process of buying. However in a broader sense, the term involves determining the needs, selecting the supplier, arriving at a proper price, terms and conditions, issuing the contract or order, and following up to ensure proper delivery. It focus is to purchase or obtain materials in the right quantity, in the right quality, at the right price, at the right time, and from the right supplier and delivering to the right place.

SUPPLY CHAIN MANAGEMENT

Supply chain management (SCM) is a process used by company’s to ensure that their supply chain is efficient and cost-effective. A supply chain is the collection of steps that a company takes to transform raw components into the final product. Typically, supply chain management is comprised of five stages: plan, develop, make, deliver, and return.

The first stage in supply chain management is known as Plan. A plan or strategy must be developed to address how a given good or service will meet the needs of the customers. A significant portion of the strategy should focus on planning a profitable supply chain.

Develop is the next stage in supply chain management. It involves building a strong relationship with suppliers of the raw materials needed in making the product the company delivers. This phase involves not only identifying reliable suppliers but also planning methods for shipping, delivery, and payment.

At the third stage, Make, the product is manufactured, tested, packaged, and scheduled for delivery. Then, at the logistics phase, customer orders are received and delivery of the goods is planned. This fourth stage of supply chain management stage is aptly named Deliver. The final stage of supply chain management is called Return. As the name suggests, during this stage, customers may return defective products. The company will also address customer questions in this stage.

STRATEGIC SUPPLY CHAIN MANAGEMENT

Development and Evolution of Purchasing and Supply functions:

Purchasing and procurement is used to denote the function of and the responsibility for procuring materials, supplies, and services. Recently, the term “supply chain management” has increasingly come to describe this process as it pertains to a professional capacity. Employees who serve in this function are known as buyers, purchasing agents, or supply managers. Depending on the size of the organization, buyers may further be ranked as senior buyers or junior buyers.

HISTORY

Prior to 1900, there were few separate and distinct purchasing departments in U.S. business. Most pre-twentieth-century purchasing departments existed in the railroad industry. The first book specifically addressing institutionalized purchasing within this industry was The Handling of Railway Supplies—Their Purchase and Disposition, written by Marshall M. Kirkman in 1887.

Early in the twentieth century, several books on purchasing were published, while discussion of purchasing practices and concerns were tailored to specific industries in technical trade publications. The year 1915 saw the founding of The National Association of Purchasing Agents. This organization eventually became known as the National Association of Purchasing Management (NAPM) and is still active today under the name The Institute for Supply Management (ISM).

Harvard University offered a course in purchasing as early as 1917. Purchasing as an academic discipline was furthered with the printing of the first college textbook on the subject, authored by Howard T. Lewis of Harvard, in 1933.

Early buyers were responsible for ensuring a reasonable purchase price and maintaining operations (avoiding shutdowns due to stock outs). Both World Wars brought more attention to the profession due to the shortage of materials and the alterations in the market. Still, up until the 1960s, purchasing agents were basically order-placing clerical personnel serving in a staff-support position.

In the late 1960s and early 1970s, purchasing personnel became more integrated with a materials system. As materials became a part of strategic planning, the importance of the purchasing department increased.

In the 1970s the oil embargo and the shortage of almost all basic raw materials brought much of business world’s focus to the purchasing arena. The advent of just-in-time purchasing techniques in the 1980s, with its emphasis on inventory control and supplier quality, quantity, timing, and dependability, made purchasing a cornerstone of competitive strategy.

By the 1990s the term “supply chain management” had replaced the terms “purchasing,” “transportation,” and “operations,” and purchasing had assumed a position in organizational development and management. In other words, purchasing had become responsible for acquiring the right materials, services, and technology from the right source, at the right time, in the right quantity.

Only in small firms is purchasing still viewed as a clerical position. When one notes that, on average, purchasing accounts for over half of most organizations’ total monetary expenditures; it is no wonder that purchasing is marked as an increasingly pivotal position.

The Role, Objectives and Contribution of Supply Chain Strategies to Corporate and Strategic Planning Process

There are two basic types of purchasing: purchasing for resale and purchasing for consumption or transformation. The former is generally associated with retailers and wholesalers. The latter is defined as industrial purchasing.

Some experts relate that the purchasing function is responsible for determining the organization’s requirements, selecting an optimal source of supply, ensuring a fair and reasonable price (for both the purchasing organization and the supplier), and establishing and maintaining mutually beneficial relationships with the most desirable suppliers. In other words, purchasing departments determine what to buy, where to buy it, how much to pay, and ensure its availability by managing the contract and maintaining strong relationships with suppliers.

In more specific terms, today’s purchasing departments are responsible for:

• coordinating purchase needs with user departments

• identifying potential suppliers

• conducting market studies for material purchases

• proposal analysis

• supplier selection

• issuing purchase orders

• meeting with sales representatives

• negotiating

• contract administration

• resolving purchasing-related problems

• maintenance of purchasing records

These functions obviously entail no insignificant amount of responsibility.

As the role of purchasing grows in importance, purchasing departments are being charged with even more responsibilities. Newer responsibilities for purchasing personnel, in addition to all purchasing functions, include participation in the development of material and service requirements and related specifications, conducting material and value-analysis studies, inbound transportation, and even management of recovery activities such as surplus and scrap salvage, as well as its implications for environmental management.

In the 1970s and 1980s purchasing fell under the rubric of “materials management.” Many corporations and individual facilities employed executives who held the title “materials manager,” responsible for purchasing and supply management, inventory management, receiving, stores, warehousing, materials handling, production planning, scheduling and control, and traffic/transportation. Today, the term materials management has expanded to include all activities from raw material procurement to final delivery to the customer, to management of returns; hence, the newer title supply chain management.

As purchasing personnel became even more central to the firm’s operations they became known as “supply managers.” As supply managers, they are active in the strategic-planning process, including such activities as securing partnering arrangements and strategic alliances with suppliers; identification of threats and opportunities in the supply environment; strategic, long-term acquisition plans; and monitoring continuous improvement in the supply chain.

A study found that strategic purchasing enables firms to foster close working relationships with a limited number of suppliers, promotes open communication among supply chain partners, and develops a long-term strategic relationship orientation for achievement of mutual goals. This implies that strategic purchasing plays a synergistic role in fostering value-enhancing relationships and knowledge exchange between the firm and its suppliers, thereby creating value. In addition, supply managers are heavily involved in cross-functional teams charged with determining supplier qualification and selection, as well ensuring early supplier involvement in product design and specification development.

A comprehensive list of objectives for purchasing and supply management personnel would include:

• to support the firm’s operations with an uninterrupted flow of materials and services:

• to buy competitively and wisely (achieve the best combination of price, quality and service);

• to minimize inventory investment and loss;

• to develop reliable and effective supply sources;

• to develop and maintain healthy relations with active suppliers and the supplier community;

• to achieve maximum integration with other departments, while achieving and maintaining effective working relationships with them;

• to take advantage of standardization and simplification;

• to keep up with market trends;

• to train, develop and motivate professionally competent personnel;

• to avoid duplication, waste, and obsolescence;

• to analyze and report on long-range availability and costs of major purchased items;

• to continually search for new and alternative ideas, products, and materials to improve efficiency and profitability; and

• to administer the purchasing and supply management function proactively, ethically, and efficiently.

Strategic Supply Chain Framework-(operation of supply chain Strategies through all functions of business)

The Supply Chain Council (SCC) has established what it calls the SCOR Project Roadmap, which is a kind of methodology. This methodology suggests an order in which specific SCOR activities could be accomplished, for which Process Pad is a key tool.

Phases in the SCOR Methodology

1. Review Corporate Strategy.

This isn’t so much a project phase, as a decision to consider whether an existing supply chain can be improved. Once this decision is taken, a team is set up, trained in the SCOR methodology if necessary, and set to work.

2. Define the Supply Chain Process.

SCOR provides a common vocabulary which is totally consistent with the use of ProcessPad for defining the major processes that make up supply chains. The first phase the team undertakes is the actual analysis of the existing process. This effort includes decisions about the number and scope of the supply chain processes to be examined.

3. Determine the Performance of the Existing Supply Chain.

Once you have captured the existing supply chain process in ProcessPad, You can use historic data to define how the existing supply chain is performing. In addition, you can compare the performance of your supply chain with benchmarks to determine how your process stacks up against similar processes in similar industries.

4. Establish Your Supply Chain Strategy, Goals and Priorities.

Once you have hard data on the performance of your existing supply chain, and benchmark data, you are in a position to consider if your supply chain strategy is reasonable. You are also in a position to identify how it might be improved, or consider alternative targets for improvement and determine how they might improve the company’s performance. Similarly, you can identify which changes would yield the highest return and prioritize any improvement efforts in ProcessPad.

5. Redesign Your Supply Chain As Needed.

Enable the Redesign and Implement. Once you have used ProcessPad to complete your SCOR design, you can implement the redesign using BPM and human performance improvement techniques. Then you may manage the new supply chain and gather data to determine if you are, in fact, meeting your new targets.

Configuration and co-ordination of the Supply Chain in market.

A supply chain is a network of retailers, distributors, transporters, storage facilities, and suppliers that participate in the production, delivery, and sale of a product to the consumer. The supply chain is typically made up of multiple companies who coordinate activities to set themselves apart from the competition.

A supply chain has three key parts:

Supply focuses on the raw materials supplied to manufacturing, including how, when, and from what location.

Manufacturing focuses on converting these raw materials into finished products.

Distribution focuses on ensuring these products reach the consumers through an organized network of distributors, warehouses, and retailers. While often applied to manufacturing and consumer products, a supply chain can also be used to show how several processes supply to one another. The supply chain definition in this sense can apply to Internet technology, finance, and many other industries.

A supply chain strategy defines how the supply chain should operate in order to compete in the market. The strategy evaluates the benefits and costs relating to the operation. While a business strategy focuses on the overall direction a company wishes to pursue, supply chain strategy focuses on the actual operations of the organization and the supply chain that will be used to meet a specific goal.

Another term associated with a supply chain is supply chain management (SCM), which is the oversight of materials, information, and finances as they are distributed from supplier to consumer. The supply chain also includes all the necessary stops between the supplier and the consumer. Supply chain management involves coordinating this flow of materials within a company and to the end consumer.

Supply chain management can be divided into three main flows:

The Product flow includes moving goods from supplier to consumer, as well as dealing with customer service needs.

The Information flow includes order information and delivery status.

The Financial flow includes payment schedules, credit terms, and additional arrangements.

The Storage flow includes a warehouse where goods are stored, and where they may be catalogued, shipped, or received, depending upon the type of products. The principal operation of the place is receiving, getting in new products, and shipping out products already stored. Another important part of maintaining a good warehouse is keeping inventory of what products are presently in the warehouse, what has been shipped and what has been received. This process is again largely automated.

The control and creation of added value

Value analysis is a systematic effort to improve upon cost and/or performance of products (services), either purchased or produced. It examines the materials, processes, information systems, and the flow of materials involved. Value Analysis efforts began in earnest during WW II by General Electric, concerned with the difficulties in obtaining critical materials needed to produce war material, GE assigned an engineer, Lawrence D Miles to the Purchasing department. His mission was to find adequate material and component substitutes for critical materials to manufacture needed war equipment. In his search, Miles found that each material has unique properties that could enhance the product if the design was modified to take advantage of those properties.

Miles discovered that he could meet or improve product performance and reduce its production cost by understanding and addressing the intended function of the product. His method was – Blast (dissecting products to discern key competitive advantages), Create (detailed analysis of the disassembled products, identifying those functions of concern and soliciting ideas for improving), Refine (selecting the most value adding, cost-effective ideas and preparing a business case for the implementation of the proposals).

Implemented diligently, value analysis can result in -

reduced material use and cost

reduced distribution costs

reduced waste

improved profit margins

increased customer satisfaction

increased employee morale

The importance of purchasing in any firm is largely determined by four factors: availability of materials, absolute Naira volume of purchases, percent of product cost represented by materials, and the types of materials purchased. Purchasing must concern itself with whether or not the materials used by the firm are readily available in a competitive market or whether some are bought in volatile markets that are subject to shortages and price instability. If the latter condition prevails, creative analysis by top-level purchasing professionals is required.

If a firm spends a large percentage of its available capital on materials, the sheer magnitude of expense means that efficient purchasing can produce a significant savings. Even small unit savings add up quickly when purchased in large volumes.

When a firm’s materials costs are 40 percent or more of its product cost (or its total operating budget), small reductions in material costs can increase profit margins significantly. In this situation, efficient purchasing and purchasing management again can make or break a business.

Perhaps the most important of the four factors is the amount of control purchasing and supply personnel actually have over materials availability, quality, costs, and services.

Large companies tend to use a wide range of materials, yielding a greater chance that price and service arrangements can be influenced significantly by creative purchasing performance.

The role of Strategic Supply Chain in the design of products and services

Market globalization and the rapid advancement of technologies require that companies differentiate themselves with innovative products and services to create competitive advantage. Increasingly, manufacturers face shortened product life cycles and increased pressure to shorten their time to market. These factors, in conjunction with the reality that companies are increasing their reliance on outsourcing necessitate that organizations involve suppliers in the new product.

Effective integration of suppliers into the product value / supply chain will be a key factor for manufacturers in achieving the improvements necessary to remain competitive. Moreover, because purchasing specialists are usually a key liaison between the supplier and the buyer, an investigation of their role in the new product development process is worthwhile.

In progressive firms, purchasing has a hand in new product development. As a part of a product development team, purchasing representatives have the opportunity to help determine the optimal materials to be used in a new product, propose alternative or substitute materials, and assist in making the final decision based on cost and material availability. Purchasing representatives may also participate in a make-or-buy analysis at this point. The design stage is the point at which the vast majority of the cost of making an item can be reduced or controlled.

Whether or not purchasing had an impact on a product’s design, the purchasing agent’s input may certainly be needed when defining the materials-purchase specifications.

Product Design and Process Models

This refers to all efforts focused on creating a new product, process or service. The five generic phases of product development process are as follows:

• Idea generation: voice of the customer

• Business / technical assessment (preliminary)

• Product / process service concept development

• Product / process service engineering and design

• Prototype build, test and pilot / ramp-up for operations

Concept and design “lock in” as much as 80 percent of the total cost of a new product. For this reason, it is crucial for firms to bring in as much product, process and technical expertise as possible early in the product development process. The supplier often possesses much of this critical expertise. Purchasing specialists are frequently tasked with facilitating the transfer of supplier expertise.

So how can organizations get purchasing more involved? Researchers have identified two factors that appear to aid the involvement of purchasing in the product development process: personnel and organization.

The Personnel Factor:

The competencies and skills of purchasers are important determinants of successful PD process contribution. Organizations should have personnel with the right education, skills, and experience. Researchers found that important competencies and skills include (4):

• Type of previous experience

• Type and level of training/education

• Degree of technical expertise

• Degree of proactiveness

• Capabilities as perceived by others (credibility)

The process of developing new products varies between companies, and even between products within the same company. Regardless of organizational differences, a good new product is the result a methodical development effort with well defined product specifications and project goals. A development project for a market-pull product is generally organized along the lines shown in Figure 1.

Figure 1

Concept Development

Identify

Customer

Needs

Establish

Target

Sepcifications

Generate

Product

Concepts

Select a

Product

Concept

Refine

Specifications

Analyze

Competitive

Products

Perform

Economic

Analysis

Plan

Remaining

Development

Project

Concept Development

Environmental Procurement

At this time, there is little consensus about what “green” means, so there is no standard definition. Identification of “environmentally preferable” materials requires analysis of the comparative environmental advantages and disadvantages of products with many attributes.

According to the Federal Environmental Protection Agency (FEPA): “Environmentally preferable” mean products or services that have a lesser or reduced effect on human health and the environment when compared with competing products or services that serve the same purpose. This comparison may consider raw materials acquisition, product, manufacturing, packaging, distribution, reuse, operation, maintenance, or disposal of products and services.

It’s about taking environmental and social factors into account in purchasing decisions with the aim of minimizing the environmental and social impacts of the purchases you make.

There are benefits to both the firm and the environment – these include:

Cost savings

Enhancing corporate image

Ensuring compliance with legislation

Conserves natural resources

Reduces pollution

Reduces the amount of waste sent to landfill

Simple steps to environmental purchasing:

When making purchasing decisions consider whether you can purchase a product that:

Is made partly or wholly from recycled material

Can be recycled once it has been finished with

Is energy efficient – purchase electrical appliances that have an A or B energy rating

Do not include excess packaging

Are sourced from local suppliers

Environmental Labels

Environmental labels can help consumer’s spot products that are less damaging to the environment. Many products contain such symbols, but there is no standardized symbol and it is not always obvious what these labels mean. The most commonly used symbol is the mobius loop, but this can represent recycled content and/or that the product is recyclable.

