To be able to meet customer demand, every business needs to have enough product on hand.
And to have enough product, the business needs to have sufficient quantities of raw materials, parts and components needed to manufacture the product.
When these items are purchased from an external supplier, Purchase Management is required.
Here’s what we’ll cover in this article.
- Purchase Management defined
- Why Purchase Management is important
- The Purchase Lifecycle: Step by Step
- Why consider a Purchase Management System
- Key Takeaways
Purchase Management defined
Purchase Management refers to the set of business functions and processes with which companies purchase items from external suppliers.
A company’s Purchase Management strategy is directly linked to the company’s strategic objectives as it helps the company meet its performance metrics – especially its profitability targets.
Purchase Management includes a range of activities from managing internal demands, searching externally for items and suppliers, managing the purchase order processes, ensuring the deliveries are received on time and on quality as well as liaising with inventory management and accounting as needed.
We’ll cover these activities in some detail later in the article.
Why Purchase Management is important
Competent Purchase Management can have a very positive effect on all critical parts of your business including, and especially, your bottom line.
Benefits of Purchase Management when done correctly:
- Access to high quality raw material, parts or components for your product
- Build an ecosystem of reliable suppliers.
- Have adequate inventory levels to always be able to meet customer demand.
- Ensure a high–quality end-product.
- Improve your business’s cash flows.
- Improve your Profit Margins
Let’s review each of these, one by one.
Quality Raw Material, Parts, Components
A key task of Purchase Management is to research the market for the materials (or services) which need to be externally acquired. In this respect, Purchase Management processes play a direct role in acquiring only the material of the highest quality within the available time and budget.
An ecosystem of Reliable Suppliers
A key necessity of a successful production supply chain is to have suppliers you can always count on. These are suppliers who will always deliver as promised – on quality and on time. Purchase Management is responsible for managing ongoing relations with suppliers to ensure that these are mutually beneficial and to create an ecosystem of reliable suppliers.
Adequate Inventory Levels
Adequate inventory levels of raw materials, parts and/or components are essential for you to have enough finished products to meet customer demand.
Purchase Management’s role is to ensure that it has enough of the right suppliers lined up to deliver sufficient inventory to you at the right time.
This is especially crucial if you deploy an inventory management technique like Just-in-time where you really have no buffer inventory. Any foul-up in deliveries by a supplier and you may not be able to fulfill your sales.
Purchase Management has the important role of ensuring regular, smooth flow of inventory including the set-up of supplier redundancies to reduce the risk associated with low inventory levels.
Quality of your end-product
Needless to say, the quality of your end-product will be highly dependent on the quality of the raw material, parts and components that go in it.
So, the downstream effect of Purchase Management ensuring high quality of inventory from suppliers is that it becomes more likely that your end product will be of high quality as well.
Improved Cash Flows
Purchase Management can have a very direct impact on a business’s finances – on cash flows as well as on profitability.
Purchase Managers can negotiate preferable payment terms with suppliers, including delayed payment for stocks purchased or the acquisition stock on consignment – in which case you don’t pay until the stock is sold.
In short, Purchase Management can help maximize free cash flow by keeping a minimal amount of cash is tied up in inventory.
Improved Profit Margins
As you’ve seen a key function of Purchase Management is the search for suppliers who can deliver the needed raw materials, parts or components at the best possible price.
In other words, price negotiation with suppliers is very much within the scope of Purchase Management.
And so, the more aggressively Purchase Managers negotiate prices with suppliers, the more positive the impact that they can have on the company’s profit margins. This is especially true in businesses where items acquired from external suppliers constitute a significant proportion of the total cost of manufacturing the end product.
Price negotiation with suppliers also becomes necessary if your company decides to follow an aggressive pricing strategy in order to enter a new market or retain or advance your position in an existing market.
The Purchase Lifecycle
The Purchase Lifecycle (or just Purchase cycle) refers to all the steps that a company needs to go through before, during and after the purchase of an item from an external supplier.
1) Understanding the need
The very first step in any Purchase Management process is understanding why the purchase needs to be made.
The request for a purchase typically comes to the Purchase department from an internal business unit.
