Differences in the procurement of capital equipment
1. Non-recurring procurement
Capital equipment procurements do not occur with regular frequency. A production machine, for example, may remain in use for 10 to 15 years. Even furniture may last over 5 years.
Another unique feature of most capital equipment procurements is the lead-time requirement. While some types of capital equipment are standard, off-the-shelf products, many are not. Much production machinery and even some tools are built to operate under specific conditions peculiar to each buyer’s operation.
2. Nature and size of expenditure
An expenditure of company funds for capital equipment is an investment. If procured wisely and operated efficiently, capital equipment generates profit for its owner. Because it exerts a direct influence on the costs of production, the selection of major capital equipment is a matter of significant concern to top management.
Although capital equipment prices cover a wide range, the procurement of most major equipment involves the expenditure of a substantial sum of money. However, the procurement price for a piece of equipment is frequently overshadowed in importance by other elements of cost. Since a machine is often used for ten years or more, total costs of operation and maintenance during its lifetime may far exceed its initial cost. Hence, the total life cost of a machine, relative to its productivity, is the cost factor of primary importance. Estimating operating and maintenance costs, which will be incurred in future years, is not easy. Frequently, these costs vary from year to year. Consequently, discussions involving the choice between several alternative machines often centre on the probable accuracy of specific cost estimates. We shall explore this in more detail later.
The timing of many capital equipment procurements often presents a paradoxical situation. Typically, the general supply capabilities of capital equipment producers do not adjust quickly to changes in levels of demand. Thus, because capital equipment procurements are made infrequently and can often be postponed, producers of capital equipment frequently find themselves in a ‘feast or famine’ type of business. For instance, when a buyer’s business is good, it needs additional equipment to satisfy customers’ burgeoning demands. However, other buyers could also be in the same situation when the market is up. The buyer will find capital equipment prices rising in a market of short supply.
3. Consideration in source selection
When procuring capital equipment, selection of a supplier is governed largely by four general considerations:
a. Operating characteristics: This is by far the most influential factor in selecting the supplier for particular capital equipment. Once the user and engineering personnel have clearly established the function the equipment is to perform, design and operating capability are crucial in selecting the specific equipment to be procured.
The challenge is that design and operating features for a given type of equipment can differ significantly among the equipment available from
different suppliers. For this reason, the number of suppliers capable of meeting every aspect of a buyer’s operating requirements, no more no less, is frequently limited. This is one reason why Procurement usually finds its freedom of sourcing and selecting capital equipment limited as compared with buying production materials and supplies.
b. Engineering features: Closely related to the equipment’s operating characteristics are its engineering features. These features must be compatible with the buyer’s existing equipment, process, plant-layout, established standards if applicable, e.g., physical size and mounting dimensions, flexibility, power requirements, maintenance, safety features, pollution characteristics, etc. The general questions to be answered are: How does this piece of equipment fit in with the existing operation? Will many costly modifications be involved in adapting the equipment to the existing system?
c. Economic analysis: After acceptable equipments have been identified, a thorough evaluation of their relative merits is undertaken. The task is a complicated one. An analysis of the major operating alternatives includes a comparative economic analysis of the potential new equipment, and a comparison of each with the alternative of using the existing equipment now in operation. In all cases, the analysis of equipment must relate its total expected life cost to its total expected productivity. A payback analysis is then often used to determine the number of year’s equipment requires to pay for itself from additional earnings generated by its increased level of operation efficiency, which is a useful measure for evaluating a potential procurement in light of the buying firm’s liquidity position.
The economic analysis is a critical portion of the formal proposal justifying the need for additional equipment to be prepared for top management. Although the proposal must consist of more than the economic analysis, a complete quantitative analysis showing the potential profitability of the various alternatives should constitute a major section of such a proposal.
d. Qualitative considerations: Certain qualitative factors concerning potential suppliers are important in making any procurement. However, not all the factors important in selecting sources for production materials weigh as heavily in selecting sources for capital equipment. Capital equipment procurements require a different type of cooperative relationship between the buyer and the seller. It is important, initially, that a supplier be willing to work with the buyer’s technical personnel to ensure a good fit of equipment to operating needs. After the procurement, the buyer may need help with installation, start-up, adjustments and so on. In fact, adjustment or calibration may be a continuing need, depending on the type of equipment and the buyer’s in-house capability.
At some future date, the buyer may also require a warranty adjustment. Especially important is an assessment of the supplier’s policy and
cooperativeness with respect to the supply of replacement parts and service for the equipment, particularly later when the equipment is superseded by a new model. These types of factors represent one group of qualitative considerations that a buyer considers in making a capital equipment procurement decision, with each individual case posing its own unique requirements.
Another group of qualitative considerations are those indicating a supplier’s ability to produce reliable equipment that performs in accordance with specifications. This implies the definite need for an assessment of the supplier’s technical and production capabilities. As the situation demands, a good buyer uses various approaches and personnel in making such an assessment, including plant visits and technical
discussions with the supplier’s personnel. However, buyers should not overlook the simple technique of investigating a supplier’s reputation among present customers. This is an invaluable source of information that is easy to tap.
Generally speaking, qualitative considerations do not play a primary role in the selection of a supplier for capital equipment. They are usually considered in the final analysis, after the major factors have been weighed. The qualitative factors are the straws that tip the balance one way or the other for the several potential suppliers who rank high on combined technical and economic considerations.
|Question to activity 5.1
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4. Joint selection of equipment
It should now be clear that the final selection of major capital equipment should be a joint undertaking by all departments having a legitimate interest in the decision. To facilitate this process, larger firms frequently utilise a buying team composed of representatives from Operations, Process Engineering, Plant Engineering, Finance and Procurement, depending on the nature of the procurement. In smaller firms, this coordination may be achieved less formally by a series of meetings among the appropriate functional individuals; in this case, procurement’s capital equipment buyer often serves in a coordinating or administrative role. In either case, because major capital equipment represents a long-range investment, a general management executive frequently makes the final procurement decision, based on recommendations from this interdepartmental group.
What contributions and interests do the various functional departments have on capital equipment procurement? Obviously, the head of the department where the capital equipment is to be used has an important interest in the decision, and the enthusiasm or reluctance of his or her acceptance may have a direct bearing on the efficiency of the equipment in actual use. For instance, because the operations manager is responsible for the efficiency of the total production operation, his or her views logically carry a great deal of weight in the selection of production equipment. Similarly, the technical contribution to be made by process engineering and plant engineering representatives is clearly an important one. As for the Finance department, it has three primary interests in capital equipment. First, this department usually administers the firm’s capital budget; it is therefore concerned with the allocation of funds for the proposed procurement. Second, Finance department has the responsibility of deciding how to finance such procurements. Third, the Finance department should review and evaluate the economic analysis of alternative equipment.
Then what is the role of Procurement function in capital equipment procurement?