If a product has been awarded the European ecolabel it means that it has been independently assessed and found to meet strict environmental criteria.

Product life circle

One of the most ubiquitous marketing concepts is that of the product life-cycle (PLC), the realization that products have life-cycles just like human beings. A child is born and grows, passes through stages of childhood, adolescence, maturity and old age, then finally death. Likewise, a product is invented, developed, introduced into the market, goes through stages of maturity, then dies.

The stages of the PLC can be expressed as follows:-

Introduction: In the first stage, the product is introduced onto the market. Sales are initially very low and the product is making a loss due to the amount of money spent on research, development, advertising, promotion, etc.

Growth: During the growth stage, possibly as a result of the lack of competition, sales increases are rapid and profitability high.

Maturity: Eventually, sales begin to rise at a slower pace and profitability is less than in the previous stage. There can be many reasons for this, but often it is because of increased competition and the need for larger marketing budgets in order to retain market share.

Decline: Finally, we see a period of product decline and saturation. More competitors have probably entered the market, supply exceeds demand and prices fall (along with profitability!).

There is now a much greater recognition that products and services have life-cycles. This is largely due to innovation, new technologies and the speed/impact of communications.

SUPPLY ORGANIZATIONS AND STRUCRURES

Definition and assessment of organizational structure

Organizational structure – is the formal system of task and reporting relationships that controls, coordinates, and motivates employees so that they cooperate to achieve an organization’s goals.

Your task as a manager is to create an organizational structure and culture that:

1. Encourages employees to work hard and to develop supportive work attitudes

2. Allows people and groups to cooperate and work together effectively.

Structure and culture affect:

1. Behavior

2. Motivation

3. Performance

4. Teamwork and cooperation

5. Inter-group and Interdepartmental relationships

Once an organization decides how it wants its members to behave, what attitudes it wants to encourage, and what it wants its members to accomplish, it can then design its structure and encourage the development of the cultural values and norm to obtain these desired attitudes, behaviors, and goals.

Grouping Organizational Activities

Differentiation – is the grouping of people and tasks into functions and divisions to produce goods and services.’

Function – is a set of people who work together and perform the same types of tasks or hold similar positions in an organization.

As organizations grow and their division of labor into various functions increases, they typically differentiate further into divisions.

In developing an organizational structure, managers must decide how to differentiate and group an organization’s activities by function and division in a way that achieves organizational goals effectively.’

The result of this process can be most easily seen in an organizational chart that shows the relationship between an organization’s functions and divisions.

The Purchasing department

The actual purchase of all materials is usually made by the purchasing department headed by a general purchasing agent. In some small and medium size companies, however, department heads or supervisors have authority to purchase materials as the need arises. In any case, systematic procedures should be in writing in order to fix responsibility and to provide full information regarding the ultimate use of materials ordered and received. The purchasing department should receive purchase requisitions for materials, supplies, and equipment; keep informed concerning sources of supply, prices, and shipping and delivery schedules; prepare and place purchase orders; and arranging for adequate and systematic reports between the purchasing, the receiving, and the accounting departments. An additional function of the purchasing department in many enterprises is to verify and approve for payments all invoices received in response to purchase orders placed by the department. This procedure has the advantage of centralizing the verification and approval of invoices in the department that originates the purchases and that has complete information concerning items and quantities ordered, prices, terms, shipping instructions, and other conditions and details of the purchases. However, invoice verification and approval by the purchasing department may violate sound procedures and principles of internal control, particularly if the same individual prepares an order and later approves the invoice. Consequently, invoice audit and approval in many instances have been made a function of the accounting department, which receives a copy of the purchase order. The purchase order carries all necessary information regarding prices, discount agreement, and delivery stipulations, as well as the number of the account to which the order is to be charged. Furthermore, the centralization of invoice approval in the accounting department helps avoid delaying payments beyond the discount period.

Purchasing and other functions in the firm

Purchase department received requisition and buy material on behalf of the organization. They process the requisition and make necessary contacts with suppliers for contract negotiation, inspections of materials for specification and receipt of material falls within their purview.

The finance department takes the responsibility for processing bills and act promptly by settling the bills as directed by the purchase department. Finance must checks the purchasing department punitive purchase behavior in order to ensure prudent buying. They make payment as stipulated in the contract and to take advantages of prompt payment rebates.

The production department is responsible for production of goods within the firm. Production does not exist in a vacuum, it must interact with the purchasing department for the materials which are needed. Purchasing must ensure that they liaise with production in term of material specification requirements and quality.

The role of marketing in stock control can not overstate. Marketing management are responsible for finding out what the consumers want in terms of varieties, functionalities and quality. They transmit this information to production who informs purchasing as the materials required. Marketing must ensure that the final product is sold at a profit so that the firm will continue to be in business.

The purchasing department must communicate to HR department in matters connected with their professional expertise, performance evaluations, rewards etc. This is to ensure that the people who are responsible for spending about 80% of organizations money in terms of material purchases have the required knowledge and experience to carry out the task.

These other department makes inputs in one way or the order in deciding the level and quality of material held in stock.

Centralized Organization

Centralized purchase exists and the responsibility for the purchasing function is assigned to a single group and its manager. This person is accountable to management for proper performance of the purchasing function regardless of where the actual buying takes place. Centralized purchasing can be entirely satisfactory in a multi-plant organization if the plants are manufacturing similar products from similar materials.

Decentralized Organization

In a single plant company decentralization of purchasing exists when operations, marketing, finance, engineering do their own buying. This tends to produce duplication of effort, inefficiency and waste.

Departmentalized Organization

Neither completely rigid centralized nor loose decentralized of purchasing seems to meet the needs of all firms. A large company may have a Vice president, a director or a Manager of purchasing and a number of division or plant purchasing managers. Responsibilities at the different levels vary, but a compromise between centralization and decentralization is usually employed in an attempt to gain advantages of both and to minimize their disadvantages.

Strategic Planning

In an environment characterized by many unknowns, purchasing professionals must assist general management by providing purchasing expertise for strategic decisions. Purchasing can assist in calculating the probable impact of outside factors on supply, quality and price. Key areas of strategic forces include economic concerns, regulatory issues, environmental and ecological influences, Changes in the organizations, financial factors, technology assessments and general changes in the nature and structure of competition.

SPECIFYING AND MANAGING QUALITY

What is quality?

If a product fulfils the customer’s expectations, the customer will be pleased and

consider that the quality is of acceptable or even high quality. If his or her expectations are not fulfilled, the customer will consider that the product is of low quality. This means that the quality of a product may be defined as “its ability to fulfill the customer’s needs and expectations”.

Among popular alternative concepts of quality are;

 Quality if fitness for use.

 Quality is doing it right the first time-and every time.

 Quality is the customer’s perception.

 Quality provides a product or service at a price the customer can afford.

 You pay for what you get (quality is the most expensive product or service).

Quality needs to be defined firstly in terms of parameters or characteristics, which vary from product to product. For example, for a mechanical or electronic product these are performance, reliability, safety and appearance. For pharmaceutical products, parameters such as physical and chemical characteristics, medicinal effect, toxicity, taste and shelf life may be important. For a food product they will include taste, nutritional properties, texture, and shelf life and so on.

Preparing product design

The specifications and drawings produced by the designer should show the quality standard demanded by the customer or marketplace in clear and precise terms. Every

dimension should have realistic tolerances and other performance requirements should have precise limits of acceptability so that the production team can manufacture the product strictly according to specification and drawings. To achieve the above, those responsible for design, production and quality should be consulted from the sales negotiation stage onwards. The overall design of any product is made up of many individual characteristics. For example these may be:

Dimensions, such as length, diameter, thickness or area;

Physical properties, such as weight, volume or strength;

Electrical properties, such as resistance, voltage or current;

Appearance, such as finish, color or texture;

Functional qualities, such as output or kilometer per liter;

Effects on service, such as taste, feel or noise level.

Manufacturing drawings and specifications are prepared by the designers and these should indicate to the production team precisely what quality is required and what raw materials should be used.

STANDARDIZATION AND VARIETY REDUCTION

Standardization supports the fundamental precepts of build-to-order and mass customization: All parts must be available at all points of use, not just “somewhere in the plant,” which eliminates the setup to find, load, or kit parts. As a stand-alone program, standardization can reduce cost and improve flexibility.

Standardization makes it easier for parts to be pulled into assembly (instead of ordering and waiting) by reducing the number of part types to the point where the remaining few standard parts can receive the focus to arrange demand-pull just-in-time deliveries. Fewer types of parts ordered in larger quantities reduce part cost and material overhead cost.

. Reducing active part numbers, say from 20,000 to 15,000 will, in fact, lower material overhead somewhat, but may not reach the threshold (eliminating part related setup) that would enable the plant to build products flexibly without delays and setups to get the parts, kit the parts, or change the part bins.

STANDARDIZATION BENEFITS

Cost Reduction

• Purchasing costs reduced through purchasing leverage

• Inventory cost reduction

• Floor space reduction

• BOM/MRP/ordering expense avoided when common parts are simply drawn as needed from spontaneous resupply

• Overhead cost reduction

Quality:

• Product quality

• Continuous Improvement

• Vendor reduction

Flexibility:

• Eliminating setup

• Inventory reduction

• Simplify supply chain management

• Internal material logistics

• Breadtruck deliveries

• Flexible manufacturing

Responsiveness:

• Build-to-Order

• Parts availability

• Quicker deliveries from vendors

VARIETY REDUCTION

Definition:

The deliberate elimination of the number of variants in a PRODUCT range or line in order to improve efficiency and secure scale economies.

VALUE ANALYSIS AND VALUE ENGINEERING

Value Engineering

Value analysis is a systematic effort to improve upon cost and/or performance of products (services), either purchased or produced. It examines the materials, processes, information systems, and the flow of materials involved. Value Analysis efforts began in earnest during WW II. GE, concerned with the difficulties in obtaining critical listed materials to produce war material, assigned an engineer, Lawrence D Miles to the Purchasing department. His mission was to find adequate material and component substitutes for critical listed material to manufacture needed war equipment. In his search, Miles found that each material has unique properties that could enhance the product if the design was modified to take advantage of those properties.

Miles discovered that he could meet or improve product performance and reduce its production cost by understanding and addressing the intended function of the product. His method was – Blast (dissecting products to discern key competitive advantages), Create (detailed analysis of the disassembled products, identifying those functions of concern and soliciting ideas for improving), Refine (selecting the most value adding, cost-effective ideas and preparing a business case for the implementation of the proposals) – the VA Tear Down Analysis. The key element in Miles’ work is that he separated Function (what it must do) from the characteristics of the design (how it does it). Value = Function/Cost (esteem value – want, exchange value – worth, utility value – need).

Why is it important?

Implemented diligently, value analysis can result in -

reduced material use and cost

reduced distribution costs

reduced waste

improved profit margins

increased customer satisfaction

increased employee morale

Value Engineering

Value engineering (VE) is a systematic method to improve the “value” of goods or products and services by using an examination of function. Value, as defined, is the ratio of function to cost. Value can therefore be increased by either improving the function or reducing the cost. It is a primary tenet of value engineering that basic functions be preserved and not be reduced as a consequence of pursuing value improvements.

VE follows a structured thought process that is based exclusively on “function”, i.e. what something “does” not what it is. For example a screw driver that is being used to stir a can of paint has a “function” of mixing the contents of a paint can and not the original connotation of securing a screw into a screw-hole. Value engineering uses rational logic (a unique “how” – “why” questioning technique) and the analysis of function to identify relationships that increase value. It is considered a quantitative method similar to the scientific method, which focuses on hypothesis-conclusion approaches to test relationships, and operations research, which uses model building to identify predictive relationships.

Value engineering is often done by systematically following a multi-stage job plan. plan.” One modern version has the following eight steps:

1. Preparation

2. Information

3. Analysis

4. Creation

5. Evaluation

6. Development

7. Presentation

8. Follow-up

THE TOOLS OF QUALITY MANAGEMENT

Statistical process control

Statistical Process Control (SPC) is an effective method of monitoring a process through the use of control charts. Control charts enable the use of objective criteria for distinguishing background variation from events of significance based on statistical techniques. Much of its power lies in the ability to monitor both process center and its variation about that center. By collecting data from samples at various points within the process, variations in the process that may affect the quality of the end product or service can be detected and corrected, thus reducing waste as well as the likelihood that problems will be passed on to the customer. With its emphasis on early detection and prevention of problems, SPC has a distinct advantage over quality methods, such as inspection, that apply resources to detecting and correcting problems in the end product or service.

Histograms

A histogram is a specialized type of bar chart. Individual data points are grouped together in classes, so that you can get an idea of how frequently data in each class occur in the data set. High bars indicate more points in a class, and low bars indicate fewer points.

The strength of a histogram is that it provides an easy-to-read picture of the location and variation in a data set.

Pareto Charts

Vilfredo Pareto, a turn-of-the-century Italian economist, studied the distributions of wealth in different countries, concluding that a fairly consistent minority – about 20% – of people controlled the large majority – about 80% – of a society’s wealth. This same distribution has been observed in other areas and has been termed the Pareto effect.

The Pareto effect even operates in quality improvement: 80% of problems usually stem from 20% of the causes. Pareto charts are used to display the Pareto principle in action, arranging data so that the few vital factors that are causing most of the problems reveal themselves. Concentrating improvement efforts on these few will have a greater impact and be more cost-effective than undirected efforts.

Flowcharting

Flowcharts are maps or graphical representations of a process. Steps in a process are shown with symbolic shapes, and the flow of the process is indicated with arrows connecting the symbols. In quality improvement work, flowcharts are particularly useful for displaying how a process currently functions or could ideally function. Flowcharts can help you see whether the steps of a process are logical, uncover problems or miscommunications, define the boundaries of a process, and develop a common base of knowledge about a process. Flowcharting a process often brings to light redundancies, delays, dead ends, and indirect paths that would otherwise remain unnoticed or ignored. But flowcharts don’t work if they aren’t accurate, if team members are afraid to describe what actually happens, or if the team is too far removed from the actual workings of the process.

Fishbone diagrams

Ishikawa diagrams (also called fishbone diagrams or cause-and-effect diagrams) are diagrams that show the causes of a certain event. Common uses of the Ishikawa diagram are product design and quality defect prevention, to identify potential factors causing an overall effect.

Causes in the diagram are often categorized, such as to the 4 M’s, described below. Cause-and-effect diagrams can reveal key relationships among various variables, and the possible causes provide additional insight into process behavior.

Causes can be derived from brainstorming sessions, successively sorted through affinity-grouping to collect similar ideas together.

The original 4 M’s

• Machine (Equipment)

• Method (Process/Inspection)

• Material (Raw,Consumables etc.)

• Man

Off-line quality control

Taguchi methods

Taguchi methods are statistical methods developed by Genichi Taguchi to improve the quality of manufactured goods.

Taguchi realized that the best opportunity to eliminate variation is during the design of a product and its manufacturing process. Consequently, he developed a strategy for quality engineering that can be used in both contexts. The process has three stages:

1. System design;

2. Parameter design; and

3. Tolerance design.

FMEA

A failure modes and effects analysis (FMEA) is a procedure in operations management for analysis of potential failure modes within a system for classification by severity or determination of the effect of failures on the system. It is widely used in manufacturing industries in various phases of the product life cycle and is now increasingly finding use in the service industry. Failure modes are any errors or defects in a process, design, or item, especially those that affect the customer, and can be potential or actual. Effects analysis refers to studying the consequences of those failures.

Basic terms

Failure mode: “The manner by which a failure is observed; it generally describes the way the failure occurs.”

Failure effect: Immediate consequences of a failure on operation, function or functionality, or status of some item

Indenture levels: An identifier for item complexity. Complexity increases as levels are closer to one.

Local effect: The Failure effect as it applies to the item under analysis.

Next higher level effect: The Failure effect as it applies at the next higher indenture level.

End effect: The failure effect at the highest indenture level or total system.

Failure cause: Defects in design, process, quality, or part application, which are the underlying cause of the failure or which initiate a process which leads to failure.

Severity: “The consequences of a failure mode. Severity considers the worst potential consequence of a failure, determined by the degree of injury, property damage, or system damage that could ultimately occur.”

Advantages

• Improve the quality, reliability and safety of a product/process

• Improve company image and competitiveness

• Increase user satisfaction

• Reduce system development timing and cost

• Collect information to reduce future failures, capture engineering knowledge

• Reduce the potential for warranty concerns

• Early identification and elimination of potential failure modes

• Emphasis problem prevention

• Minimize late changes and associated cost

• Catalyst for teamwork and idea exchange between functions

• Reduce the possibility of same kind of failure in future

Limitations

Since FMEA is effectively dependent on the members of the committee which examines product failures, it is limited by their experience of previous failures. If a failure mode cannot be identified, then external help is needed from consultants who are aware of the many different types of product failure. FMEA is thus part of a larger system of quality control, where documentation is vital to implementation.