The Purchase Manager should work with the business unit to answer questions like:
- What problem will the purchased item solve? What need will it satisfy?
- What will happen if the purchase isn’t made?
- What substitutes exist for the item to be purchased and why can’t these be used instead?
- How and where will be purchased item be used?
- By when does the item need to be acquired?
- What budgetary restrictions exist?
- Are there any geographic restrictions while sourcing the item?
And many more … Most importantly, the Purchase Manager needs to understand the need for the item being purchased. This is a prerequisite for starting to find a supplier.
2) Defining selection criteria
Once the purpose of the item to purchase is clear, the next step is to define the criteria for selecting one or more suppliers.
Should the Purchasing process look for suppliers within the existing supplier base of the company or is there a need to look for a new supplier? Would the supplier need to offer special services together with the item being purchased? Would the supplier need to demonstrate financial stability? Are there any specific legal requirements the supplier needs to satisfy? Are there standard quality standards (eg ISO standards) that the supplier needs to have?
A clearly defined and comprehensive selection criteria can prevent regrets later on. During this step, the framework for a Request for Proposal (RFP) is built.
3) Researching the market
The goal of this step is to search for potential suppliers, make a shortlist, briefly tell them what you are looking for and invite them to an information exchange session.
During informal discussions, Purchase Managers vet the potential supplier to confirm that they meet the defined selection criteria.
This is also the time when the supplier decides whether they would be interested in bidding for the business.
If both parties express interest, then the process moves forward.
4) Request for Proposals
Purchase Managers now send out formal Requests for Proposal to all potential suppliers and await a response.
5) Selection and contract negotiation
Based on the defined selection criteria the Purchase Manager works with the business units to select one or more suppliers to move to the contract stage.
Suppliers are informed and formal contract negotiation is initiated.
6) Placing the Purchase Order(s)
Once contracts are signed, Purchase Managers will issue Purchase Orders to the suppliers. At this time budgets are released so that payments can be made as foreseen in the contracts.
7) Tracking supplier progress
If the chosen suppliers are delivering items that they already have in stock, this step may not be needed.
However, if the suppliers are manufacturing the ordered items and if this is expected to take a considerable amount of time, Purchase Management may need to track the supplier’s progress to make sure the production and planned delivery are on schedule.
8) Receiving / Reviewing / Testing deliverables
The ordered items need to be formally received and signed for. Quantities have to be verified. Quality has to be checked. Depending on the type of item, functionality and performance testing may be required.
Ensuring that these things happen is a part of Purchase Management. But most certainly the Purchase Manager will need to work with the internal business units to perform these functions.
9) Inventory and Accounting
The received items need to be accounted for in the company’s inventory management system.
This is where Purchase Management, Inventory Management and Accounting processes intersect. Depending on the agreement with the supplier the company may or may not take the inventory on its books.
10) Ensuring that the need has been met
Purchase Management needs to close the loop with the business unit which requested the purchase to ensure that the business need has been met.
This is also the time to evaluate the Purchase Management process and the performance of the supplier.
11) Managing relationship with the supplier
If the company decides to pursue an ongoing relationship with the supplier, the responsibility for nurturing this relationship and ensuring a mutually beneficial partnership rests with Purchase Management.
Why consider a Purchase Management System
A good Purchase Management system can help automate several steps in the Purchase Management lifecycle.
It can help make supplier management more efficient with a single place to track supplier information, assign suppliers to products and rank suppliers based on different criteria.
It can automate the issuing Request for Proposals, accepting Proposals and issuing Purchase Orders and managing Invoices from suppliers. If your business relies heavily on suppliers and many suppliers at that, then an investment in a Purchase Management System would be justified.
- Purchase Management includes business functions and processes following which companies purchase items from external suppliers.
- Purchase Management can help you ensure adequate inventory levels of raw materials, parts, components so that you can always have enough finished products to meet customer demand.
- Purchase Management can directly benefit your company’s cash flows and profitability.
- The Purchase Management Lifecycle defines the processes that a company follows to purchase and item from a supplier.
- A good Purchase Management system can automate and streamline the Purchase Management processes making them more efficient and effective.