9/7/2006 9:19 AM A Purchasing Manager's Guide to Strategic Proactive Procurement David N. Burt, Ph.D. NAPM Professor of Supply Management and Marketing, School of Business Administration, University of San Diego Richard L. Pinkerton, Ph.D., C.P.M. Professor of Marketing and Logistics, The Sid Craig School of Business, California State University, Fresno American Management Association New York · Boston · Chicago · Kansas City · San Francisco · Washington, D.C. Brussels · Mexico City · Tokyo · Toronto 9/7/2006 9:23 AM This book is available at a special discount when ordered in bulk quantities. For information, contact Special Sales Department, AMACOM, a division of American Management Association, 1601 Broadway, New York, NY 10019 This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. Library of Congress Cataloging-in-Publication Data Burt, David N. A purchasing manager's guide to strategic proactive procurement/ David N. Burt, Richard L. Pinkerton. p. cm. Includes bibliographical references and index. ISBN 0-8144-0288-7 1. Industrial procurement. 2. Purchasing. I. Pinkerton, Richard L. II. Title. hd39.5.b857 1996 658.7'2—DC20 95-44558 CIP ©1996 David N. Burt and Richard L. Pinkerton. All rights reserved. Printed in the United States of America. This publication may not be reproduced, stored in a retrieval system, or transmitted in whole or in part, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of AMACOM, a division of American Management Association, 1601 Broadway, new York, NY 10019 Printing number 10 9 8 7 9/7/2006 9:27 AM To Lamar Lee, Jr., Gayton Germane, and Bob Davis, all former members of Stanford University's great School of Business, and mentors of David N. Burt To William P. Stilwell, J. Howard Westing, Harland E. Samson, and Isadore V. Fine, all professors emeriti, The University of Wisconsin, Madison, and the superb teachers of Richard L. Pinkerton 9/7/2006 9:27 AM Page v Contents Preface ix Acknowledgments xv 1 Benefits of the Integrated Procurement System 1 The IPS diamond; success stories; the effect of quality of purchased material on productivity and profits; five approaches to doubling profits; IPS in manufacturing, service organizations and hospitals, government, and construction; purchasing and materials management; the steps to successful integration; summary. 2 Determining What to Purchase: The Design Process 23 Developing requirements; the design process and procurement; crossfunctional teams; the investigation phase; the laboratory phase; the manufacturing phase; engineering change management (ECM); key purchasing inputs; how to integrate engineering successfully into the procurement system; material engineers; design review committee; project teams; approved components list; suggestions from pros; summary. 3 Developing the Right Purchase Description to Save You Time and Money 37 Classifying an inventory catalog; requirement trade-off analysis; describing the purchase by brand name, samples, standard specifications, design specifications, or performance specifications; how to select the right approach; summary. 4 Procuring Services 49 Six major problems; objectives; statement of work (SOW); professional services; technical services; operating services; SOW language; summary. 9/7/2006 9:28 AM Page vi 5 How to Stretch Your Equipment and Building Dollar 59 Major problems; the capital equipment buying team; the capital equipment procurement flowchart; the process flow of procuring equipment; classification of capital equipment; installation; requests for proposals; supplier selection; total cost of ownership (TCO); financing vs. leasing, new vs. used; purchasing plant facilities; top management functions; alternative methods of purchasing construction; summary. 6 Two Key Interfaces: Production Planning and Inventory Control 72 Production planning; scheduling; forecasting; MRP; MRP II; JIT; supplier schedules in production control; the role of purchasing under MRP and JIT; proper levels of inventory; inventory costs; the fallacy of EOQ; catalogs; distribution resource planning (DRP); integrating marketing, production planning, and inventory management into the production system; electronic data interchange (>EDI); purchasing credit cards; summary. 7 To Make or to Buy: That Is the Question 96 The issues: strategy, cost, quality, quantity, service, specialized knowledge, design or production process secrecy, urgency, labor problems, plant capacity, capital equipment, use of idle resources; make and buy; vertical integration vs. specialization; summary. 8 How to Select the Right Supplier 106 Prescreening; sourcing outline and checklist for major purchases; the pre-experience supplier evaluation form; the critical evaluation factors of management: financial strength, financial ratio tests, production capacity, experience, quality assurance; R&D, delivery, purchasing expertise, price/cost controls; direct or indirect, number of proposals, local or national suppliers, global sources; request to bid, quote, or get information; what is an offer?; lower bid implications; when to use competitive bidding; selecting the source; source development; supplier certification; supplier contract management; final supplier rating forms; suggestions to reduce mistakes; summary. 9 Price Analysis 132 Basic supplier pricing strategies; pricing elements under the control of purchasing; defining fair and reasonable pricing; the price analysis process; competition; catalog or market price; price comparisons; engineering estimates; keeping total cost low; transportation costs; two-step procurement; the special case of "price in effect at time of delivery"; 9/7/2006 9:28 AM target pricing and cost drivers; summary. 