Price may vary between suppliers at different times due to the following factors:
(i) Quantity Consideration:-
Some suppliers do offer an incentive to buyer (quantity discounts) so as to give the supplier a larger share of the available business. The vendor may also pass on to the buyer some part of the savings made on large purchases in the areas of production, selling and transport costs.
(ii) Payment consideration:
To ensure prompt payment, suppliers do offer cash discount, as it enables them reduce borrowing and the risk of possible bad debts.
(iii) Time consideration:
Discounts may be offered to encourage purchasers during slack periods or off-season.
(iv) Quality consideration:
Where more expensive materials are used, this reflects on the cost of production. It may even be due to higher standards of accuracy or a “brand name”
(v) Distribution terms:
Oftentimes, suppliers do offer trade discounts to compensate suppliers or buyers for undertaking distributive function.
(vi) Transport terms:
This depends on whether the goods arrived on either EX, FOB, FAS, C&F or CIF conditions.
What is the Right Price?
The right price may not necessarily be the lowest price. What is the right price depends on the situation, since it is influenced by quality, quantity and delivery time. Price is also related to the supplier, and the price quoted will reflect the efficiency of his or her production facilities and also to the extent to which he or she desired the required business, and whether his or her prime aim is to make a quick profit or to establish a long-term connection based on a reputation for quality and reliability.
It can be deduced from the above that any price is a concept of cost, economic and competitive factors. The competent buyer will have a sound grasp of all these factors and will seek to buy at the lowest cost that in the line with the constraints of his buying power. On the whole, the buyer usually realizes that price and value do not mean the same thing
The Right Time
Stated in simplified form, the purchasing department’s responsibility is to buy material of the right quality, from the right supplier, for the right price at the right time, in the right quantity. When purchasing most materials, the last three responsibilities are closely interrelated. The time at which some purchases are made frequently determines the price paid; similarly, the quantity to be purchased at any given time is a direct function of anticipated future purchase timing. It is essentially a prime responsibility of any buying activity to ensure that supplies are available when required. This is not a simple task because of the vagaries of supply, Late deliveries are always the bane of a buyer’s life.
Rightly, the difficult supplier is taken to task and probably penalized, in some way, when further business is being considered. The “right” time to order, or obtain delivery of goods ordered, depends upon some factors which can be particularly significant in different circumstances. The main factors are:
1. The regularity with which supplies are available.
2. The regularity or continuity of usage
3. The effect oftiming on the costs of ordering
4. The effect oftiming on the stock holding costs
5. The “cash flow” situation of the buying company
6. Whether the timing of orders affects or is affected by the price to be paid
7. The effect of the lead times involved.
The relevance and importance of the majority of these factors has already been discussed at various points in earlier topics
Lead time is the time between when an action is initiated and that action is implemented. In a manufacturing set-up, there are several lead-times, such as ‘production planning lead time” design lead time” and manufacturing lead time”, but in purchasing, the “overall lead time is that between the recognition of a need and the ultimate satisfaction of that particular need.
This will include the following steps:
(1) Definition of a material need
(2) Notification of the need to purchase through requisition or delivery schedule.
(3) Selection of the suppliers and ordering by the purchasing department.
(4) Production of the goods by the supplier.
(5) Transportation of the goods to the buyer
(6) Receipt, inspection and storage of the goods for the user to requisition
The time between the placement of the order and receipt of the goods is the “delivery lead time”. The overall lead time can be reduced quite considerably by the buying company through any of the following measures:
(a) Efficient production scheduling, giving early notice of needs and requirements; or
Better stock control procedures enabling quicker order processing.
(b) More efficient purchasing procedures enabling quick order processing
(c) A very efficient system of suppliers’ selection giving more reliable production and delivery times.
(d) Better transport and handling of supplies giving rapid availability.
Economic Ordering and Scheduling
Economic ordering, as it affects quantity, had been treated in the early part of this chapter. This particular portion is more concerned with economic ordering in terms of time. Receiving goods ordered too early or too late (earlier than or later than programmed) creates some problems outlined here-under, which can seriously affect the profitability of the company.
Economic ordering of items held in stock will depend upon a company determining and maintaining maximum order and minimum stock levels, which ensure continuity of supply with minimum investment in stock.
Economic ordering of items to be used directly in line with production will depend upon the provision of accurate delivery schedules, bearing in mind the lead time involved and economic quantities.
Effects of Early Delivery
If a buying concern receives goods ordered for before the time schedule for delivery. It is faced with the following problems:
1. Unnecessary capital tied up in stock
2. Unmcessary use of valuable space
3. Possible confusion and handling difficulties
4. Possible damage or deterioration of materials
Effect of Late Deliveries
This really has far-reaching and more serious negative effects such as:
1. Stoppages in production
2. Under-utilisation of production facilities
3. Late deliveries to customers
4. Loss of business goodwill and reputation
Factors Affecting Lead Times and ordering Policy
Apart from, whether demand is dependent or independent, variable or constant, and special sensitive commodities, important aspects relating to the determination of lead times and ordering policy include:
(a) Forecasting demand
(b) Review of stock levels
(c) Insurance against loss through stockouts; and
(d) Fixing reorder levels and buffer stocks
Much of this information can be provided quickly by computerized systems but the essential principles should be understood.
