METHODS AND TECHNIQUES FOR CONTROLLING THE PERFORMANCE OF THE NPR PURCHASING PROCESS

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1 METHODS AND TECHNIQUES FOR CONTROLLING THE PERFORMANCE OF THE NPR PURCHASING PROCESS Corina POP SITAR North University of Baia Mare Abstract This paper investigates the current practice with regard to the methods and techniques that are used in order to control the performance of the NPR (non-product-related) purchasing process. First we emphasis the importance of the purchasing and we concentrate over to the NPR purchasing. Furthermore we present the control concept. Then, we describe the current methods and techniques that are used for controlling the performance of the NPR purchasing process. At the end of the paper we present the major disadvantages of the current methods and we propose new approaches for controlling the performance of the NPR purchasing. Keywords: control, purchasing, management. 1 INTRODUCTION It appears that during the past few years purchasing has begun to play an ever more important role in the strategy of the firm (Ellram, 1994; Carter and Narasimhan, 1996; Weele and Rozemeijer, 2006). In order to survive, managers have begun to rethink their competitive priorities and their value chain. Increasing numbers of organizations have recognized that effective purchasing holds the potential to transform their competitive performance for the better. The importance attached to effective purchasing has increased not only because organizations realize that one dollar reduction in purchasing spending equals a one dollar increase in profit (whereas one dollar in sales might only lead to a 10 cents increase in profit) but also because of the tangible success of high visibility organizations as Toyota, Daimler Benz, Siemens, Philips, etc who have each developed effective purchasing and supply chain management as a core competence. The supposed increased importance of the purchasing function is most notably reflected in the growing share of turnover organizations spend on paying their suppliers for delivering all kinds of products and services. The purchase value of goods and services contributes substantially to a company s turnover (see table 1). The importance of the purchasing function is not limited to the financial impact on the organization. The significance of the purchasing function can be related to the growing need for companies to simultaneously meet market demands such as quality, price, flexibility and the level of innovation (Wijnstra, 1997). In order to meet these demands as well as to achieve cost reduction, companies have been forced to apply a more integrated approach in quality management and logistics. Given the significance of purchasing outlined above, it can be concluded that purchasing has an important effect on the profitability of an organization and that it forms an important (potential) source of competitive advantage for many companies. Therefore, there is too much at stake for the company s purchasing activities not to be well equipped and professionally organized, and not to form an integrated part of the organization. 118

2 Table1 Company Purchasing ratio Canon 89.9 % Minolta 74,7% Nikon 77% Olympus 83% Ricoh 83,3% Sharp 71% Sony 90,8% Purchasing ratio in some leading Dutch companies Source: van Weele (2006) NPR goods and services are known by many names: indirect goods and services, goods not for resale, non-bill of materials. No matter how they are called, the NPR purchases include all goods and services other than raw materials, production items, and MRO supplies, such as: capital equipment (e.g. vehicles, lathes, etc); services (e.g. health care plans, insurance, advertising, legal assistance, and telecommunications). The obvious characteristic of NPR goods and services is that they are not used in the primary production processes. They are purchased in order to support and facilitate all other activities within the organization. Non-product related purchases have a number of characteristics (Telgen and de Boer, 1995): they comprise a wide range of goods and services, which are often purchased from an even larger number of suppliers; they are often time consuming as many are non-standardized items which are usually purchased in small orders; they show high end user involvement in the tactical purchasing phase which leads the NPR purchasing process to be spread out all over the company; in total there is a lot of money involved in NPR purchasing; however NPR typically receives limited management attention. A dominant factor to be considered with regard to the importance of NPR purchasing is the yearly amount of money involved. In many services and government organizations such as banks, accounting firms, and hospitals, the total purchase volume can be regarded as purchasing expenditures on non-product related goods and services. In industrial and retail organizations this will naturally not be the case because a considerable part of the total purchase volume consists of purchasing for primary process. However, in the purchasing of NPR goods and services huge amounts of money are involved. Large corporations typically spend over 30 % percent of their revenues on NPR purchases. AT&T, for example, found out that they spent 60% of their $20 billion-a-year purchasing bill on NPR goods and services such as travel and car-rental, real estate, computer hardware and software, services, office furniture and supplies, services, cleaning materials, etc. Another example is Xerox who spent almost 73% of their $6 billion-a-year total spend on NPR goods and services (Rozemeijer and van Weele, 1996). 119