TQM

Total Quality Management is the organization-wide management of quality. Management consists of planning, organizing, directing, control, and assurance. Total quality is called total because it consists of two qualities: quality of return to satisfy the needs of the shareholders, or quality of products.

As defined by the International Organization for Standardization (ISO):

“TQM is a management approach for an organization, centered on quality, based on the participation of all its members and aiming at long-term success through customer satisfaction, and benefits to all members of the organization and to society.” ISO 8402:1994

One major aim is to reduce variation from every process so that greater consistency of effort is obtained.

In Japan, TQM comprises four process steps, namely:

1. Kaizen – Focuses on “Continuous Process Improvement”, to make processes visible, repeatable and measurable.

2. Atarimae Hinshitsu – The idea that “things will work as they are supposed to” (for example, a pen will write).

3. Kansei – Examining the way the user applies the product leads to improvement in the product itself.

4. Miryokuteki Hinshitsu – The idea that “things should have an aesthetic quality” (for example, a pen will write in a way that is pleasing to the writer).

A ‘Total Quality Organization’ generally benefits from having an effective Quality Management System (QMS). A Quality Management System is typically defined as: “A set of co-coordinated activities to direct and control an organization in order to continually improve the effectiveness and efficiency of its performance.” Customer expectations inevitably drive and define ‘performance’ criteria and standards. Therefore Quality Management Systems focus on customer expectations and ongoing review and improvement.

TQM requires that the company maintain this quality standard in all aspects of its business. This requires ensuring that things are done right the first time and that defects and waste are eliminated from operations.

Sourcing and the management and Development of Suppliers

Supplier Selection and Pre-Qualification

Publicising the Contract

In order to ensure that value for money is achieved it is essential that a sufficient number of competent, financially sound suppliers with adequate capacity to undertake the work be identified. Purchasers should bear in mind when considering the method of attracting suppliers that adequate publicity be given in order to satisfy the principle of transparency. No specific level has been set to determine at what level contracts should be advertised. Factors that contracting authorities should take into account include:

• The likely attractiveness of a given contract to potential supplies, at a local or international level. What is considered adequate publicity will depend on the specific nature of the contract and the commodity sought, and may be affected by factors such as the value of the contract or the complexity of the project.

• Where the value of the contract is likely to be below some amount, the purchaser will nonetheless have the option of advertising.

• If a purchase is likely to be above the relevant, publication is mandatory. The Govt. directives allow advertisements for such contracts to appear in media before the notice is despatched to suppliers. Any advertisement should make it clear what the business need is so that suppliers can see what services are required. Suppliers can then assess whether they can do it/want to do it.

Supplier Appraisal/Evaluation

This refers to the process of evaluating and approving potential suppliers by factual and measurable assessment. The purpose of supplier evaluation is to ensure a portfolio of best in class suppliers is available for use. Supplier evaluation is also a process applied to current suppliers in order to measure and monitor their performance for the purposes of reducing costs, mitigating risk and driving continuous improvement

Supplier evaluation is a continual process within purchasing departments and forms part of the pre-qualification step within the purchasing process, although in many organizations it includes the participation and input of other departments and stakeholders.. It often takes the form of either a questionnaire or interview, sometimes even a site visit, and includes appraisals of various aspects of the supplier’s business including capacity, financials, quality assurance, organizational structure and processes and performance. Based on the information obtained via the evaluation, a supplier is scored and either approved or not approved as one from whom to procure materials or services. In many organizations, there is an approved supplier list (ASL) to which a qualified supplier is then added. If rejected the supplier is generally not made available to the assessing company’s procurement team. Once approved, a supplier may be reevaluated on a periodic, often annual, basis. The ongoing process is defined as supplier performance management.

Criteria for Supplier’s Evaluation

This focuses on obtaining and interpreting the following supplier information:

-Organization;

- Core business;

- Capability and reputation;

- Working procedures related to the service

-Requirement;

- Finances;

- Capacity; and

- Track record.

This information enables the contracting organization to determine the overall capability and capacity of the prospective service provider It is crucial to the achievement of best value for money that only competent suppliers are selected.

Obtaining Information

A request for proposal (referred to as RFP) is an invitation for suppliers, often through a bidding process, to submit a proposal on a specific commodity or service. A bidding process is one of the best methods for leveraging a company’s negotiating ability and purchasing power with suppliers.

RFPs often include specifications of the item, project or service for which a proposal is requested. The more detailed the specifications, the better the chances that the proposal provided will be accurate. Generally RFPs are sent to an approved supplier or vendor list.

Request for Quotation (RFQ) is used when discussions with bidders are not required (mainly when the specifications of a product or service are already known) and when price is the main or only factor in selecting the successful bidder. An RFQ may also be used as a step prior to going to a full-blown RFP to determine general price ranges. In this scenario, products, services or suppliers may be selected from the RFQ results to bring in to further research in order to write a more fully fleshed out RFP.

RFP is sometimes used for a request for pricing.

Request for Qualifications (RFQ) is a document often distributed before initiation of the RFP process. It is used to gather vendor information from multiple companies to generate a pool of prospects. This eases the RFP review process by preemptively short-listing candidates which meet the desired qualifications.

Best and Final Offer (BAFO).The bidders return a proposal by a set date and time. Late proposals may or may not be considered, depending on the terms of the initial RFP. The proposals are used to evaluate the suitability as a supplier, vendor, or institutional partner. Discussions may be held on the proposals (often to clarify technical capabilities or to note errors in a proposal). In some instances, all or only selected bidders may be invited to participate in subsequent bids, or may be asked to submit their best technical and financial proposal, commonly referred to as a Best and Final Offer (BAFO).

Selecting quality and capable suppliers

Selecting supplier is not an easy process. Many different formulas and techniques can be used. One effective method assigns suppliers to four basic categories based upon their level of performance in key areas, such as delivery, quality and responsiveness.

Early Supplier Involvement

For many companies, the cost of purchased materials accounts for more than half of their expenses, so it’s a good place to try to reduce costs. As well as increased use of suppliers, the future will also see them being involved earlier in the product development process.

In the past, suppliers weren’t involved early in the process. The activities of the product development process were carried out in series, and suppliers were only involved near the end of the process. A typical product would go through many activities – it might start life in the marketing function, and then go through conceptual design, engineering design and analysis, testing, detailed design, manufacturing engineering, process planning, tooling, production planning, purchasing, machining, assembly, testing, packaging, installation and maintenance.

In some cases, suppliers were only brought into the process to compete against each other on pricing. As a result the company finished up working with a large number of suppliers, and even with different suppliers on similar products. It was impossible to build up the stable, long-term quality-generating relationships that lead to client satisfaction.

To respond to the need to get products to market faster, to reduce the cost of developing products and to make sure the product provides customer satisfaction, the product development process needs to be re-organized.

In team-oriented companies, people from different functions will work together on the upstream activities, effectively taking the major decisions about the entire product development process in the initial design phase. The team will need to know in detail at an early stage about the different parts of the product, and the way the parts fit together. The team will want to make the best possible use of suppliers with the aim of getting a customer-satisfying product to market as quickly as possible. This will probably mean involving the supplier right at the beginning of the process, when the major modules of the product are being defined. The supplier will then be given the job of designing and manufacturing a complete sub-assembly.

In the re-organized process, suppliers will be expected to respond quickly, to be responsible and to be reliable. They will be expected to have excellent skills, knowledge and experience concerning particular parts or activities. The company will want to have long-term relationships with a small group of highly competent, knowledgeable and trusted suppliers.

In companies that don’t have early supplier involvement, improvement initiatives in the Engineering Department will only provide some of the expected improvements in the performance of the product development process and in engineering productivity.

Early Buyers involvement

All brave sellers want a qualified buyer to pay very close to maximum value for their business. In addition to high range value, sellers consistently prefer to deal with a buyer whom they like and can trust with the future of their business and its employees. What attitude attracts and retains a qualified buyer through the closing?

All brave buyers hope to find a bargain, but expect to pay a fair price. In addition to a fair price, buyers always prefer to deal with a willing and cooperative seller, whom they like and can trust. What attitude encourages open dialog and bonding?

Proactive and cooperative sellers set the tone for fair value negotiations. Proactive buyers always respond favorably to a seller’s cooperative tone. When a seller’s cooperation is sincere, a buyer generally tries harder to meet a seller’s needs. In the best transactions a special rapport builds, which results in an extra effort by the seller to help the buyer succeed.

The most successful buyers actively communicate with the seller and follow-up with a fax or letter. Successful buyers have conversations with the seller about post-acquisition issues. Personal involvement is critical. Most sellers want to sell to a buyer who both shares the seller’s vision and will preserve the existing corporate culture. The price paid is very important, but the winning buyers are those who establish rapport, a shared vision, and a personal bonding with the seller.

Remember, intermediaries bring buyers, advice, and assist. Sellers must actively sell their business. The term “Buyer” is reserved for those who have pulled the trigger and closed. Others are just “Prospective Buyers”.

Successful closings, a high commitment for direct personal involvement is required between the seller and the buyer.

Supplier Management Team

Supplier management team is a discipline of working collaboratively with those suppliers that are vital to the success of your organization, to maximize the potential value of those relationships.

Once the sourcing (procurement) team has engaged a supplier there is a real need to maintain a balance of control in the new relationship to ensure the benefits of that deal are delivered. Without proper control it has been suggested that the value of a contract can degrade by up to 30% in the first year (based upon typical industry benchmarks; post contractual opportunities – reference data: Procurement Strategy Council)

This can lead to not only the failure to deliver the projected on-boarding benefit but create frustrating and unsatisfactory relationships which in turn can impact service, cost and the ability to adapt to changing market influences.

There are of course other benefits to creating robust relationships with suppliers from a customer’s perspective especially if a stand alone SMT function exists. Cross category supplier measurement can take place, risk mitigation exercises (both reactive and proactive) can be undertaken and knowledge and innovation can be shared for mutual gain. Equally an SMT function can create a community for the SMTs, (or Account Managers, Supply Chain Consultants, Supplier Performance Managers) in which they can centralize knowledge and deliver revenue generating opportunities for both parties through the exploration of additional, out of current contract business opportunities.

Simultaneous Engineering/Cross-functional teams

SE is a concept that refers to the participation of all the functional areas of the firm in the product design activity.

Benefits:

• Designs that meet the most stringent manufacturing best practices

• Reliable, timely launches

• Achievement of program targets

A Cross-functional team is a group of people with different functional expertise working toward a common goal. It may include people from finance, marketing, operations, and human resources departments. Typically, it includes employees from all levels of an organization. Members may also come from outside an organization (in particular, from suppliers, key customers, or consultants).

Cross-functional teams often function as self-directed teams responding to broad, but not specific directives. Decision-making within a team may depend on consensus, but often is led by a manager/coach/team leader.

Outsourcing

Outsourcing involves the transfer of the management and/or day-to-day execution of an entire business function to an external service provider. The client organization and the supplier enter into a contractual agreement that defines the transferred services. Under the agreement the supplier acquires the means of production in the form of a transfer of people, assets and other resources from the client. The client agrees to procure the services from the supplier for the term of the contract.

Strategic outsourcing is the organizing arrangement that emerges when firms rely on intermediate markets to provide specialized capabilities that supplement existing capabilities deployed along a firm’s value chain. Such an arrangement produces value within firms’ supply chains beyond those benefits achieved through cost economies.

Reasons/ Benefits for outsourcing

Organizations that outsource are seeking to realize benefits or address the following issues.

• Cost savings.

• Focus on Core Business.

• Cost restructuring.

• Improve quality.

• Knowledge. Contract. Operational expertise.

• Access to talent.

• Capacity management. Catalyst for change. Enhance capacity for innovation

• Risk management.

• Venture Capital.

• Tax Benefit.

MATCHING SUPPLY WITH DEMAND

Stock control, otherwise known as inventory control, is used to show how much stock you have at any one time, and how you keep track of it.

It applies to every item you use to produce a product or service, from raw materials to finished goods. It covers stock at every stage of the production process, from purchase and delivery to using and re-ordering the stock.

Efficient stock control allows you to have the right amount of stock in the right place at the right time. It ensures that capital is not tied up unnecessarily, and protects production if problems arise with the supply chain.

How much stock should you keep?

Deciding how much stock to keep depends on the size and nature of your business, and the type of stock involved. If you are short of space you may be able to buy stock in bulk and then pay a fee to your supplier to store it, calling it off as and when needed.

Stock levels depending on type of stock

There are four main types of stock:

Raw materials and components

Work in progress – stocks of unfinished goods

Keeping stocks of unfinished goods can be a useful way to protect production if there are problems down the line with other supplies.

Finished goods ready for sale

Consumables (MRO)

For example, fuel and stationery. How much stock you keep will depend on factors such as:

Stock control and inventory

Stock control methods

There are several methods for controlling stock, all designed to provide an efficient system for deciding what, when and how much to order.

• Minimum stock level – you identify a minimum stock level, and re-order when stock reaches that level. This is known as the Re-order Level.

• Stock review – you have regular reviews of stock. At every review you place an order to return stocks to a predetermined level.

Re-order lead time – allows for the time between placing an order and receiving it.

Economic Order Quantity (EOQ) – a standard formula used to arrive at a balance between holding too much or too little stock. It’s quite a complex calculation, so you may find it easier to use stock control software.

Batch control – managing the production of goods in batches. You need to make sure that you have the right number of components to cover your needs until the next batch.

First in, first out – a system to ensure that perishable stock is used efficiently so that it doesn’t deteriorate. Stock is identified by date received and moves on through each stage of production in strict order.

METHOD OF AVOIDING CARRYING STOCK

Independent demand situations and the use of fixed order quantity and periodic review systems

In planning, and controlling inventories forecasting is based on whether demand for items in inventories is independent or dependent

Dependent items are usually subassemblies or components parts that will be used in the production of final or finished products. Demand (i.e. usage) of subassemblies and components parts is derived from the numbers of finished product to be produced. And example is demand for wheels for new cars. If each car is to have four wheels, then the total number of wheels require for a production run is simply a function of the number of cars that are to be produced in that run. For instance; if 500 cars are to be produce in a run, then the numbers of wheels required is 500 x 4 = 2000 wheels.

Independent demand items are the finished goods or other end items that are sold to someone. There is usually no way to determine precisely how many of these items will be demanded during any given time period because demand typically includes an element of randomness.

Forecasting plays an important role in stocking decision, whereas stock requirements for dependent demand items are determined by reference to the production plan.

EOQ, Perpetual inventory, and Two- bin system etc, all deals with dependent demand.

Inventories are used to satisfy demand requirements, so it is essential to have reliable estimates of the amount and timing of demand it is important to know how long it will take for orders to be delivered. Managers need to know the extent to which demand and lead time might vary; the greater the potential variability, the greater the need for additional stock to reduce the risk of shortage between deliveries. Thus there is crucial link between forecasting and inventory management.

MRP and MRP11

MRP

Material Requirements planning is a computer-based information system designed to handle ordering and scheduling dependent demand inventories. (E.g. raw materials, components parts, and subassemblies). A production plan for a specified number of finished products is translated into requirements for component parts and raw materials working backward from the due date, using lead times and other information to determined when and how much to order. Thus MRP is designed to answer the questions: what is needed? How much is needed? And when it is needed?

To implement MRP you need:

 The master schedule: master schedule also refers to as mater production schedule, states which end items are to be produced, when they are needed, and what quantities.

 Bill-of-Materials file: BOM contains a listing of all the assemblies, subassemblies, parts, and raw materials that are needed to produce one unit of a finished product. Thus each finished product has its own bill of materials.

 Inventory Record file: This is used to store information on the status of each item by time period. This includes gross requirements, scheduled receipts, and expected amount on hand. It also includes other details for each items, such as supplier, lead-time, and lot-size, changes due to stock receipts and cancelled order, withdrawals and similar events are also recorded in this file.

 Hardware and Software: Computers and appropriate software program to handle computations and maintained records.

Advantages of MRP

 Low level of in-process inventories

 The ability to keep tract of material requirements

 The ability to evaluate capacity requirements generated by a given mater scheduled.

 A means of allocating production time.

Disadvantages of MRP

 Need to maintained accurate record in master record and BOM. Inaccuracy can lead to unpleasant surprises, ranging from missing parts, ordering two many of some items or too few of others and failure to stay on schedule.

 It is very tedious and costly to implement.

MRP11

Manufacturing Resource Planning. It represents an effort to expand the scope of production resources planning, and to involve other functional areas of the firm in the planning process especially marketing and finance. In too many instances, production, marketing, and finance operate without complete knowledge or regards for what other areas of the firm are doing. For the firm need to focus on a common set of goals. This is the major purpose of MRP2, to integrate all functions.