(a) Forecasting demand:
Before an effective system of inventory control can be implemented, it is rather important to analyse the trend of demand for a given material in stock over an estimated period of time, from available
records, with a view to forecasting future requirements. There are two common approaches namely: the use of moving averages and of exponentially weighted averages. These methods can, of course, be used in respect of any type of purchases and not necessarily restricted
(b) Review of stock levels
Most methods of stock control fall into either a fixed order or periodic review system:
(i) Fixed order system:
In this case, stock is continuously reviewed and an order placed when the total stock, including any outstanding purchase orders, equals or falls below a predetermined reorder level known as the reorder point.
The purchase order is thus for a fixed quantity and will be calculated thus: lead time x usage x safety stock=order quantity.
(ii) Periodic review system:
Here, the stock position is subject to review periodically and a purchase order issued, if necessary, at each review. However, the order will only be for a variable amount namely: the quantity required to bring the stock up to a predetermined fixed level. Maximum stock can be determined by adding one review period to the lead time, multiplying the sum by the average rate of usage and adding any safety stock.
(c) Insuring against stockouts:
Very early reordering implies a high safety stock and a low stockout risk. Except where the stockout cost would be high, as would probably be the case with most category ‘A’ items in an ABC analysis or “V”items in a VED analysis, such a policy is likely to be uneconomical. It is therefore necessary to determine in respect of significant items what is an acceptable risk of stockout and fix order quantities and buffer stocks on this basis.
(d) Reorder levels and buffer stocks
The probabilities mentioned above can be used to calculate reorder levels and buffer stocks to ensure a specified degree of security against stockouts. Apart from dependent and independent demand, cases to consider; viz where demand is constant and where it is variable. These will determine the reorder level.
Market Conditions for Special Commodities
There are items which are materials for industrial usage and are, in most cases, natural resources of the originating countries. By nature, their availability is restricted to some countries. What is significant is that their prices fluctuate daily and are determined essentially at interational market exchange. In this case, the buyer aims to target the purchasing of his requirements at the most competitive prices. Such commodities are copper, cotton, iron ore, tin ore, crude oil, cocoa, etc.
The market condition of these commodities are heavily influenced by the following economic and political factors.
(a) Government policies:
This depends on both the selling and buying countries’ policies on, say import controls, export regulations, stock-piling policy, etc.
(b) Currency fluctuations
e.g the strength of the sterling or dollar at the material time;
e.g the effect of increased material and labour costs;
(d) Interest rate
eg minimum and/or maximum lending rates;
(e) ‘Glut’ or shortage of supply e.g crop failure;
(f) Relationship between exporting and importing countries
e.g oil may be used as a political weapon.
Economic Conditions of the Market
To be able to purchase competitively and wisely in this market, a thorough understanding of the market conditions will be very appropriate. A market for any of these products can be one of two types, namely:
(i) Buyer’s market: Here, the buyer has the upper hand in determining policy regarding price and other purchase term; or
(ii) Seller’s market: On the other hand, the controlling power for policy determination on price and other terms rest solely with the producer or main distributor/seller
Market conditions also indicate whether prices in the short or long term will either be volatile (subject to considerable fluctuation) or stable (subject only to minor fluctuations in price). It should be noted, however, that the terms ‘short, and long are not easy to define and are sometimes complex, if not ambiguous. In their book titled “Economic Theory”. Stonier and Hagne define short term as “a period of time within which firms can only increase output by hiring more labour and buying more materials” i.e fixed costs such as capital equipment cannot be altered during the period. long term is thus regarded as the opposite of short term.
Information sources regarding present and future conditions of the market of any of these commodities could be from the following:
(i) Government sources e.g Ministry of Trade
(ii) Documentary sources either general e.g business journals or ‘specialized technical publications relating to the particular commodity,
(iii) Federation e.g World Cocoa Council, OPEC, etc.
(iv) Chambers of Commerce
(v) Exchange: They essentially include independent research undertaken by brokers and dealers into commodity as regards its short and long term prospects.
(vi) Data banks
(vii) Analysts: They include economists and statisticians employed by organisations to advise on corporate planning and purchasing policies and external units such as the Commodities Research Bureau.
What is required of the buyer is to synthesize and evaluate information and recommendations gathered from the above and put forward appropriate policies. Such policies are essentially in two categories, namely
(a) Hand-to-mouth buying; and
(b) Forward buying
The buying here is done essentially according to need and not in the most economic quantities. Such a policy can be necessitated by circumstances as falling prices or imminent change in design of either the product or its end-product. Thus, there is the necessity to avoid large stocks.
This is applied when purchases are made in order to increase stocks beyond the minimum quantities needed to meet normal production requirements which is based on average delivery times. Forward buying may be applied under any of the following conditions:
(a) to obtain the benefits of EOQs;
(b) when savings made by buying in anticipation of a price increase will be greater than the interest lost on increased stocks or the cost of storage;
(c) to avoid breakdowns in production due to occurrences such as strikes or stock-piling to avoid shortages;
(d) to secure materials for future requirements when the opportunity arises
Forward buying can be applied to any material or equipment. However, the aspect of forward buying that is particularly applicable to commodities is Futures dealing.