10 Cost Analysis 146 Cost within a traditional relationship; the supplier's cost breakdown: materials, labor, overhead; activity-based costing; proof profit; the role 9/7/2006 9:28 AM Page vii of estimates; price increases; cost within a strategic supply alliance; target costing; summary. 11 Value Analysis and Value Engineering 156 Development of value analysis and value engineering; principles, techniques, and examples; the VA-VE procedure; the two faces of VA/VE; the keys to successful implementation; summary. 12 Quality Assurance Overview 169 Defining quality; total quality management (TQM); mapping TQM, quality function deployment (QFD); continuous improvement (CI); the major technical quality tools; statistical process control (SPC); the control; the investigative tools of quality assurance; design of experiments (DOE); Pareto analysis; cause-and-effect diagrams or "fishbones"; plan-do-check-act (PDCA); the poka-yoke system; Certification Program; the Malcolm Baldrige National Quality Award; the Deming Prize; supplier certification; benchmarking; the role of purchasing in quality assurance; summary. 13 Team Building 188 What is a team?; the team's charter; a recent case history; how to have more effective teams; clearly defined objectives; explicit goals and vision; team structure and mandate; competent team members; types of team members; unified commitment; collaborative climate; the four stages of team development; standards of excellence; exterior support; recognition, rewards, and motivation; principled informal and formal leadership; the special situation of cross-functional sourcing teams; measuring team progress; final thoughts and warnings; summary. 14 The Winning Way of Negotiating 199 What is negotiation?; the best of Fisher, Ury, and Patton's "Getting to Yes"; problems in negotiating; when to negotiate; what to negotiate; preparing for negotiation and fact-finding; determining bargaining strength; final agenda preparation; practice; the negotiating meetings; negotiating techniques; how to handle the difficult potential or current supplier; hints for the negotiator; terminating and/or documenting the agreement; negotiation post mortem; negotiating with someone from another culture; summary. 15 Strategic Supply Management 218 Supply as a competitive weapon; integrating supply strategy with the strategic business units' (SBUs) strategy; gaining velocity during 9/7/2006 9:28 AM development and production; measuring continuous improvement; sourcing globally; optimizing the cost of ownership; centralizing supply strategy; purchasing power with measurement; data available and 9/7/2006 9:29 AM Page viii used; supply base by design; leverage supplier technology; monitoring the supply management; managing relationships; value chain management; summary. 16 Planning for Proactive Procurement 229 Defining "planning"; procurement planning; the current situation analysis phase; the objective phase; the consolidation procedure as a major planning tool; the creative new action steps (the new plan); the great assumptions; the materials plan; the procurement planning chart; planning hazards; implementation, monitoring, and revision; summary. Appendix A: Make-or-Buy Policy and Procedure 241 Appendix B: Supplier Welcome Booklet 248 Appendix C: The Learning Curve 269 Appendix D: Alternative Methods of Contract Pricing 274 Appendix E: Other Approaches to Cost Estimating 282 Appendix F: Special Secondary Source Techniques for Estimating Cost Components 287 Appendix G: Managing Price Increases 290 Appendix H: Statistical Process Control 292 Appendix I: Design of Experiments 297 Appendix J: Supplier Quality Survey Example 300 Appendix K: Sample Audit-Situational Analysis Questionnaire 307 Index 313 9/7/2006 9:29 AM Page ix Preface Much has happened in procurement circles since David N. Burt's book Proactive Procurement was published in 1984. We like to think Proactive Procurement had at least a small part in focusing attention on the importance of procurement in containing costs, improving quality, increasing productivity, shortening concept to customer delivery times, and strengthening the integration of materials management into the total operations of an organization. A Purchasing Managers Guide to Strategic Proactive Procurement retains the visionary topics of Proactive Procurement while adding the very latest and, indeed, future procurement methods for effective purchasing in the twenty-first century. A great many trade books addressing an organization's relations with its suppliers have appeared recently. Perhaps the most advanced is the American Keiretsu by Burt and Michael Doyle (Homewood, Ill.: Business One Irwin, 1993). Whether these books stress early supplier involvement, partnerships, alliances, strategic procurement, or supply management, all these themes require and expressly state the need for the procurement process to be a "value adder." The integrated procurement system (or IPS) as first described in Proactive Procurement adds value to the firm's operations. The heart of the IPS is the cross-functional procurement team composed of representatives of Design Engineering, Manufacturing Engineering, Purchasing, Manufacturing, Quality Control, key suppliers, Marketing, and, when relevant, Finance. This integrated procurement system preceded the horizontal corporation by some 10 years, and in some ways, it prepared the way for this approach to organization and management. The other major action