The rationale for having these functional areas work together is the increased likelihood of developing a plan that works and with which everyone can live by. Again, because each of the functional areas is involved in formulating the plan, they will have reasonably knowledge of the plan and more reason to work towards achieving it.

This is MRP2 comes into play, generally material requirements and schedules. Next, management must make more detailed capacity requirements planning to determine whether these more specific capacity requirements can be met.

Note that, MPR2 is not a replacement of MRP nor is it an improved version of MRP.

DRP:

Distribution Requirement Planning is a system for inventory management and distribution planning. It is especially useful in multi-echelon warehouse system. (factory and regional warehouse) It extends the concepts of material requirements planning to multi-echelon warehouse inventory, starting with demand at the end of the channel and working that back through the warehouse system to obtain time phased replenishment, schedules for moving inventories through the warehouse network. DRP is used to plan and coordinate transportation, warehousing location, workers, equipment, and financial flows.

JUST-IN-TIME (JIT).

The Just in Time System is a manufacturing practice developed by the Japanese in order to minimize holdings of stock. Suppliers deliver materials needed for production at the exact moment they are required. Goods are produced only as they are needed for the next phase of production. Stock is frequently delivered therefore there is a zero inventory situation. The firm only produces something when there is actual customer demand for it (First sell it, then make it). The Just in Time system only work when there is high employee flexibility and commitment and a well coordinated production system to ensure quality and continuous improvements to minimize bottlenecks.

 The Just in Time system has a much less risk of their stock becoming obsolete or going bad (losing its quality).

 The firm keeps a small inventory hence using less space required, lower maintenance costs and capital requirements.

 As a result of the ‘First sell it, then make it’ method of operation the right quantities are produced at the right time.

 There is increased workforce participation as a result of their employment flexibility and commitment.

 The continuous emphasis on improvement and problem solving results in higher quality, good customer service and reduced costs.

Kanban Method

Kanban is a Japanese word meaning “signal” or “visible record”. In a pull system workflow is dictated by “next-step demand”. A system can communicate such demand by using a kanban card. When a worker needs material or works from the preceding station, he/she uses a kanban card. The kanban card is an authorization to move or work on parts. In kanban system no part can be worked or move without one of the card.

It worked like this. Each container is affixed with a card. When a process or work station needs to replenish its supply of parts, a worker goes to the area where these parts are stored and withdraws one container of parts. Each container holds a predetermined quantity. The worker removes the kanban card from the container and posts it in a designated spot where it will be clearly visible. The worker moves the container to the work station. The posted kanban card is then picked up by a stock person who replenished the stock with another containerm and so on down the line.

The number of kanban card need for a given production level can be calculated using this formular:

N = DT (1+X)/C

Where: N = Total number of containers (1 card per container)

D= Planned usage rate of a center

T= Average waiting time

X= Policy variable set by management

C= Capacity of a standard container (should not be less than 10%

daily usage)

Note that D & T must use the same units (e.g. minutes or days)

Advantages

 Kanban system is very simple to implement

 Kanban usually have very small lot size.

 It handles changes very easily.

 Kanban has short lead time, and high quality output, and simplifies teamwork.

 Kanban is two-bin types of inventory management. Suppliers are replenished as soon as inventories reach predetermined level.

LEAN SUPPLY

Increased competition and rising business costs are forcing companies to rethink the way they coordinate and manage vendor and customer relationships. Rather than work independently, these firms are creating networks dedicated to maximizing value at all points in the supply chain—in effect, creating a “value stream”. Increasingly at the leading companies, these efforts are based on “lean principles.”

Lean Manufacturing to Lean Supply Chain

A concept first used by automobile manufacturers to enhance their operational efficiencies, lean focuses on driving non-value added activities from a company’s operations, while streamlining its value-added activities. Lean centers on eliminating waste and speeding up business processes. In the supply chain context, it encompasses the procedures that precede and follow the actual, physical manufacturing process.

Lean works particularly well in the supply chain, where redundancy and waste can hamper the overall productivity of all partners. That waste can seriously hinder profitability. In fact, the Yankee Group says U.S. companies hold more than $117 billion in excess inventory and lose $83 billion annually because of “disconnected and uncoordinated supply chains.”

Extending lean throughout the entire enterprise—from product concept, through manufacturing and out into the customer’s hands—requires the participation of all nodes along the value chain. Companies that have transitioned lean from the manufacturing floor to the supply chain emphasize quality, preventative maintenance and continuous improvement. The end result is a company that can truly leverage its supply partners’ strengths and create value through a single, continuous flow.

Eliminate poor demand visibility, long order cycles, high product costs, and low margins, improve responsiveness, reduce waste and variability, and improve flow and cycle times, and lower IT management costs.

MAKE OR BUY

Are we outsourcing enough? What functions can we move to China? Are we doing business with India yet?

It is likely that a procurement manager somewhere is being asked these questions right now. Executives have noticed their peers increasingly relying on outsourcing.

While outsourcing may seem new, it really is just a new focus on the classic make or buy procurement decision. You need to ensure that such decisions are made intelligently and not just based on the outsourcing trend.

When dealing with a make vs. buy decision, there are four numbers you need to know:

1. Your volume

2. The fixed costs associated with making (e.g., the tooling that must be bought)

3. The per-unit direct costs of making

4. The per-unit landed cost from a supplier

So, you plug these numbers into a couple of formulas:

CTB = V * LC and CTM = FC + (PUDC * V)

Where,

CTB = Cost To Buy

V = Volume

LC = Supplier’s Per Unit Landed Cost

CTM = Cost To Make

FC = Fixed Costs (of making)

PUDC = Per Unit Direct Cost (of making)

If CTM exceeds CTB, then it is more financially desirable to buy. If CTB exceeds CTM, the opposite is true.

Make/buy decisions aren’t just about numbers, though.

Questions you absolutely must consider include:

• Is this the organization’s core competency?

• Could we be harmed by disclosing proprietary information?

• What will be the impact on quality or delivery?

• What additional risks would we be facing?

• How irreversible is the decision?

Make v. Buy

Considerations when outsourcing to reduce cost

The decision to outsource a part or assembly is often based on lack of internal resources, refocus of core competencies, or cost reduction. The focus of this article is on outsourcing with the objective of lower cost. If you are attempting to outsource a part or assembly that is produced in-house based on lower cost, you must perform a thorough analysis. In many cases, cost can only be reduced if the supplier is going to use a more efficient process or significantly less expensive labor. You must be careful in comparing costs. Because standard cost includes fixed costs, comparing standard cost with the prices being quoted is not an “apples to apples” comparison. Unless you are going to eliminate some fixed costs, the only real cost reduction is the variable cost. If the supplier cannot produce the part for a price lower than your variable cost, you are not saving your company money.

If you are in the process of outsourcing a part or assembly in an effort to reduce cost, you should be searching for a supplier that can produce the part using a more efficient method than you (or a much lower labor rate) are currently using. This might allow them to produce the part faster and/or at a lower labor cost than you can produce the part. Even after they add in their overhead and profit, it is possible that the supplier can produce the part for less cost than you can in house.

OPTIMIZING STOCK TURNOVER

How hard is the money you have invested working for you? You’ve probably been asked that question several times by stock brokers or “investment counselors.” No, I’m not going to try to sell you mutual funds. This article isn’t about how you are managing your personal investments. Instead, we are going to look at the performance of your company’s largest asset: inventory.

The Concept of Inventory Turnover

Say you sell N10,000 worth of a product (at cost) each year. Total revenue received from sales of the product is N12,500. If we bought the entire N10,000 worth of the product on January 1st, at the end of the year we would have made a N2,500 gross profit on an investment of N10,000.

But do we have to buy the entire N10,000 worth of the product at one time? What if we bought N5,000 worth of the product on January 1st. Then, just before running out of stock, we bought an additional N5,000 worth of the product with part of the revenues received from selling the first shipment. At the end of the year we’ve still sold N10,000 worth of the product, still made N2,500 gross profit, but on an investment of about N5,000.

Could we make the same gross profit on an even smaller investment? What if we were to buy N2,500 dollars worth of material. Sell most of it. Buy another N2,500 dollars worth of the product. Sell most of that shipment and then repeat the process two more times before the end of the year. The annual gross profit of N2,500 is now generated with an investment of about N2,500.

Which investment option is better? Selling N10,000 worth of a product (and making N2,500 gross profit) with an investment of N10,000, N5,000 or N2,500? The best option is N2,500. Investing N2,500 (rather than N10,000) frees up N7,500 that can be used for other purposes… such as stocking other products that have the potential of generating additional profits.

CAPITAL BUYING

What Is Capital Goods buying

In the economic realm, “capital goods” is a specialized term which refers to real objects owned by individuals, organizations, or governments to be used in the production of other goods or commodities. Capital goods include factories, machinery, tools, equipment, and various buildings which are used to produce other products for consumption. Capital goods also refer to any material used or consumed to manufacture other goods and services.

Capital goods are generally man-made, and do not include natural resources such as land or minerals, or “human capital”–the intellectual and physical skills and labor provided by human workers.

Capital goods are important to businesses, because they use capital goods to help their business make functional goods for the buying public or to provide consumers with a valuable service. As a result, capital goods are sometimes referred to as “producers’ goods” or “means of production.”

Goods with the following features are capital:

• It can be used in the production of other goods (this is what makes it a factor of production).

• It was produced, in contrast to “land,” which refers to naturally occurring resources such as geographical locations and minerals.

• It is not used up immediately in the process of production unlike raw materials or intermediate goods. (The significant exception to this is depreciation allowance, which like intermediate goods, is treated as a business expense.)

Capital Equipment: Lease vs. Buy

The major factors that must be taken into consideration when you are deciding to lease or buy a piece of capital equipment.

What are the major factors that must be taken into consideration when you are deciding to lease or buy a piece of capital equipment?

 Leasing offers a great alternative in preserving customers’ cash flow, as it does not require a large cash outlay. A minimal down payment consisting of a first and last payment is usually required in advance, and the monthly payments remain the same for the duration of the lease.

 Lenders in this industry understand the equipment and its use, which in turn generates fast and easy approvals.

 Many accountants advise their customers to lease, as it can offer distinct tax benefits and preserve their bank credit lines.

 Leasing rates are competitive and comparable to bank financing. Plus, electronic documents can be generated the same day as the approval so you can watch a machine demo, apply for credit, have documents signed and receive a purchase order all in the same day.

 Owning a piece of equipment does not necessarily translate into making profits. The use of a piece of machinery to make a product is what makes a company income. Leasing provides an easy, affordable method of using equipment that allows a monthly payment without obtaining a bank loan or worrying about budget justification. Leasing also keeps your other lines of credit open and total system financing, including delivery and installation, can be spread over the lease term. When acquiring new equipment, leasing provides advantages such as:

1. Conservation of cash: Leasing doesn’t require the cash outlay of a purchase.

2. Longer terms and lower payments — Lease terms can be flexible up to 84 months.

3. Periodic equipment updates — Reduce obsolescence risks with life cycle management.

4. Manageable upfront costs — Little or no down payment.

5. Purchase options — At lease end, purchase at agreed upon price or return the equipment.

6. 100 percent financing — “Soft costs” such as installation, etc., can be added.

7. Tax advantages — As an expense, lease payments may reduce tax liability.

8. Simplified documentation — Minimal paperwork.

9. Customized lease options and payment plans — Alternatives to meet your cash-flow needs.

10. Time value of money benefits — Acquire equipment with today’s cheaper dollars.

Significant factors to consider when choosing to lease or buy equipment are:

1. Your cash — Hold or spend it; leasing preserves capital for other uses whether they are known or those that are unforeseen.

2. Cost level — Instead of a large upfront dollar outlay when purchasing equipment, leasing minimizes it. Another way of asking that question is: “Do I have enough extra capital to spend today for something that will make me money (pay back) in months and years to come?”

3. Equipment value — There is little financial benefit for leasing, when acquiring equipment under $5,000, due to fees ranging from $150 to $400 and higher rates for lower dollar lease amounts.

LIFE CYCLE COSTING

Life cycle costs (LCC) are all costs from project inception to disposal of equipment. LCC applies to both equipment and projects. LCC costs are found by an analytical study of total costs experienced during the life of equipment or projects.

The object of LCC analysis is to choose the most cost-effective approach from a series of alternatives so the least long term cost of ownership is achieved. LCC analysis helps engineers justify equipment and process selection based on total costs rather than the initial purchase price of equipment or projects. LCC provides best results when both art and science are merged together with good judgment (as is true with most engineering tools).

LCC costs have two major elements: 1) acquisition costs and 2) sustaining costs. Acquisition and sustaining costs are not mutually exclusive. Frequently the cost of sustaining equipment is 2 to 20 times the acquisition cost.

INVESTMENT APPRAISAL

One of the key areas of long-term decision-making that firms must tackle is that of investment – the need to commit funds by purchasing land, buildings, machinery and so on, in anticipation of being able to earn an income greater than the funds committed. In order to handle these decisions, firms have to make an assessment of the size of the outflows and inflows of funds, the lifespan of the investment, the degree of risk attached and the cost of obtaining funds.

The main stages in the capital budgeting cycle can be summarized as follows:

1. Forecasting investment needs.

2. Identifying project(s) to meet needs.

3. Appraising the alternatives.

4. Selecting the best alternatives.

5. Making the expenditure.

6. Monitoring project(s).

Looking at investment appraisal involves us in stage 3 and 4 of this cycle.

We can classify capital expenditure projects into four broad categories:

• Maintenance – replacing old or obsolete assets for example.

• Profitability – quality, productivity or location improvement for example.

• Expansion – new products, markets and so on.

• Indirect – social and welfare facilities.

Even the projects that are unlikely to generate profits should be subjected to investment appraisal. This should help to identify the best way of achieving the project’s aims. So investment appraisal may help to find the cheapest way to provide a new staff restaurant, even though such a project may be unlikely to earn profits for the company.

Investment appraisal methods:

One of the most important steps in the capital budgeting cycle is working out if the benefits of investing large capital sums outweigh the costs of these investments. The range of methods that business organizations use can be categorized one of two ways: traditional methods and discounted cash flow techniques. Traditional methods include the Average Rate of Return (ARR) and the Payback method; discounted cash flow (DCF) methods use Net Present Value (NPV) and Internal Rate of Return techniques.

Traditional Methods

Payback:

This is literally the amount of time required for the cash inflows from a capital investment project to equal the cash outflows. The usual way that firms deal with deciding between two or more competing projects is to accept the project that has the shortest payback period. Payback is often used as an initial screening method.

Payback period = Initial payment / Annual cash inflow

So, if N4 million is invested with the aim of earning N500, 000 per year (net cash earnings), the payback period is calculated thus:

P = N4, 000000 / N500,000 = 8 years

This all looks fairly easy! But what if the project has more uneven cash inflows? Then we need to work out the payback period on the cumulative cash flow over the duration of the project as a whole.

Arguments in favor of payback

Firstly, it is popular because of its simplicity. Research over the years has shown that UK firms favor it and perhaps this is understandable given how easy it is to calculate.

Secondly, in a business environment of rapid technological change, new plant and machinery may need to be replaced sooner than in the past, so a quick payback on investment is essential.

Thirdly, the investment climate in the UK in particular, demands that investors are rewarded with fast returns. Many profitable opportunities for long-term investment are overlooked because they involve a longer wait for revenues to flow.

Arguments against payback

It lacks objectivity. Who decides the length of optimal payback time? No one does – it is decided by pitting one investment opportunity against another.

Cash flows are regarded as either pre-payback or post-payback , but the latter tend to be ignored.

Payback takes no account of the effect on business profitability. Its sole concern is cash flow.

Average Rate of Return:

The average rate of return expresses the profits arising from a project as a percentage of the initial capital cost. However the definition of profits and capital cost are different depending on which textbook you use. For instance, the profits may be taken to include depreciation, or they may not. One of the most common approaches is as follows:

ARR = (Average annual revenue / Initial capital costs) * 100

Let’s use this simple example to illustrate the ARR:

A project to replace an item of machinery is being appraised. The machine will cost N240 000 and is expected to generate total revenues of N45 000 over the project’s five year life. What is the ARR for this project?

ARR = (N45 000 / 5) / 240 000 * 100

= (N9 000) / 240 000 * 100

= 3.75%

Advantages of ARR

As with the Payback method, the chief advantage with ARR is its simplicity. This makes it relatively easy to understand. There is also a link with some accounting measures that are commonly used. The Average Rate of Return is similar to the Return on Capital Employed in its construction; this may make the ARR easier for business planners to understand. The ARR is expressed in percentage terms and this, again, may make it easier for managers to use.