3 Another typical factor regarding NPR purchasing is the low attention from top management. NPR purchasing is not seen by managers as a necessity, compared to the purchasing of items and services for the primary process. As a consequence, structural attention and mangement of purchasing of NPR goods and services is not considered as a tool for improving effectiveness and reducing expenditures. Because of the lack of clear and direct insight in the size and contents of the purchasing volume of non-production items and services, managers are missing out opportunities for adding value to their organizations 2 THE CONTROL CONCEPT The control model that has been created by De Leeuw (1974) contains three basic elements: 1. a controlling system; 2. a system that is subject to control (controlled system); 3. an environment which can impact the two other systems both positively and negatively (see figure number 1). Environment Controlling system Controlled system Figure nr.1: Control paradigm (De Leeuw, 1974) Using this paradigm, and taking the viewpoint of the controlling system, Kramer (1978) defines four conditions for effective control of the controlled system: 1. the controlling system must define a goal, which serves as a guide in deciding on which controlactions to take; 2. the controlling system must have an adequate model of the controlled system; 3. the controlling system must have sufficient information on the environment and the system under control; 4. the controlling system must have a sufficiently rich set of alternative courses of action to choose from. For example, the controlling system could be the general management in an organization and the controlled system could consist of the purchasing department. Naturally, the boundaries of the controlling and controlled systems may be fixed in other ways. For example, the controlling system can be the purchasing department in an organization and the controlled system can consist of all the buyers within the entire organization. In this case the environment consists of all internal customers. Another possibility is when the purchasing department is the controlling system, while the controlled system consists of all the active suppliers and the environment consists of the internal customers. The examples can continue but the general idea is the same (see figure 2). We emphasize that figure 2 is not exhaustive. Given a specific control configuration has been decided upon, appropriate measures have to be taken in order to comply with the conditions for effective control. For example, the general goal of 120

4 achieving optimal purchasing performance must be specified in more detail according to the particular control configuration under consideration. Purchasing performance is a relation between the purchasing output or results (purchasing effectiveness) and the purchasing input or resources (purchasing efficiency) through which the purchasing objectives are realized (Van Weele 2000). On a general level, Purchasing effectiveness can be evaluated along four main dimensions: - contribution to cost reduction; - contribution to product and process quality; - contribution to logistical performance; - contribution to customer satisfaction. Organization Internal customer Internal customer General Management General Management Purchasing Department Purchasing Department Buyers Suppliers Figure 2: Examples of controlling and controlled systems However, depending on the definition of the controlled system, these general effectiveness dimensions may require different measures. If we want to investigate the effectiveness of the buyers in the organization we may need other measures of cost reduction compared to the cost effectiveness of say suppliers. The same applies to Purchasing efficiency: depending on the controlled system (buyers, departments, commodities, suppliers etc) the kinds of input (resources) employed will differ and hence need different measures. 3 METHODS AND TECHNIQUES FOR CONTROLLING THE PERFORMANCE OF THE NPR PURCHASING PROCESS Follwing Telgen (1998) Purchasing Control can be defined as an instrument for supporting the regulating or managing the entire purchasing function. In particular, it contributes in two ways: 1. Providing quantitative insight in purchasing flows through the organization. Basically, it provides answers to questions like: - What is the total purchase volume? - How much of that is spent on BOM and Non-BOM related items and services? - How much do the different departments buy? In total as well as broken down into different commodities etc. - How many active suppliers do we have? - Etc 2. Based on the quantitative data, identifying and detecting the apparent weak spots in the purchasing function. Purchasing Control is on the outlook for suspicious situations, e.g. an 121