prescribed in Burt's 1984 work was the growing practice of beginning the procurement emphasis at the design stage while contracting or outsourcing maintenance, repairs, and operating supplies (MRO) and basic raw materials under long-term systems contracts and blanket orders with one or two suppliers. Management is slowly recognizing that the major procurement effort must be strategic and play a key role at the product-service concept development stage. At this stage, quality is designed in, cost is designed out, and the time required to bring a new product to market is reduced. The foregoing changes also dictate the need for more professionally trained personnel in the purchasing or procurement function, now called supply management or sourcing by a few forward-thinking firms. Gone are the days when an individual could simply progress through on-the-job-training from secretary or [...]... item that incorporates the purchased material Purchasing 9/7/2006 9:34 AM Page 13 Exhibit 1- 5 The functional organization and procurement activities in the IPS: manufacturing 9/7/2006 9:35 AM Page 14 must maintain a good dialogue with Marketing on changes in material prices and availability and product acceptance relative to purchased components to allow Marketing to update sales quotations and current... reactive purchasing department generally are constrained by activities that have taken place before purchasing becomes involved in the procurement The very survival of the organization may be affected by the presence or absence of a viable strategic material plan Under the myopic approach of traditional reactive purchasing, the company may awaken one day to a world in which sources of supply capable of... requirements are fully occupied supplying the company's competitors and are unavailable Proactive procurement includes strategic supply management as a key responsibility and, as discussed in Chapter 15 , helps to avoid such situations 9/7/2006 9:34 AM Page 7 Materials Selection The implementation of an integrated proactive approach to procurement can significantly affect productivity For example, many of... be suitable alternatives to machined metal knobs, at a savings of 85% Market share, prices, and profits are all favorably affected by attention to quality Today, quality and reduced time to market have replaced price as the key to increased market share and profit margins Procuring the right quality materials frequently is the quickest and easiest way to improve the quality of the final product Procuring... Production Planning, an Inventory Management Into the Procurement System Purchasing managers must show missionary zeal in making Marketing, Production Planning, and Inventory managers aware of the cost and productivity implications of inadequate purchasing lead time Managers should develop examples showing the results of adequate and inadequate lead time These examplessome with happy endings and some of... alloy under consideration The zinc alloy cost half the price of the tin-bronze alternative 2 Another manufacturer found that a synthetic insulation material was far superior to asbestos in the production of high-temperature hose lines The synthetic material cost one third as much as the asbestos and avoided the latter's hazards 3 An appliance manufacturer found molded plastic knobs to be suitable alternatives... be a better way Extreme? Perhaps Perhaps not All managers have experienced many of Ted's problems There is a way of avoiding most of them, and, in turn helping the purchasing department to make a greater contribution to profitability That way is proactive procurement And you can and should be responsible for making it happen Total quality management (TQM), just-in-time (JIT) manufacturing, simultaneous... cooperation But once this cooperation is achieved, it must be maintained-one of a proactive purchasing manager's most important responsibilities Five Approaches to Doubling Profits Virtually all managers want to improve their organizations' performance For profit-making organizations, profits are a key indicator of performance For gov- 9/7/2006 9:34 AM Page 10 ernment and other not-for-profit organizations,... Procuring the right quality materials is far more likely to occur when a firm uses a proactive approach to procurement than the traditional reactive approach A recent famous case of unilateral purchasing decision making involved the enormous price pressure by Ignacio Lopez, GM's former corporate purchasing chief Lopez restored a focus on low price versus total cost at GM with, according to Business Week,... control are common indicators of performance The principle contained in the following example is easily transferable to any of these organizations A hypothetical situation with our friends at Eagle Manufacturing emphasizes the profitmaking potential of procurement Eagle has a product line with a sales volume of $2 million and expenses as shown: Sales Purchased material Labor Overhead Profit $2,000,000 1, 000,000 . concept to customer delivery times, and strengthening the integration of materials management into the total operations of an organization. A Purchasing Managers Guide to Strategic Proactive Procurement. of AMACOM, a division of American Management Association, 16 01 Broadway, new York, NY 10 019 Printing number 10 9 8 7 9/7/2006 9:27 AM To Lamar Lee, Jr., Gayton Germane, and Bob Davis, all. the implementation of IPS and a proactive approach to procurement and IPSs. By the way as far back as 19 81, Victor H. Pooler and David J. Porter were using the term proactive purchasing. 3 Successful