There are several criticisms of ARR which raise questions about its practical application:

Arguments against ARR

Firstly, the ARR doesn’t take account of the project duration or the timing of cash flows over the course of the project.

Secondly, the concept of profit can be very subjective, varying with specific accounting practice and the capitalization of project costs. As a result, the ARR calculation for identical projects would be likely to result in different outcomes from business to business.

Thirdly, there is no definitive signal given by the ARR to help managers decide whether or not to invest. This lack of a guide for decision making means that investment decisions remain subjective.

Discounted Cash Flow Methods

Net Present Value:

NPV is a technique where cash inflows expected in future years are discounted back to their present value. This is calculated by using a discount rate equivalent to the interest that would have been received on the sums, had the inflows been saved, or the interest that has to be paid by the firm on funds borrowed.

Assessing the value of NPV calculations is simple. A positive NPV means that the project is worthwhile because the cost of tying up the firm’s capital is compensated for by the cash inflows that result. When more than one project is being appraised, the firm should choose the one that produces the highest NPV.

Making the investment decision

Let’s set out the criteria for accepting or rejecting investment opportunities, using the NPV and IRR.

Imagine a scenario where the managers of a firm are considering whether to accept or reject an investment project, on the basis of their acquiring the funds necessary at a known rate of interest.

• The NPV approach asks if the present value of cash inflows less the initial investment is positive, at the current borrowing rate.

• The IRR approach asks if the IRR on the project is greater than the borrowing rate.

PAYMENT ARRANGEMENT

Table 1. International Payment Instruments Comparison Chart

Payment Method Features Advantages Disadvantages

Wire Transfer Fully electronic means of payment

Uses correspondent bank accounts and Fed Wire

U.S. Dollars and foreign currencies

Same convenience and security as domestic wires

Pin numbers for each authorized individual

Repetitive codes for frequent transfers to same Beneficiaries Fastest way for Beneficiary to receive good funds

Easy to trace movement of funds from bank to bank Cost is usually more than other means of payment

Funds can be hard to recover if payment goes astray

Intermediary banks deduct charges from the proceeds

Details needed to apply funds received for credit management purposes are often lacking/insufficient

Impossible to stop payment after execution

Foreign Checks Paper instrument that must be sent to Beneficiary and is payable in Beneficiary’s country

Uses account relationships with foreign correspondent banks

Available in U.S. Dollars and all major foreign currencies Convenient when Beneficiary’s bank details are not known

Useful when information/ documentation must accompany payment (subscriptions, registrations, reservations, etc.)

Relatively easy to stop payment if necessary Mail or courier delivery can be slow

Good funds must still be collected from the drawee bank

If payable in foreign currency, value may change during the collection period

Stale dating rules differ in various countries

Commercial Letters of Credit Bank’s credit replaces Buyer’s credit

Payment made against compliant documents

Foreign bank risk can be eliminated via confirmation of a bank in Beneficiary’s country

Acceptance credits offer built-in financing opportunity Rights and risks of Buyer and Seller are balanced

Seller is assured of payment when conditions are met

Buyer is reasonably assured of receiving the goods ordered

Confirmation eliminates country risk and commercial risk More costly than other payment alternatives

Issuance and ammendments can take time

Strict documentary compliance by Seller is required

Reduces applicant’s credit facilities

Standby Letters of Credit Powerful instrument with simple language

Increasingly popular in U.S. and abroad

Foreign bank risk can be eliminated via confirmation of a bank in Beneficiary’s country

“Evergreen” clauses shift expiry risk from Beneficiary to issuer May be cheaper than Commercial Letter of Credit

More secure than open account or Documentary Collection

Discrepancies less likely than under Commercial L/C

Confirmation eliminates country risk and commercial risk Weak language can give Beneficiary unintended advantages

More costly than Documentary Collections

Reduces Buyer’s credit facilities

Documentary Collections Seller uses banks as agents to present shipping documents to Buyer against Buyer’s payment or promise to pay

With Direct Collection Letter (DCL), Seller ships and sends shipping documents directly to Buyer’s bank, which collects and remits funds to Seller’s bank Somewhat more secure than open account

Cheaper and less rigid than Commercial L/C

No strict compliance rules apply

No credit facilities required Country risk and commercial risk exist

No guaranty of payment by any bank

No protection against order cancellation

No built-in financing opportunity as with Commercial L/C

DEFECT LIABILITY PERIOD

Defects liability clauses in construction contracts are clauses in which the parties choose to allocate risk.

Definition of Product Liability

Product Liability shall be defined as liability for damages in such case as follows:

In the case where due to a defect in the delivered product, a life, a body or property of another person (including a third party not using or consuming the product directly, and a legal person as well as a natural person) is injured, the person who manufactured, processed, imported or put his name, etc. on the product as business is liable for damages of the injured person.

The Product Liability Law takes the “defect in the product” as a condition for liability instead of the “intention or fault” of the manufacturer, etc. Therefore, after introduction of the Product Liability Law, the injured has only to verify the “defect in the product” for claiming damages.

The Product Liability Law can be said to employ the “liability without fault principle”, that is, the manufacturer, etc. is liable for damages if the injury is caused by a defect in the product regardless of whether it was his intention or fault. However, the manufacturer, etc. is not liable when there is no defect in the product.

Scope of the product

By definition, “product” means movable property manufactured or processed. Therefore, incorporeal property such as services, information, software, electricity, etc., and immovable are not the object of the Law. Moreover, agricultural, forestall, marine and mineral products which are not processed artificially are not the object of the Law.

Parties subject to liability

Parties subject to liability are as follows:

Manufacturer;

Importer;

Any person who puts his name, etc. on the product with such titles as “manufacturer” or “importer”, or any person who puts his name, etc. on the product in a manner mistakable for its manufacturer or importer

Concept of the term “defect”

A “defect” does not mean mere lack of quality of the product, but means lack of safety in the product which may cause the injury to life, body, or property. In the law, the term “defect” is defined as “lack of safety that the product ordinarily should provide,” taking into account “the nature of the product”, “the ordinarily foreseeable manner of use of the product”, “the time when the manufacturer, etc. delivered the product”, and other circumstances concerning the product.

Time Limitations

The right for damages provided in the Law shall be extinguished by prescription if the injured person or his legal representative does not exercise their rights within the following period: A period of three years from the time when the injured person or his legal representative becomes aware of the damage and the liable party for the damage (short-term negative prescription) A period of ten years from the time when the manufacturer, etc. delivered the product (long-term liable period).

After-sales Services

A lot of businesses are dedicated to improving their business through proper customer support. A good customer support system will bring in the best feed back that can be used to better the business services and products. Usually these procedures of getting customer feed back is taken in a negative sense by the employees as some businesses use this information to point out flaws in the employees relation ship with the customer or a lack of service meted out. This should not be the case. Positive or negative feed back should be used only to motivate the employee to understand their short comings. This is what good customer support is all about – making the customer satisfied and employee happy. We provide Customer Support Services so what are you waiting for ask for a quote now.

COMMODITY BUYING

A commodity is some good for which there a demand is, but which is supplied without qualitative differentiation across a market. It is a product that is the same no matter who produces it, such as petroleum, notebook paper, or milk. In other words, copper is copper. The price of copper is universal, and fluctuates daily based on global supply and demand. Stereos, on the other hand, have many levels of quality. And, the better a stereo is [perceived to be], the more it will cost.

One of the characteristics of a commodity good is that its price is determined as a function of its market as a whole. Well-established physical commodities have actively traded spot and derivative markets. Generally, these are basic resources and agricultural products such as iron ore, crude oil, coal, ethanol, salt, sugar, coffee beans, soybeans, aluminum, copper, rice, wheat, gold, silver and platinum.

A forward contract or simply a forward is an agreement between two parties to buy or sell an asset at a certain future time for a certain price agreed today.[1] This is in contrast to a spot contract, which is an agreement to buy or sell an asset today. It costs nothing to enter a forward contract. The party agreeing to buy the underlying asset in the future assumes a long position, and the party agreeing to sell the asset in the future assumes a short position. The price agreed upon is called the delivery price, which is equal to the forward price at the time the contract is entered into.

In finance, a hedge is a position established in one market in an attempt to offset exposure to price fluctuations in some opposite position in another market with the goal of minimizing one’s exposure to unwanted risk. There are many specific financial vehicles to accomplish this, including insurance policies, forward contracts, swaps, options, many types of over-the-counter and derivative products, and perhaps most popularly, futures contracts. Public futures markets were established in the 1800s to allow transparent, standardized, and efficient hedging of agricultural commodity prices; they have since expanded to include futures contracts for hedging the values of energy, precious metals, foreign currency, and interest rate fluctuations.

Futures contract, in finance, refers to a standardized contract to buy or sell a specified commodity of standardized quality at a certain date in the future, at a market determined price (the futures price). The contracts are traded on a futures exchange.

In finance, an option is a contract between a buyer and a seller that gives the buyer the right—but not the obligation—to buy or to sell a particular asset (the underlying asset) at a later day at an agreed price. In return for granting the option, the seller collects a payment (the premium) from the buyer. A call option gives the buyer the right to buy the underlying asset; a put option gives the buyer of the option the right to sell the underlying asset. If the buyer chooses to exercise this right, the seller is obliged to sell or buy the asset at the agreed price. The buyer may choose not to exercise the right and let it expire. The underlying asset can be a piece of property, or shares of stock or some other security, such as, among others, a futures contract.

Over-the-counter (OTC) trading is to trade financial instruments such as stocks, bonds, commodities or derivatives directly between two parties. It is contrasted with exchange trading, which occurs via facilities constructed for the purpose of trading (i.e., exchanges), such as futures exchanges or stock exchanges.

Purchase payment terms

Spot price/loco price

The spot price or spot rate of a commodity, a security or a currency is the price that is quoted for immediate (spot) settlement (payment and delivery). Spot settlement is normally one or two business days from trade date. This is in contrast with the forward price established in a forward contract or futures contract, where contract terms (price) are set now, but delivery and payment will occur at a future date. For securities, the synonymous term cash price is more often used.

Spot prices and future price expectations

Depending on the item being traded, spot prices can indicate market expectations of future price movements in different ways. For a security or non-perishable commodity (e.g., gold), the spot price reflects market expectations of future price movements. In theory, the difference in spot and forward prices should be equal to the finance charges, plus any earnings due to the holder of the security.

In contrast, a perishable commodity does not allow this arbitrage – the cost of storage is effectively higher than the expected future price of the commodity. As a result, spot prices will reflect current supply and demand, not future price movements. Spot prices can therefore be quite volatile and move independently from forward prices. According to the unbiased forward hypothesis, the difference between these prices will equal the expected price change of the commodity over the period.

A simple example: even if you know tomatoes are cheap in July and will be expensive in January, you can’t buy them in July and take delivery in January, since they will spoil before you can take advantage of January’s high prices. The July price will reflect tomato supply and demand in July. The forward price for January will reflect the market’s expectations of supply and demand in January. July tomatoes are effectively a different commodity from January tomatoes price.

Loco price

Denoting a price for goods that does not include any loading or transport…in loading, transporting, or shipping them to their destination. A loco price might be quoted in the form: N100 per tonne, loco PH factory.

Types of contracts

A cost-plus contract, more accurately termed a Cost Reimbursement Contract, is a contract where a contractor is paid for all of its allowed expenses to a set limit plus additional payment to allow for a profit. Cost reimbursement contracts contrast with fixed-price contract, in which the contractor is paid a negotiated amount regardless of incurred expenses.

Types

There are four general types of cost reimbursement contracts, all of which pay every allowable, allocatable, and reasonable cost incurred by the contractor plus a fee or profit which differs by contract type.

• Cost Plus Fixed Fee contracts pay a pre-determined fee that was agreed upon at the time of contract formation.

• In a Cost-Plus-Incentive Fee contract, a larger fee is awarded for contracts which meet or exceed performance targets including cost savings

• Cost Plus Award Fee contracts pay a fee based upon the contractor’s work performance. In some contracts, the fee is determined subjectively by an awards fee board whereas in others the fee is based upon objective performance metrics. An aircraft development contract, for example, may pay award fees if the contractor achieves certain speed, range, or payload capacity goals.

• Cost Plus Percentage of Cost pay a fee that rises as the contractors cost rise. Because this contract type provides no incentive for the contractor to control costs it is rarely utilized.

Usage

A cost reimbursement contract is appropriate when it is desirable to shift some risk of successful contract performance from the contractor to the buyer. It is most commonly used when the item purchased cannot be explicitly defined, as in research and development, or in cases where there is not enough data to accurately estimate the final cost.

Advantages:

• In contrast to a fixed-price contract, a cost-plus contractor has little incentive to cut corners.

• A cost-plus contract is often used when long-term quality is a much higher concern than cost, such as in the United States space program.

• Final cost may be less than a fixed price contract because contractors do not have to inflate the price to cover their risk.

Disadvantage:

• There is limited certainty as to what the final cost will be.

• Requires additional oversight and administration to ensure that only permissible costs are paid and that the contractor is exercising adequate overall cost controls.

• Properly designing award or incentive fees also requires additional oversight and administration.

• There is little incentive to be efficient.

Fixed-price contract

A fixed-price contract is a contract where the amount of payment does not depend on the amount of resources or time expended, as opposed to a cost-plus contract which is intended to cover the costs and some amount of profit. Such a scheme is often used in military and government contractors to put the risk on the side of the vendor, and control costs. However, historically when such contracts are used for innovative new projects with untested or undeveloped technologies, such as new military transports or stealth attack planes, it can and often results in a failure if costs greatly exceed the ability of the contractor to absorb unforeseen cost overruns.

However, such contracts continue to be popular despite a history of failed or troubled projects, though they tend to work when costs are well known in advance. Some laws have been written which prefer fixed-price contracts; however, many maintain that such contracts are actually the most expensive, especially when the risks or costs are unknown.

Cost-plus-incentive fee

A CPIF Cost-Plus-Incentive-Fee contract is a cost-reimbursement contract that provides for an initially negotiated fee to be adjusted later by a formula based on the relationship of total allowable costs to total target costs.

Like a cost-plus contract, the price paid by the buyer to the seller changes in relation to costs, in order to reduce the risks assumed by the contractor (seller). Unlike a cost-plus contract, the cost in excess of the target cost is only partially paid according to a Buyer/Seller ratio, so the seller’s profit decreases when exceeding the target cost. Similarly, the seller’s profit increases when actual costs are below the target cost defined in the contract. To achieve this incentive, in CPIF contracts, the seller is paid his target cost plus a initially negotiated fee plus a variable amount that is determined by subtracting the target cost from the actual costs, and multiplying the difference by the buyer ratio.

For example, assume CPIF with:

• Target costs = 1000,

• Fixed fee = 100 (also called Target Profit),

• Benefit/cost sharing = 80% Buyer / 20% Seller,

If the final costs are higher than the target, say 1100, the Buyer will pay 1000 + 100 + 0.8*(1100-1000)=1180 (seller earns 80 which is less than if he had reached the target cost) If the final costs are lower than the target, say 900, the buyer will pay 1000 + 100 + 0.8*(900-1000) = 1020 (seller earns 120 which is more than if he had reached the target cost)

To protect the buyer, it is common to set a ceiling price. This is the maximal price the buyer will required to pay the seller, regardless of how high the costs are. When the costs exceed a Point of Total Assumption, the ceiling price is paid by the buyer, and beyond that point, the seller pays for 100% of any additional costs.

The point of total assumption (PTA) is a point on the cost line of the Profit-cost curve determined by the contract elements associated with a fixed price plus incentive-Firm Target (FPI) contract above which the seller effectively bears all the costs of a cost overrun. The seller bears all of the cost risk at PTA and beyond, due to a dollar for dollar decrease in profit beyond the costs at the PTA. In addition, once the costs on an FPI contract reach PTA, the maximum amount the buyer will pay is the ceiling price. Note, however, that between the cost at PTA and when the cost equals the ceiling price, the seller is still in a profitable position; only after costs exceed the ceiling price is the seller in a loss position.

Any FPI contract specifies a target cost, a target profit, a target price, a ceiling price, and one or more share ratios. The PTA is the difference between the ceiling and target prices, divided by the buyer’s portion of the share ratio for that price range, plus the target cost.

PTA = ((Ceiling Price – Target Price)/buyer’s Share Ratio) + Target Cost

For example, assume:

Target Cost: 2,000,000

Target Profit: 200,000

Target Price: 2,200,000

Ceiling Price: 2,450,000

Share Ratio: 80% buyer–20% seller for overruns, 50%–50% for underruns

PTA = ((2,450,000 – 2,200,000)/ 0.80) + 2,000,000 = 2,312,500.

If for a moment, PTA is given and you are trying to calculate the ceiling price for the buyer (maximum amount that the buyer will have to spend),the calculation will be

(2,000,000 (target cost) + 200,000 (the profit the buyer pays to the seller) + (2,312,500 – 2,000,000)*0.8 = 2450000.