5 extremely large number of suppliers for a minor non-bom commodity. Further investigates is always necessary to assess whether the suspicion was justified. It is important to note the broad and explorative nature of Purchasing Control. In that respect, Purchasing Control is different from the often much more focused and dedicated purchasing performance measurement systems, like e.g. a particular vendor rating application. In practice approaches for purchasing performance measurement and control are grouped by Lysons (1996, pp ) under four main categories: 1. Accounting approaches: profit centers activity based costing standard costing and budgetary control 2. Comparative approaches: benchmarking ratios 3. The purchasing management audit approach 4. Management by objectives. The profit centre approach involves establishing a centralized purchasing organization that controls assets and is responsible not only for expenditures but also for income. The profitability of the purchasing function is generated by an internal accounting transfer of items and services procured by purchasing to other functions at a price above their actual direct cost. In effect purchasing sells to other functions at a transfer price. The performance is measured by the profits generated by the purchasing function. This approach is more theoretical than practical due to its weaknesses: decentralization of control increases administrative costs; an equitable transfer price is quite difficult to determine; transfer charges may lead to inter-functional conflicts. The activity based costing approach makes a distinction between value adding and non-adding activities and tries to reduce or eliminate if possible the non-adding activities. Also, an analysis of cost drivers is made and potential cost savings are identified. Standard costing is used in many organizations to evaluate the purchasing department s pricing performance. Standard costs monitor performance by comparing the effective costs with the standard costs and analyzing the variances. One of the traditional control and evaluation tools used in organizations of all types is the budgetary process. Budgets are derived from objectives. A figure is given which is the estimated expenditure required to meet the desire objective. This budget figure is then used as a control comparing actual expenditure with projected. If the materials purchase, MRO, capital, and purchasing administrative budgets are carefully prepared, based on realistic assumptions about the future, they provide a reasonable standard against which actual expenditures can be compared. These budgets only include the direct and production materials and the departmental expenses, whereas indirect materials and other items remain out of focus. They indicate only the maximum spending but they can not control the quality of purchasing: what is purchased?; at what price?; from which supplier?. Benchmarking approach aims to discover best practice wherever it might be found. The idea is to identify key characteristics of best practice and adopt them. Benchmarking of the purchasing department is seen as increasingly important factor in maximizing overall company performance. This process is becoming easier for many companies as a result of objective industry standards of performance being established through high-powered research conducted by CAPS into key purchasing areas. The purchasing performance benchmarking permits an answer to the question how is the firm doing, compared to other firms? by providing averages for measures of purchasing performance. But this comparison is not so relevant, it can only indicate if the purchasing performance measures are under or over the average. It can not indicate the causes for poor performance and what correction actions have to be done in order to obtain superior performance. 122