This is a term used in project management when managing specific fixed price contracts.

For cost reimbursable contract, the Point of Total Assumption does not exist, since the buyer agrees to cover all costs. However, a similar incentive arrangement with similar components, called a Cost-Plus-Incentive Fee (CPIF) contract sometimes is used. The CPIF includes both a minimum fee and a maximum fee. The share line in combination with the Target Fee, Maximum Fee and Minimum Fee can be used to easily calculate the points at which the incentive arrangement affects fee. The range between these points is called the “range of incentive effectiveness.”

Straight re-buy- re-purchase of an existing product, routine, simple re-orders. Modified re-buy- some minor changes to existing product, not as complex as new task.

GLOBAL SOURCING

This is a term used to describe practice of sourcing from the global market for goods and services across geopolitical boundaries. A definition focused on this aspect of global sourcing is: “proactively integrating and coordinating common items and materials, processes, designs, technologies, and suppliers across worldwide purchasing, engineering, and operating locations.

Global sourcing often aims to exploit global efficiencies in the delivery of a product or service. These efficiencies include low cost skilled labor, low cost raw material and other economic factors like tax breaks and low trade tariffs.

Majority of companies today strive to harness the potential of global sourcing in reducing cost. Hence it is commonly found that global sourcing initiatives and programs form a integral part of the strategic sourcing plan and procurement strategy of many multinational companies.

Global sourcing is often associated with a centralized procurement strategy for a multinational, wherein a central buying organization seeks economies of scale through corporate-wide standardization and benchmarking.

The global sourcing of goods and services has advantages and disadvantages that can go beyond low cost.

Some advantages of global sourcing, beyond low cost, include: learning how to do business in a potential market,

(a) Tapping into skills or resources unavailable domestically,

(b) Developing alternate supplier/vendor sources to stimulate competition, and

(c) Increasing total supply capacity.

Some key disadvantages of global sourcing can include:

(a) Hidden costs associated with different cultures and time zones,

(b) Exposure to financial and political risks in countries with (often) emerging economies,

(c) Increased risk of the loss of intellectual property, and

(d) Increased monitoring costs relative to domestic supply.

For manufactured goods, some key disadvantages include:

(a) Long lead times,

(b) The risk of port shutdowns interrupting supply, and the difficulty of monitoring product quality

What Should A Global Sourcing Strategy Address?

Costs – A global sourcing strategy is often used to benefit from lower labor costs abroad. But there are also other additional costs for a buying organization to bear that aren’t part of domestic transactions. They include multi-modal freight charges, broker fees, bank fees, taxes called duties, insurance, etc.

Laws – Global sourcing forces buyers and suppliers to choose one of three bodies of law to apply to their contract: the law of the buyer’s country, the law of the supplier’s country, or one applicable under a treaty accepted by both countries.

Currency – The buyer and the seller must agree on a currency to use. While some buyers insist on their own currency for simplicity’s sake, prudent decisions consider use of the supplier’s currency when the buyer’s currency might strengthen relative to the supplier’s currency between the agreement and payment dates.

Lead Time – Lead time for global purchases is usually significantly longer than for domestic ones. This is due to ocean travel being slower than air travel and customs clearance adding time not involved in domestic sourcing.

Language & Culture – If you’re unfamiliar with the supplier’s language and culture, you increase the risk of communication challenges, misunderstandings, and offensive or uncomfortable encounters.

Transportation – While domestic sourcing usually involves one shipping mode, global sourcing involves multi-modal transportation – a strategy for combining air, water, and ground transportation to get goods from the supplier to the port of the supplier’s country to your country’s port to your dock.

Payment Methods – Global sourcing often involves payment using a letter of credit which requires the involvement of both the buyer’s and supplier’s banks.

INBOUBD TRANSPORTATION

Optimizing the flow of incoming materials requires a value chain approach that evaluates the tradeoffs between truckload vs. less-than-truckload and multiple deliveries vs. consolidated milk runs.

High Transportation prices have forced companies to completely re-think their transportation habits, from the type of vehicles they used to how they go about their daily errands. Managers have developed a newfound awareness of transportation and logistics expenses.

With so many variables and cost drivers, getting a handle on such costs requires a value chain perspective that includes an end-to-end look at transportation. They focuses on some of the opportunities for improvement and potential savings on the inbound side of the logistics equation. This includes redefining milk runs, cross docking, scheduling deliveries and the intelligent use of technology.

Map all transportation legs.

Mapping all of the transportation legs between the point of origin and your facility can make it easy to see where and when problems are likely to arise..

By definition the receiving function does not create value. The goal is therefore to minimize the time and touches required to move material from the dock to the assembly line or work cells. Accomplishing this starts at the points of use in the plant, focusing specifically on high naira value and high frequency items. Looking at the actual rate of consumption, will reveal the optimum rate of incoming parts and subassemblies. Such analysis typically yields an ideal material flow that is characterized by smaller quantities and more frequent deliveries. Such a tactic would logically translate into higher transportation costs unless incoming shipments can be consolidated.

Consolidate shipment.

Another way to consolidate shipments into truckload quantities is to establish some form of transportation loop, known as a milk run. The truck becomes the consolidation device, picking up shipments from suppliers within a particular geographic area on a daily or weekly basis, and delivering them to the factory on a regular schedule. The cost of a truck traveling a regular route on a regular schedule will typically be less than if the trailer is only 80% to 85% full on average.

Managing Variability

Getting such an approach to work requires an ability to minimize and manage variability. Milk run truckloads will typically include a broad variety of products. Some pallets will be stackable and some will not. Building each load requires a solid understanding of each product’s dimensions, weight and volume, and how they tend to be banded and packed.

Managing variability in volume presents some special challenges as well. The size of the truck offers some opportunity for aligning the incoming flow with normal consumption patterns. Any overflow, during seasonal sales spikes for example, should be handled via alternative transportation modes. If shipment volumes for a SKU tend to have huge swings in volume-perhaps because a particular raw material is produced in large batches at irregular intervals-they should not be considered for milk run delivery. Similarly, if a particular supplier is providing unreliable delivery or quality performance, or is likely to be replaced as part of a rationalization effort, it shouldn’t be included in the design of the milk run. With sufficient oversight day-to-day execution of the route can be cost effectively managed by a third-party logistics provider. However it is managed, the mix and volume of the incoming parts flow should be re-evaluated at least every quarter.

Cross Docking

Another strategy for consolidating shipments is cross docking. A cross dock receives a variety of products and sorts and consolidates them for shipment without anything ever being put into long-term storage. These facilities, which may look similar to a normal warehouse with more staging areas and fewer storage racks, or feature miles of conveyor and highly automated sorting equipment, allow large quantities of product to be received from one channel and a mixed load to be built on the outbound side. The multi-million-sq.-ft. postal, UPS and FedEx sorting facilities are huge cross-dock operations that receive a mass of disorganized incoming material every night and sort it into the appropriate channel for next-day delivery. The concept can be just as effective on much smaller scale.

Do not Use Fire Fighting approach.

No matter the approach, effectively managing the inbound material flow offers a huge advantage when it comes to scheduling. Most receiving docks are overwhelmed with deliveries at certain times of the day. The peak time might be first thing in the morning, late in the afternoon or happen at completely unpredictable intervals. The receiving area descends into chaos with material piling up in staging areas and lift trucks dashing to and fro. During other hours there may be little for people to do but sweep the floors.

Scheduling and segmenting some portion of the inbound material flow will smooth the flow of goods through receiving. More predictable deliveries allow managers to do a better job of allocating resources, including labor, floor space and material-handling equipment. Over time this level loading of the inbound flow will dramatically shorten the lead time between when incoming material hits the receiving dock and when it’s available for manufacturing. Improved predictability also improves productivity and limits overtime requirements. Because there’s no longer a mountain of pallets that has to be processed all at once. More predictable work patterns also allow for the establishment of standardized work.

These are some of the basic tactics for streamlining the flow of incoming materials. Operations managers need to stay on top of such activity as global transportation rates rise.

Outbound Logistics: The process relates to the movement and storage of products from the end of the production line to the end user.

PURCHASING CONTRACT

Contract management or contract administration is the management of contracts made with customers, vendors, partners, or employees. Contract management includes negotiating the terms and conditions in contracts and ensuring compliance with the terms and conditions, as well as documenting and agreeing any changes that may arise during its implementation or execution. It can be summarized as the process of systematically and efficiently managing contract creating, execution, and analysis for the purpose of maximizing financial and operational performance and minimizing risk.

Common commercial contracts include employment letters, sales invoices, purchase orders, and utility contracts. Complex contracts are often necessary for construction projects, goods or services that are highly regulated, goods or services with detailed technical specifications, intellectual property (IP) agreements, and international trade.

A study has found that for “42% of enterprises…the top driver for improvements in the management of contracts is the pressure to better assess and mitigate risks” and additionally,” nearly 65% of enterprises report that contract lifecycle management (CLM) has improved exposure to financial and legal risk.”

A contract is a legally binding agreement between the parties identified in the agreement to fulfill all the terms and conditions outlined in the agreement. A prerequisite requirement for the enforcement of a contract, amongst other things, is the condition that all the parties to the contract accept the terms of the claimed contract. Historically, this was most commonly achieved through signature or performance, but in many jurisdictions – especially with the advance of electronic commerce – the forms of acceptance have expanded to include various forms of electronic signature.

Contracts can be of many types’ sales contracts (including leases), purchasing contracts, partnership agreements, trade agreements, and intellectual property agreements.

• A sales contract is a contract between a company (the seller) and a customer that where the company agrees to sell products and/or services. The customer in return is obligated to pay for the product/services bought.

• A purchasing contract is a contract between a company (the buyer) and a supplier who is promising to sell products and/or services.

• A partnership agreement may be a contract which formally establishes the terms of a partnership between two legal entities such that they regard each other as ‘partners’ in a commercial arrangement. However, that such expression may be merely a business-expression to reflect the desire of the contracting parties to act ‘as if’ both are in a partnership with common goals. Therefore, it might not be the common law arrangement of a partnership which by definition creates fiduciary duties and which also has ‘joint and several’ liabilities.

A purchase order (PO) is a commercial document issued by a buyer to a seller, indicating types, quantities, and agreed prices for products or services the seller will provide to the buyer. Sending a PO to a supplier constitutes a legal offer to buy products or services. Acceptance of a PO by a seller usually forms a one-off contract between the buyer and seller, so no contract exists until the PO is accepted.[1]

There are several reasons why companies use POs. They allow buyers to clearly and explicitly communicate their intentions to sellers, and to protect the seller in the event of a buyer’s refusal to pay for goods or services. For example, say Alice works for Company A and orders some parts from Company B. There could be a problem if Alice was not actually authorized to issue this purchase order — perhaps due to a miscommunication, the employee believed to have the boss’s permission to place the order. Once this error is discovered the order is canceled. Depending on the type of product being ordered, and at what stage the PO was canceled, Company B may incur manufacturing costs (labor, raw material, etc.) as well as shipping and packing costs. They might also lose the product entirely (for example, if it is perishable).

To prevent such problems, sellers often request purchase orders from buyers. This document represents the buyer’s intent to purchase specific quantities of product at specified prices. In the event of non-payment, the seller can use the PO as a legal document in a court of law to demonstrate the buyer’s intent and to facilitate collection efforts. Companies usually request POs when doing business with other companies for orders of significant size, as the PO reduces the risks involved.

In the course of the accounts payable process, purchase orders are matched with invoices and packing slips before the invoices are paid. The purchase order is a contract between the seller and buyer that details pricing, delivery and the products or merchandise. It is used for internal control in business so that costs are identified prior to the receipt of the invoice. It is also the basis to contest an invoice should the purchase order and invoice not be in agreement.

The sales order, sometimes abbreviated as SO, is an order issued by a business to a customer. A sales order may be for products and/or services. Given the wide variety of businesses, this means that the orders can be fulfilled in several ways. Broadly, the fulfillment modes, based on the relationship between the order receipt and production, are as follows:

• Digital Copy – Where products are digital and inventory is maintained with a single digital master. Copies are made on demand in real time and instantly delivered to customers.

• Build to Stock – Where products are built and stocked in anticipation of demand. Most products for the consumer would fall into this category

• Build to Order – Where products are built based on orders received. This is most prevalent for custom parts where the designs are known beforehand.

• Configure to Order – Where products are configured or assembled to meet unique customer requirements e.g. Computers

• Engineer to Order – Where some amount of product design work is done after receiving the order

A sales order is an internal document of the company, meaning it is generated by the company itself. A sales order should record the customer’s originating purchase order which is an external document. Rather than using the customer’s purchase order document, an internal sales order form allows the internal audit control of completeness to be monitored as a sequential sales order number can be used by the company for its sales order documents. The customer’s PO is the originating document which triggers the creation of the sales order. A sales order, being an internal document, can therefore contain many customer purchase orders under it. In a manufacturing environment, a sales order can be converted into a work order to show that work is about to begin to manufacture, build or engineer the products the customer wants.

Common order types

• Quote

• Spot order

• Sales contract

• Intra-company order

• Pull order

• Service order

• Return order

• Product Number

Customer order fulfillment

The steps involved in fulfilling the demands made in a sales order make up the order fulfillment process.

Order fulfillment (in BE also: order fulfillment) is in the most general sense the complete process from point of sales inquiry to delivery of a product to the customer. Sometimes Order fulfillment is used to describe the more narrow act of distribution or the logistics function, however, in the broader sense it refers to the way firms respond to customer orders.

The first research towards defining order fulfillment strategies was published by Mather (1988) and his discussion of the P:D ratio, whereby P is defined as the production lead-time, i.e. how long it takes to manufacture a product, and D is the demand lead-time, i.e. how long customers are willing to wait for the order to be completed. Based on comparing P and D, a firm has several basic strategic order fulfillment options:

• Engineer-to-Order (ETO) – Here, the product is designed and built to customer specifications; this approach is most common for large construction projects and one-off products, such as Formula 1 cars

• Build-to-Order (BTO); syn: Make-to-Order (MTO) – Here, the product is based on a standard design, but component production and manufacture of the final product is linked to the order placed by the final customer’s specifications; this strategy is typical for high-end motor vehicles and aircraft

• Assemble-to-Order (ATO) – Here, the product is built to customer specifications from a stock of existing components. This assumes a modular product architecture that allows for the final product to be configured in this way; a typical example for this approach is Dell’s approach to customizing its computers.

• Make-to-Stock (MTS); / Build-to-Forecast (BTF) Here, the product is built against a sales forecast, and sold to the customer from finished goods stock; this approach is common in the grocery and retail sectors.

• Digital Copy (DC) Where products are digital assets and inventory is maintained with a single digital master. Copies are created on-demand, downloaded and saved on customers’ storage devices.

In its broadest definition the possible steps in the process are

Product Inquiry – Initial inquiry about offerings, visit to the web-site, catalog request

• Sales Quote – Budgetary or availability quote

• Order Configuration – Where ordered items need selection of options or order lines need to be compatible with each other

• Order Booking – The formal order placement or closing of the deal (issuing by the customer of a Purchase Order)

• Order Acknowledgment / Confirmation – Confirmation that the order is booked and/or received

• Invoicing / Billing – The presentment of the commercial invoice / bill to the customer

• Order Sourcing / Planning – Determining the source / location of item(s) to be shipped

• Order Changes – Changes to orders, if needed

• Order Processing – Process step where the distribution center or warehouse is responsible to fill order (receive and stock inventory, pick, pack and ship orders).

• Shipment – The shipment and transportation of the goods

• Delivery – The delivery of the goods to the consignee / customer

• Settlement – The payment of the charges for goods / services / delivery

• Returns – In case the goods are unacceptable / not required

The order fulfillment strategy also determines the de-coupling point in the supply chain which describes the point in the system where the “push” (or forecast-driven) and “pull” (or demand-driven see Demand chain management) elements of the supply chain meet. The decoupling point always is an inventory buffer that is needed to cater for the discrepancy between the sales forecast and the actual demand (i.e. the forecast error). It has become increasing necessary to move the de-coupling point in the supply chain to minimize the dependence on forecast and to maximize the reactionary or demand-driven supply chain elements. This initiative in the distribution elements of the supply chain corresponds to the Just-in-time initiatives pioneered by automobile manufacturers in the 1970s.

The order fulfillment strategy has also strong implications on how firms customize their products and deal with product variety Strategies that can used to mitigate the impact of product variety include modularity, option bundling, late configuration, and build to order (BTO) strategies — all of which are generally referred as mass customization strategies.

Purchase requisition

As part of an organization’s internal financial controls, the accounting department may institute a purchase requisition process to help manage requests for purchases. Requests for the creation of purchase of goods and services are documented and routed for approval within the organization and then delivered to the accounting group.

Typically an accounting staff member is assigned responsibility for purchase order management, referred to commonly as the PO (purchase order) Coordinator.

Purchase requests are tracked against both internal departmental budgets as well as general ledger (GL) categories.

Structure

A purchase requisition is an authorization for a purchasing department to procure goods or services. It is originated and approved by the department requiring the goods or services. Typically, it contains a description and quantity of the goods or services to be purchased, a required delivery date, account number and the amount of money that the purchasing department is authorized to spend for the goods or services. Often, the names of suggested supply sources are also included.

A purchase requisition is owned by the originating department and should not be changed by the purchasing department without obtaining approval from the originating department. This important distinction (e.g. essential control) is not clearly defined in some of the more popular integrated procurement software systems on the market today.

In some industrial (e.g. production line) environments, the purchasing department may be assigned responsibility for requesting and purchasing goods. This is especially true for raw material purchases where the purchasing department is also responsible for inventory management. A purchase requisition is not a purchase order and therefore should never be used to purchase goods or services or be used as an authorization to pay an invoice from a supplier or service provider.

Standard Contract Terms for Sales Contract and Purchase Order

To reduce your business’ exposure to liability, every sales contract and purchase order should contain many, if not all, of the commercial reasonable standard provisions set forth below. While the following terms are by no means exhaustive, they do represent some of the standard terms that should be printed on every sales contract and every purchase order form supplied by a seller to a prospective buyer. I remind you that this advice is general and not intended to cover all of the legal issues involved in your business, so please use this information merely as a starting point for educating yourself about the legal aspects of your business, not as a substitute for a lawyer.

1. Delivery Terms.

Every sales contract should contain a “force majeure clause” which excuses a delay in performance for a reasonable time in the event it is caused by an event beyond your business’ reasonable control (e.g., fire, earthquake, tornado, labor strike, etc.). Another thing to be especially aware of is “time is of the essence” clauses (also sometimes referred to as “delivery is of the essence”. These types of clauses should be deleted from any sales contract or purchase order if possible, as they allow the buyer to terminate and/or collect damages if your business is even one day late in delivery.

2. Acceptance Terms.

When will the buyer be required to accept the goods? Will the buyer be given an opportunity to reject the goods well after delivery, or will the time frame be limited to 48 or 72 hours. After acceptance, the buyer’s remedies are generally limited to those specified in your warranty clause — which hopefully has been expressly limited to repair, replacement or refund. Prior to the time of acceptance, the buyer’s remedies are much broader — e.g., it may reject non conforming goods and recover money damages. It is important that your sales contract and purchase order form set forth the manner and means by which the buyer must accept and reject your goods.

3. F.O.B. Terms.

In the absence of any specific language contained in your sales contract or purchase order terms, the F.O.B. destination point will determine the point at which risk of loss, title and transportation expenses shift from your business to Buyer. Ask yourself the following three questions: (1) When will the risk of loss pass to the buyer; (2) when will title to the property pass to the buyer; and (3) who is responsible for paying the cost of delivery. All of these questions should be answered in your sales contract. Small businesses often use a purchase order form, in lieu of a sales contract, which is fine so long as the back of the purchase order form contains the terms of the sale.

4. Tax Terms.

You want to ensure your sales contract, or purchase order terms, specifically states that the buyer is required to pay all taxes, duties and other governmental charges in connection with the sale, purchase, delivery and use of any of the goods (except for taxes based upon your business’ net income). Many states have gross receipts taxes in lieu of sales taxes, and these should normally be for the account of the Buyer.

5. Special, Indirect, Consequential and Punitive Damage Clauses.

Your sales contract and purchase order terms should specifically limit damages to “Actual Damages” and should expressly state that the Buyer is prohibited from recovering special, indirect, and consequential or punitive damages.

6. Warranty Clauses.

If you are selling a product, your business will probably be expected to provide a warranty that the product meets certain defined specifications and is free from defects in material and workmanship. The first issue when addressing warranties is what will be the warranty period. If the contract fails to state a specific time frame, the warranty period will generally be set by state law, which typically provides for 4 years. You can, however, limit this period to 6 months or 1 year in your sales contract, or purchase order terms. The second issue arising with respect to warranties is the type of remedy you are providing to the buyer in the event there is a defect in material or workmanship. You can expressly limit the buyer’s remedy for breach of warranty to repair, replacement, or refund of the purchase price, less shipping and handling (if applicable). The third issue that arises is whether you will provide the implied warranties of “merchantability” and “fitness for a particular purpose” or you can expressly exclude all implied warranties.

7. Modifications and Change Order Terms.

Oftentimes, after a contract has been signed, the buyer will want to effectuate a change or modification. You want to make sure your sales contract, or purchase order terms: (1) specifically set forth what can and cannot be modified; (2) specifically set forth the procedures for making a modification and (3) provides that no requested modifications will be deemed binding upon the other party absent that party’s written consent.

8. Indemnity Clauses.

Does your sales contract require your business to defend and indemnify the Buyer against all claims, liabilities, losses and damages arising out of actual or alleged defects in material or workmanship, or anything else? If it does, your business may be assuming significant contingent liabilities that can easily be limited by excluding such a clause. It is considered commercially reasonable and common practice for a seller to limit his business’s responsibility to repair, replacement, or refund, which can be covered in the warranty clause.

9. Termination Clauses.

The first issue which arises is limiting the time period during which the Buyer may cancel and the reasons why a buyer may cancel. The buyer’s right to terminate should occur only for a material default and a failure to cure after 15 or 30 days written notice. Your sales contract or purchase order terms should also state that in the event the Buyer elects to terminate the contract that your business is entitled to recover money damages, including: (a) the cost of the work in process; (b) the cost of the raw materials utilized; (c) and a certain reasonable amount for lost profits and reasonable overhead. Be careful not to limit your recovery just to the cost of the work in process and raw materials allocable to the terminated work. Finally, you should ensure that your business is afforded the right to terminate the contract in the event the Buyer materially breaches the contract.

10. Entire Agreement Clause.

All contracts (including purchase order terms) should contain an “Entire Agreement” clause– This agreement represents the entire agreement of the parties and supersedes all other oral and written promises, assurances, and agreements. This type of clause will prohibit future claims that oral promises were made.

11. Patent/Copyright/Trademark Indemnification Clauses.

Any clause agreeing to indemnify and hold the buyer harmless again infringement claims should be specifically tailored to limit your potential liability. For example, patent, copyright or trademark infringement can be limited to indemnifying the buyer for alleged infringement of U.S. patents, trademarks, and copyrights only. You should also have the right, at your option, to: (1) defend of any such action; (2) procure the right for the Buyer to continue using the goods, (3) modify the goods within a reasonable time so they no longer infringe a third party’s right or (4) refund the purchase price (preferably less depreciation). This part of the contract should also provide that you will not indemnify Buyer, and the Buyer will indemnify you, if the claimed infringement is a result of (a) the buyer’s detailed specifications, (b) parts supplied or designated by Buyer, (c) modification of the goods, by someone other than your business, or (d) combination of your business’ products with other products, the combination of which is alleged to be infringing.

12. Choice of Law and Venue Terms.

You want to ensure that your state’s law governs the construction and validity of your sales contract (purchase order) and that any claim or cause of action will be adjudicated in your local county, either in the state or federal courts or before an arbitrator.

13. Confidentiality Clauses.

In many instances a confidentiality clause is unnecessary, but where confidential information is being disclosed be sure to include a clause requiring both parties to maintain the confidentiality of proprietary information or enter into a separate non-disclosure agreement.

14. Compliance with Government Regulations or Standards.

If your products are regulated by certain government standards, the buyer will insist these standards be met. These requirements should be set out specifically in the specifications for the goods and specifically limited to those regulations and standards in effect on the date of the contract. Larger buyers may also insist on compliance with OSHA or other government regulations; this type of clause should be resisted, if possible, but if such a provision must be included, it should be treated in the same manner discussed above.

Note

The contract clauses discussed above are by no means exhaustive, but they do represent some of the common commercial reasonable language that should be included in your purchase order form or sales contract. Negotiate these clauses at the outset, reduce them to a writing and have your sales contract (purchase order) signed by the buyer BEFORE your business commences work under the sales contract or purchase order.

Types of contracts

A cost-plus contract, more accurately termed a Cost Reimbursement Contract, is a contract where a contractor is paid for all of its allowed expenses to a set limit plus additional payment to allow for a profit. Cost reimbursement contracts contrast with fixed-price contract, in which the contractor is paid a negotiated amount regardless of incurred expenses.

There are four general types of cost reimbursement contracts, all of which pay every allowable, allocatable, and reasonable cost incurred by the contractor plus a fee or profit which differs by contract type.

• Cost Plus Fixed Fee contracts pay a pre-determined fee that was agreed upon at the time of contract formation.

• In a Cost-Plus-Incentive Fee contract, a larger fee is awarded for contracts which meet or exceed performance targets including cost savings

• Cost Plus Award Fee contracts pay a fee based upon the contractor’s work performance. In some contracts, the fee is determined subjectively by an awards fee board whereas in others the fee is based upon objective performance metrics. An aircraft development contract, for example, may pay award fees if the contractor achieves certain speed, range, or payload capacity goals.

• Cost Plus Percentage of Cost pay a fee that rises as the contractors cost rise. Because this contract type provides no incentive for the contractor to control costs it is rarely utilized.

Usage

A cost reimbursement contract is appropriate when it is desirable to shift some risk of successful contract performance from the contractor to the buyer. It is most commonly used when the item purchased cannot be explicitly defined, as in research and development, or in cases where there is not enough data to accurately estimate the final cost.

Pros and cons

Advantages:

• In contrast to a fixed-price contract, a cost-plus contractor has little incentive to cut corners.

• A cost-plus contract is often used when long-term quality is a much higher concern than cost, such as in the space program.

• Final cost may be less than a fixed price contract because contractors do not have to inflate the price to cover their risk.

Disadvantage:

• There is limited certainty as to what the final cost will be.

• Requires additional oversight and administration to ensure that only permissible costs are paid and that the contractor is exercising adequate overall cost controls.

• Properly designing award or incentive fees also requires additional oversight and administration.

• There is little incentive to be efficient.

Fixed-price contract

A fixed-price contract is a contract where the amount of payment does not depend on the amount of resources or time expended, as opposed to a cost-plus contract which is intended to cover the costs and some amount of profit. Such a scheme is often used in military and government contractors to put the risk on the side of the vendor, and control costs. However, historically when such contracts are used for innovative new projects with untested or undeveloped technologies, such as new military transports or stealth attack planes, it can and often results in a failure if costs greatly exceed the ability of the contractor to absorb unforeseen cost overruns.

However, such contracts continue to be popular despite a history of failed or troubled projects, though they tend to work when costs are well known in advance. Some laws have been written which prefer fixed-price contracts; however, many maintain that such contracts are actually the most expensive, especially when the risks or costs are unknown.

Cost-plus-incentive fee

A CPIF Cost-Plus-Incentive-Fee contract is a cost-reimbursement contract that provides for an initially negotiated fee to be adjusted later by a formula based on the relationship of total allowable costs to total target costs.

Like a cost-plus contract, the price paid by the buyer to the seller changes in relation to costs, in order to reduce the risks assumed by the contractor (seller). Unlike a cost-plus contract, the cost in excess of the target cost is only partially paid according to a Buyer/Seller ratio, so the seller’s profit decreases when exceeding the target cost. Similarly, the seller’s profit increases when actual costs are below the target cost defined in the contract. To achieve this incentive, in CPIF contracts, the seller is paid his target cost plus a initially negotiated fee plus a variable amount that is determined by subtracting the target cost from the actual costs, and multiplying the difference by the buyer ratio.

For example, assume CPIF with:

• Target costs = 1000,

• Fixed fee = 100 (also called Target Profit),

• Benefit/cost sharing = 80% Buyer / 20% Seller,

If the final costs are higher than the target, say 1100, the Buyer will pay 1000 + 100 + 0.8*(1100-1000) =1180 (seller earns 80 which is less than if he had reached the target cost) If the final costs are lower than the target, say 900, the buyer will pay 1000 + 100 + 0.8*(900-1000) = 1020 (seller earns 120 which is more than if he had reached the target cost)

To protect the buyer, it is common to set a ceiling price. This is the maximal price the buyer will required to pay the seller, regardless of how high the costs are. When the costs exceed a Point of Total Assumption, the ceiling price is paid by the buyer, and beyond that point, the seller pays for 100% of any additional costs.

Straight re-buy- re-purchase of an existing product, routine, simple re-orders. Modified re-buy- some minor changes to existing product, not as complex as new task.

E-PURCHASING AND E-PROCUREMENT

The Internet and e-commerce is drastically changing the way purchasing is done. Internet use in buying has led to the terms “e-purchasing” or “e-procurement.” Certainly, communication needed in competitive bidding, purchase order placement, order tracking, and follow-up are enhanced by the speed and ease afforded by establishing online systems. In addition, negotiation may be enhanced and reverse auctions facilitated. Reverse auctions allow buying firms to specify a requirement and receive bids from suppliers, with the lowest bid winning.

E-procurement is considered one of the characteristics of a world-class purchasing organization. The use of e-procurement technologies in some firms has resulted in reduced prices for goods and services, shortened order-processing and fulfillment cycles, reduced administrative burdens and costs, improved control over off-contract spending, and better inventory control. It allows firms to expand into trading networks and virtual corporations.

Criteria for e-purchasing include:

• Supporting complete requirements of production (direct) and non-production (indirect) purchasing through a single, internet-based, self-service system.

• Delivering a flexible catalog strategy.

• Providing tools for extensive reporting and analysis.

• Supporting strategic sourcing.

• Enhancing supply-chain collaboration and coordination with partners

E-procurement (electronic procurement, sometimes also known as supplier exchange) is the business-to-business or business-to-consumer or Business-to-government purchase and sale of supplies, Work and services through the Internet as well as other information and networking systems, such as Electronic Data Interchange and Enterprise Resource Planning.

Typically, e-procurement Web sites allow qualified and registered users to look for buyers or sellers of goods and services. Depending on the approach, buyers or sellers may specify costs or invite bids. Transactions can be initiated and completed. Ongoing purchases may qualify customers for volume discounts or special offers. E-procurement software may make it possible to automate some buying and selling. Companies participating expect to be able to control parts inventories more effectively, reduce purchasing agent overhead, and improve manufacturing cycles. E-procurement is expected to be integrated into the wider Purchase-to-pay (P2P) value chain with the trend toward computerized supply chain management.

E-procurement is done with a software application that includes features for supplier management and complex auctions. The new generation of E-Procurement is now on-demand or a software-as-a-service.(SaS)

There are seven main types of e-procurement:

• Web-based ERP (Enterprise Resource Planning): Creating and approving purchasing requisitions, placing purchase orders and receiving goods and services by using a software system based on Internet technology.

• e-MRO (Maintenance, Repair and Overhaul): The same as web-based ERP except that the goods and services ordered are non-product related MRO supplies.

• e-sourcing: Identifying new suppliers for a specific category of purchasing requirements using Internet technology.

• e-tendering: Sending requests for information and prices to suppliers and receiving the responses of suppliers using Internet technology.

• e-reverse auctioning: Using Internet technology to buy goods and services from a number of known or unknown suppliers.

• e-informing: Gathering and distributing purchasing information both from and to internal and external parties using Internet technology.

• e-marketsites: Expands on Web-based ERP to open up value chains. Buying communities can access preferred suppliers’ products and services, add to shopping carts, create requisition, seek approval, receipt purchase orders and process electronic invoices with integration to suppliers’ supply chains and buyers’ financial systems.

The e-procurement value chain consists of Indent Management, eTendering, eAuctioning, Vendor Management, Catalogue Management, and Contract Management. Indent Management is the workflow involved in the preparation of tenders. This part of the value chain is optional, with individual procuring departments defining their indenting process. In works procurement, administrative approval and technical sanction are obtained in electronic format. In goods procurement, indent generation activity is done online. The end result of the stage is taken as inputs for issuing the NIT.

Elements of e-procurement include Request For Information, Request For Proposal, Request for Quotation, RFx (the previous three together), and eRFx (software for managing RFx projects).

Advantages

This section appears to contain a large number of buzzwords.

In reality e-procurement has the advantage of taking supply chain management to the next level, providing real-time business intelligence to the vendor as to the status of a customer’s needs. For example, a vendor may have an agreement with a customer to automatically ship materials when the customer’s stock level reaches a low point, thus bypassing the need for the customer to ask for it.

SPEND MANAGEMENT

Spend management is the way in which companies control and optimize the money they spend. It involves cutting operating and other costs associated with doing business. These costs typically show up as “operating costs” or SG&A (Selling, General and Administrative) costs, but can also be found in other areas and in other members of the supply chain.