6 Ratios show the relation between two variables and can be used to indicate trends, set standards and control costs. Some of the ratios that are used to measure and control purchasing performance are: purchase dollars as percent of corporate sales; average purchasing order cycle time; percent of total goods purchased handled by purchasing department; average cost of orders placed, etc. Most of the ratios serve primarily as indicators or warning-signals. They do not explain why certain problems occur and additional research is needed to identify their cause. The purchasing management audit approach assesses the extent to which goals and objectives of the purchasing department are balanced with its resources. Scheuing (1989, pp.137) has defined the purchasing management audit as a comprehensive, systematic, independent and periodic examination of a company s purchasing environment, objectives, strategies and tactics to identify problems and opportunities and facilitate the development of appropriate action plans. A purchasing management audit usually analyzes the following issues: purchasing personnel; purchasing organization; purchasing policies and procedures; purchases, suppliers and prices; inventory; purchasing reports; purchasing problems and opportunities. Purchasing management audits are little used because of the time and costs involved. Management by objectives approach aims to identify the objectives that a manager or function should be expected to achieve within a given period. At the end of the period the actual performance and will be compared with the desired results. Management by objectives approach entails goal setting, participation, periodic reviews and evaluation. There are three main types of objectives: improvement objectives, personal development objectives and maintenance objectives. This approach can be used for assessing the effectiveness of the purchasing function. 4 CONCLUSION We observe a growing dissatisfaction with actual performance measurement and control systems. In particular, we point out three problems: 1. Measurement and control systems have failed to keep up with changes in functions, task-skills and expectations; 2. Most of the performance measurement systems concentrate only on purchasing activities that are performed in the purchasing department, while the purchasing performance outside the purchasing department remains out of focus; 3. Performance measurement and control systems described in the Purchasing and Supply literature seem to show a gap in linking efficiency-measures with effectiveness-measures in Purchasing. Most systems concentrate on controlling and measuring only purchasing efficiency based on the assumption that an excellent purchasing organization leads to high purchasing performance (purchasing effectiveness). In many organizations non-product related goods and services are purchased without the involvement of the Purchasing Department. This is not necessarily bad but it requires management to control these purchases in order to make sure the organization s interest is well served. Two approaches can be used in performing the control phase of purchasing management: problem prevention (pre-action control) where possible, followed with a monitoring system that detects problems (post-action control) that slip through the prevention net. With regards to control of the purchasing performance the following methods can be used in practice: A. Pre-action control: 1. Budgeting - In the purchasing area several budgets may be used e.g. per purchasing package (materials, MRO-items, capital investments) and/or per department. 2. Limited buyer authority. The manager can control expenditures by requiring larger expenditures to be signed by a purchasing manager. 123

7 B. Post-action control: 3. Monitoring purchasing cost savings - These refer to the extent to which the purchasing function is able to lower total costs of purchased materials. 4. Ratios and indices 5. Purchasing reports - Information on how the purchasing function operates may be regularly reported to top-management. 6. Audit - The purchasing audit is a review-procedure to ensure that proper procedures relative to purchasing and management principles have being applied. Also, for all of these approaches to be manageable we have to create within the organization appropriate structures and to provide appropriate training, supervisory guidance and motivation for personnel in order to be able to do it properly. 124

8 REFERENCES [1] AXXELSON, B. and WYNSTRA, F., Companies buy services, don t they?. Proceedings 9 th IPSERA Conference,2000, London, Ontario, Canada, [2] ATKINSON, W., Buyers are involved cradle to grave. Purchasing Magazine,, 2000, October 19, [3] ELLRAM, L.M., Strategic Purchasing : a history and review of the literature, Journal of Purchasing and Materials Management, 1994, Spring, pp [4] [5] FEARON, H.E. and BALES, A.W., Purchasing of nontraditional goods and services, 1995, CAPS Report, NAPM. [6] DUMOND, E. J. Performance measurement and decision making in a purchasing environment International Journal of Purchasing Management, 1991, Spring, pp [7] MICHELS, W. L., Nontraditional Purchasing needs nontraditional methods. NAPM s 81 st Annual International Conference Proceedings, 1996, Chicago,IL. [8] NOWIKOW, C., Revolution, or evolution, Supply Management, 1999, September 23, [9] PORTER, A. M., Taking control of indirect corporate spending, Purchasing Magazine,1999, September 2, [10] ROZERMEIJER, F.A., How to manage corporate purchasing synergy in a decentralised company?, Proceedings 8 th IPSERA Conference, 1999, Belfast and Dublin, pp [11] TELGEN, J. and de BOER, L., Developments in purchasing of non-production items. Proceedings 4 th IPSERA Conference, 1995, Eindhoven, 1-8. [12] WEELE, A.J. van and ROZERMEIJER, F., Revolution in purchasing: building competitive power through pro-active purchasing., Philips Electronics, 1996, Eindhoven. [13] WEELE, A.J van, Purchasing management: analysis, planning and practice, 2006, Chapman & Hall. [14] WIJNSTRA, J.Y.F., Purchasing and the role of suppliers in product development, licentiate thesis,1997, Uppsala University. 125