Whether it is the money spent on goods or services for direct inputs (raw goods and materials used in the manufacture of products), indirect material (office supplies and other expenses that do not go into a finished product), or services (temporary and contract labor, print services, etc.), a company needs a mechanism by which they are not only able to save money but control costs.

Spend Management is meant to represent a holistic view of the activities involved in the “source-to-settle” process. This process includes spend analysis, sourcing, procurement, receiving, payment settlement and management of accounts payable and general ledger accounts.

In an enterprise, spend management is managing how to spend money to best effect in order to build products and services. The term is intended to encompass such processes as outsourcing, procurement, e-procurement, and supply chain management. Since the “spend manager” could have a significant impact on a company’s results, it has been advocated that this manager have a senior voice in running the company.

Cost reduction vs revenue generation

Companies divide money into two major buckets – revenue and cost. In hard economic times, when revenue is harder to come by, companies often turn to cost cutting initiatives. Cost cutting will increase net income. An increase in net income leads to a greater earnings per share and ultimately a higher market value (higher market capitalization).

Because cost cutting affects a company’s bottom line directly, certain types of cost cutting can be the quickest way companies can increase their market value. The typical consensus is that the revenue to cost ratio is about 3 to 1; for instance, increasing revenue by N300 has about the same effect as cutting costs by N100.

This is why, in hard times, companies typically turn to cost cutting measures such as layoffs and product quality reductions. However, most analysts agree that this short term tactic creates little long term value, nor any long term sustainable savings. This is why “Spend Management” has become a key long term strategy for companies seeking to maintain long term and sustainable value.

Spend management systems

Most recently, companies have been utilizing new tools such as e-sourcing (for bidding and reverse auction), e-procurement (to control and monitor purchasing activities and contracts), and e-spend analytics (to gain insight into how much money is being spent on what types of services or products).

These tools promise, not only to automate paper intensive and manual processes, but also to help monitor and control spending activity and to create an integrated process in which each activity feeds into another.

How spend management saves money

1. Decreasing “maverick” spend — “Maverick” spend is the process whereby requestors (those who are creating a request for an item or service that will be turned into an order to a supplier) buy items or services that are outside the preferred process or system. This often means that a “maverick” purchase typically results in an individual or department buying an item in an ad-hoc fashion that result in paying a 20% premium for that item. Instead of buying from a preferred supplier with which the company has negotiated a contract with discount pricing, an individual goes outside the normal process and purchases that same item at retail.

2. Increase of spend economies of scale — By directing more spend toward a particular supplier, a company can negotiate more favorable pricing based on how much money it spends with that supplier in a given year. Many companies may purchase like items from many suppliers at different prices. By consolidating this “spend” and directing it toward one or a few suppliers, companies are able to get bigger discounts. (The activity that a company goes through is called strategic sourcing (also called “supplier rationalization”). This takes a commodity-by-commodity look, taking into account business unit, location, and other requirements to find opportunities for economies of scale savings).

3. Increase process efficiencies– Automating sourcing, procurement and payment processes can greatly improve the efficiency of paper based and manual processes. However, different companies have had varying degrees of success in this area. The general idea is not to just automate, but also use the technology to improve upon these processes. (Process savings can be measured in various ways such as: how long it takes to process a purchase order, how many individuals need to touch the purchase order before it can be sent (“touch points”), how long it takes to reconcile and pay the supplier, as well as many other methods to measure these process improvements).

4. Increase procurement efficiency — This involves using e-sourcing tools for the bidding and contract award process (similar to eBay, in which you may have one buyer and many suppliers, or one supplier and many buyers). These supply chain management tools also help to develop product requirements that can be sent to suppliers (typically called an “RFP” or Request For Proposal).

A buyer (i.e. an individual at a company that has determined a need for a particular product) will develop a document that lists the need (i.e. the type of product they need and why), specifications, the bidding process (how the process will work and how suppliers will be scored), rules for the bidding process, and other factors.

Buyers will then invite suppliers to register online, and open the event for a set period of time so that suppliers can bid. At the end, the buyer awards the contract to one of several suppliers. The award can be based on price, delivery time (the time it takes the supplier to fulfill an order), or other factors such as quality or how closely the product meets the needs.

The e-sourcing of direct items (raw materials) is often much more complex than indirect (office supplies, etc.), as the deciding factor is not just price but also the way the product fits into the overall manufacturing of a product.

The way a company collaborates and transacts with their suppliers is a critical part of spend management as well. This is sometimes called “Supplier Relationship Management”. This term is often incorrectly used in place of “Spend Management”.

Spend management in context

Spend Management is a subset of Total Cost Management, which takes into consideration financial management aspects such as tax/VAT, exchange rates, the impact of demand (i.e. sales), manufacturing, and other factors.

When considered from a holistic viewpoint, Spend Management can start to feed into supply management, as it also affects how assets (capital and otherwise) and inventory are procured and managed. Spend Management (and in a bigger view Total Cost Management) starts to inform a company of Total Cost of Ownership, and is often used to understand the total cost of items such as assets (from their acquisition, to their use and depreciation, and finally to the assets’ retirement).

In the end, however, Spend Management is about creating long-term and sustainable savings. True Spend Management (and by extension Total Cost Management) is considered by many to be an ongoing cyclical process.

STRATEGIC SOURCECING

The term “Strategic Sourcing” was popularized through work with Blue Chip companies by a number of consulting firms such as PricewaterhouseCoopers, KPMG, in the early 90s. This methodology has become the norm for procurement departments in larger, sophisticated companies.

Strategic sourcing is an institutional procurement process that continuously improves and re-evaluates the purchasing activities of a company. In a production environment, it is often considered one component of supply chain management. Strategic sourcing techniques are also applied to non -traditional area such as services or capital.

The steps in a strategic sourcing process are:

1. Assessment of a company’s current spend (what is bought where?)

2. Assessment of the supply market (who offers what?)

3. Total cost analyses (how much does it cost to provide those goods or services?)

4. Identification of suitable suppliers

5. Development of a sourcing strategy (where to buy what considering demand and supply situation, while minimizing risk and costs)

6. Negotiation with suppliers (products, service levels, prices, geographical coverage, etc.)

7. Implementation of new supply structure

8. Track results and restart assessment (continuous cycle)

Outsourcing is a method that can be employed as part of the overall sourcing strategy for services. This involves the transfer of staff and assets to an external or third-party company which then provides them back as a service.

NEGOTIATION

Negotiation: An interactive process between two or more parties seeking to find common ground on an issue or issues of mutual interest or dispute where the involved parties seek to make or find a mutually acceptable agreement that will be honored by all the parties concerned.

Negotiation is a vital tool for the buyer as it allows you to communicate, influence and manage your suppliers more effectively.

When parties negotiate, they usually expect give and take. While they have interlocking goals that they cannot accomplish independently, they usually do not want or need exactly the same thing. This interdependence can be either win-lose or win-win in nature, and the type of negotiation that is appropriate will vary accordingly.

Mutual adjustment is one of the key causes of the changes that occur during a negotiation.

The parties have to exchange information and make an effort to influence each other.

As negotiations evolve, each side proposes changes to the other party’s position and makes changes to its own. This process of give-and-take and making concessions is necessary if a settlement is to be reached. If one party makes several proposals that are rejected, and the other party makes no alternate proposal, the first party may break off negotiations. Parties typically will not want to concede too much if they do not sense that those with whom they are negotiating are willing to compromise.

The parties must work toward a solution that takes into account each person’s requirements and hopefully optimizes the outcomes for both. As they try to find their way toward agreement, the parties focus on interests, issues, and positions, and use cooperative and/or competitive processes to come to an agreement.

Planning for Negotiation

“The foundation for success in negotiation is not in the game playing or the dramatics. The dominant force for success in negotiation is in the planning that takes place prior to the dialogue.” (CIArb) Yes, the tactics used during negotiations are important, and success is also influenced by how you react to the other side and implement your own negotiation strategy. However, the foundation for success is preparation.

1. Defining the Issues. Analyze the overall situation and define the issues to be discussed. The more detailed the better.

2. Assembling the Issues and Defining the Bargaining Mix. Assemble the issues that have been defined into a comprehensive list. The combination of lists from each side of the negotiation determines the bargaining mix. Large bargaining mixes allow for many possible components and arrangements for settlement. However, large bargaining mixes can also lengthen negotiations because of the many possible combinations to consider. Therefore, the issues must be prioritized.

3. Defining Your Interests. After you have defined the issues, you should define the underlying interests and needs. Remember, positions are what a negotiator wants. Interests are why you want them. Asking “why” questions will help define interests.

4. Knowing Your Limits and Alternatives. Limits are the point where you stop the negotiation rather than continue. Settlements beyond this point are not acceptable. You need to know your walk away point. Alternatives are other deals you could achieve and still meet your needs. The better alternatives you have, the more power you have during negotiations.

5. Setting Targets and Openings. The target point is where you realistically expect to achieve a settlement. You can determine your target by asking what outcome you would be comfortable with, or at what point would you be satisfied. The opening bid or asking price usually represents the best deal you can hope to achieve. One must be cautious in inflating opening bids to the point where they become self-defeating because they are too unrealistic.

6. Assessing My Constituents. When negotiating in a professional context, there are most likely many constituents to the negotiation. Things to consider include the direct actors, the opposite actors, indirect actors, interested observers, and environmental factors.

7. Analyzing the Other Party. Meeting with the other side allows you to learn what issues are important to them. Things to consider include their current resources, interests, and needs. In addition, consider their objectives, alternatives, negotiation style, authority, and likely strategy and tactics.

8. What Strategy Do I want to Pursue? Most likely you are always determining your strategy, and have been all along the planning stages. However, remember not to confuse strategy with tactics. Determine if your engagement strategy will be Competition (Distributive Bargaining), Collaboration (Integrative Negotiation), or Accommodative Negotiation.

9. How Will I Present the Issues to the Other Party? You should present your case clearly and provide ample supporting facts and arguments. You will also want to refute the other party’s arguments with your own counterarguments. There are many ways to do this, and during your preparation you should determine how best to present your issues.

10. What Protocol Needs to Be Followed in This Negotiation? The elements of protocol or process that should be considered include the agenda, the location of the negotiation, the time period of negotiation, other parties who may be involved in the negotiation, what might be done if the negotiation fails, and how will the parties keep track of what is agreed to? In most cases, it is best to discuss the procedural issues before the major substantive issues are raised.

Method of Negotiation

Distributive Negotiation: A distributive negotiation type or process that normally entails a single issue to be negotiated. The single issue often involves price and frequently relates to the bargaining process. It is also referred to as ‘Win – Lose’, or ‘Fixed – Pie’ negotiation because one party generally gains at the expense of another party.

Haggling: Is a form of distributive negotiation. Haggling means to negotiate, argue, or barter about the terms of a business transaction, usually focusing on the purchase or selling price of a product or service.

Integrative Negotiation: Integrative negotiation is often referred to as ‘win-win’ and typically entails two or more issues to be negotiated. It often involves an agreement process that better integrates the aims and goals of all the involved negotiating parties through creative and collaborative problem solving. Relationship is usually more important, with more complex issues being negotiated than with Distributive Negotiation.

Lose-Lose Negotiation: A negotiation result where all parties to a negotiation leave resources or gold on the table at the conclusion of a negotiation and fail to recognize or exploit more creative options that would lead to a ‘win-win’ negotiated outcome.

Lose-Win Negotiation: This term refers to a distributive negotiation whereby one party’s gain is another party’s loss. Both parties are competing to get the most value from the negotiation. ‘fixed-pie’ scenario in that there is only a limited amount to be distributed so there must be a winner and loser.

Win-Win Negotiation: A win-win negotiation settlement is an integrative negotiated agreement. In theory this means the negotiating parties have reached an agreement after fully taking into account each others’ interests, such that the agreement cannot be improved upon further by any other agreement. By definition, there are no resources or ‘gold’ left on the table and all creative options have been thoroughly exploited. “Win-Win” has its roots in Economics Game Theory.

Terms in Negotiation

Arbitration: A process to resolve a dispute between negotiating parties who have reached a deadlock in their negotiation. The parties in dispute are referred to a ‘third party’, which is one that is either agreed upon by the parties in dispute, or as provided by legislated law. The third party renders a judgment that is binding on the parties in dispute. Arbitration is often used in international negotiations and in collective bargaining.

BATNA: An acronym which means Best Alternative to a Negotiated Agreement. It is the alternative action that will be taken should your proposed agreement with another party result in an unsatisfactory agreement or when an agreement fails to materialize. If the potential results of your current negotiation only offers a value that is less than your BATNA, there is no point in proceeding with the negotiation, and one should use their best available alternative option instead. Prior to the start of negotiations, each party should have ascertained their own individual BATNA.

Bargaining: Is a form of distributive negotiation that is both competitive and positional. Bargaining predominates in one-time negotiations and often revolves around a single issue – usually price. One party usually attempts to gain advantage over another to obtain the best possible agreement.

Bargaining Zone: Is the range or area in which an agreement is satisfactory to both parties involved in the negotiation process. It is essentially the overlap area in the low and high range that each party is willing to pay or find acceptable in a negotiation.

Common Ground: This term refers to the area of agreement or a basis for an understanding, which is mutually agreed upon by all parties to a negotiation.

Facilitator: This is usually a mutually agreed upon neutral third party to lead a complex meeting of two or more parties involved in a negotiation. Often employed in ‘multi party’ negotiations. Their purpose is to organize, aid, and offer assistance in helping the negotiating parties find their own solutions on the issues under discussion.

Framing: A means to process and organize information. A frame provides a perspective of the problems or issues for a decision maker. One can use a frame to understand the importance of facts or issues in relation to each other. One can use this understanding of the facts or issues to then determine possible outcomes and consider contingency actions to solve a problem. Using a framework can allow you to consider all potential gains and losses and available options for any situation.

Interests: Interests are considered to be the motivating factor(s) and underlying reasons behind the ‘position’ adopted by a negotiating party. They often entail some combination of economic, security, recognition, and control issues, or the desires, concerns, aims or goals of a negotiating party in a negotiation process.

Mediation: Mediation usually consists of a negotiation process that employs a ‘mutually agreed’ upon third party to settle a dispute between negotiating parties to find a compatible agreement to resolve disputes.

Negotiation Concessions: Negotiation Concessions are also sometimes referred to as ‘Trade-Offs’ where one or more parties to a negotiation engage in conceding, yielding, or compromising on issues under negotiation and do so either willingly or unwillingly. Negotiation Concessions often include ‘log rolling’.

Negotiation Logrolling: A negotiation exchange that involves making negotiation concessions or the ‘trading-off’ of issues so as to maximize on each side’s value. So you will offer the other side something that they value more than you, in exchange for gaining something from them that you value more than they do.

Position: This is the official defined stance or standpoint which will be strongly defended by a negotiator. A position is usually determined by the interests of a negotiating party in the negotiation process. A position is often defined in the contract that a party puts forward or is proposing to their counterpart.

Reservation Price: The reservation price is the least favorable point at which one will accept a negotiated agreement. For example, for a seller this means the least amount (minimum) or bottom line they would be prepared to accept, while for a buyer it would mean the most (maximum) or bottom line that they would be prepared to pay. It is also sometimes referred to as the ‘walk away’ point.

Risk-Averse: A low level or approach in the amount of risk that a negotiator is prepared to accept in a negotiation. A negotiator who decides to accept the “sure thing” where a result is certain to be achieved is said to be “risk-averse”, and is not willing to gamble further on a potential negotiated result.

Risk-Seeking: A high level or approach in the amount of risk that a negotiator is prepared to accept in a negotiation.. A negotiator who decides to gamble rather than accept the ‘sure thing’, and who has the expectation that they will gain more in a negotiation is said to be ‘risk-seeking’.

Winners Curse: Occurs when an under aspiring negotiator sets their target or aspirations (goals or objectives) too low at the outset of a negotiation and is granted an immediate agreement by their negotiating counterpart.

ZOPA: An acronym which means Zone of Possible Agreement. It is the range or area in which an agreement is satisfactory to both parties involved in the negotiation process. Often referred to as the “Contracting Zone”. ZOPA or the Contracting Zone is essentially the range between each parties real base or bottom lines, and is the overlap area in the low and high range that each party is willing to pay or find acceptable in a negotiation.

Styles of Negotiation

Competitive

 Lack of concern for the needs of others

 Use of power to coerce others

Collaborative

 Desire & concern for others

 Assertiveness & cooperation at the same time

Avoidance

 Evasion of conflict

 No concern for own needs & others

 Self preservation by conflict avoidance

 Neither assertive nor cooperative

Accommodative

 Self- sacrifice to satisfy others

 Very cooperative

 Less assertive