Relations with other functions
We have discussed in the earlier section that organisations have replaced the segmented structure of the procurement function with integrated structures, and procurement has moved on from being a discrete activity to being the hub of a large part of the organisation’s business activity. By its very nature, procurement has continuing relationships with many other functions in an organisation, in addition to the relationships established with the organisation’s suppliers and customers. The procurement operations cut across most departmental lines. Figure 1.5 provides a graphic illustration of procurement’s many interfaces within the organisation.
Figure 1.5 The many internal interfaces of the Procurement function
The perspective of procurement as problem solving requires cross-functional teamwork. However, procurement and other functions often view common problems differently. This is a normal and healthy situation — provided the functional opinions are held objectively. We shall now explore some of the challenges that often surface in the team working between procurement and four other key functions.
1. Procurement and Design engineering
Procurement, Engineering and Production have many mutual problems. Design engineering, like Production, greatly influences the amount of time Procurement has to handle a procurement assignment. Engineering usually has the initial responsibility for preparing the technical specifications for an organisation’s products and the materials that go into them. To exercise this responsibility effectively, Engineering must have the constant help of Procurement and Production. A number of organisations have initiated early Procurement and early supplier involvement programs to assist this effort. The prices paid for production materials and the cost to fabricate them are inextricably related to their specifications. Similarly, specifications can be written in a manner that reduces or enlarges the number of organisations willing to supply specific items. If profit is to be maximised, the materials specified by engineering must be both economical to procure and economical to fabricate, and they should normally be available from more than one efficient, low-cost producer.
Procurement and Engineering occasionally differ in their concepts of materials problems. This is understandable. Engineers naturally tend to
design conservatively. Hence, their specifications provide amply for quality, safety and performance. By training, the engineer may be inclined to seek the ‘ideal’ design, material or equipment without complete regard for cost or timing. The buyer, on the other hand, often believes it is appropriate to reduce the designer’s performance goals and safety margins, and to work closer to actual performance requirements. Is an expensive design with a high safety factor necessary if a less costly design with a lower safety factor will do the job? Why use costly chrome plate if brushed aluminium is adequate? Clearly, such conflicting functional interests cannot always be resolved easily. The answers to such problems are seldom clear-cut. Mutual understanding and willingness to give and take are required from both sides if mutually satisfactory solutions areto be reached.
2. Procurement and Production
The Procurement-Production relationship begins when the Production function transmits its manufacturing schedule or materials requisitions to the Procurement function. Procurement subsequently translates these documents into a procurement schedule. Procurement timing is often the most difficult problem faced when making this translation. When Production does not allow Procurement sufficient time to procure wisely, many needless expenses inevitably creep into the final costs of an organisation’s products. When Procurement has inadequate time to develop competition or to negotiate properly, premium prices are certain to be paid for materials. Costly special production runs and premium transportation costs are two additional factors that frequently result from inadequate procurement lead time.
The most serious problem stemming from insufficient procurement lead time is a production shutdown. In most process types of operation, for example, chemicals, cement, paint and flour, equipment either runs at nearly full capacity or it does not run at all. Consequently, material shortages in these industries can be catastrophic, resulting in complete production stoppage. Losses resulting from material shortages in non-process industries are not always so disastrous or apparent. A production shutdown in a custom metal fabricating shop, for example, can be piecemeal. The indirect costs of such shortages, consequently, are often hidden in production costs. One or two machines from a large battery of perhaps fifty can be shut down as routine occurrence. Conventional accounting records fail to reveal the financial impact of this kind of slow profit-draining inefficiency of asset utilisation.
Coordination between Procurement and Production pays off in many ways. For example, a more expensive alternative material that will save
the organisation money can on occasion be selected. This may sound like a paradox. “Pay more and save more” — how can this happen? Savings in manufacturing and assembling costs often can exceed the increased procurement costs. In the normal manufacturing operations of casting, forging, machining, bending, grinding, punching, stamping, and so on, some materials are much more economical to work with than others.
The potential consequences of a production stoppage cause many Production managers to advocate an excessively large inventory of production materials. Again, this is understandable. For Production managers to reach their main manufacturing objective of low unit costs, they must minimise idle time and keep the production line operating. However, Procurement has the related objective of accomplishing the task with the minimum reasonable capital investment in inventory, a major concern which production typically does not share with equal intensity. The cost of carrying inventory is high. Reconciling these two conflicting organisation objectives (one calling for a higher inventory than the other) requires capable, informed and understanding functional heads. Although chief executives themselves must occasionally resolve the issue, it should normally be resolved by the functional heads within adopted policy guidelines.
The scenarios just described are but just a few of the numerous operating situations that illustrate the continuing and coordinative nature of the Procurement and Production relationship.
3. Procurement and Sales
All organisations recognise the direct relationship between the sales function and profit. In their enthusiasm to increase sales, however, many organisations overlook the leaks in profit that can occur when the sales activity is not properly meshed with the Procurement and Production activities.
The Procurement-Production-Sales cycle has its genesis in a sales forecast. Most sales forecasts include two important parts:
1. An estimate of sales based on what has happened in the past to an organisation’s products, territories and markets; and
2. An adjustment of this estimate to include changes the organisation expects in its future sales.
The changes reflect alterations in the marketing program and shifts in economic and competitive conditions. The sales forecast is the basis for the production schedule. The sales forecast also influences an organisation’s capital equipment budget, as well as its advertising campaigns and other sales activities.
Prompt communication to Production and Procurement of changes in the sales forecast permits these functions to modify their schedules as painlessly and economically as possible. Changes in the production schedules should be communicated immediately to sales. This action permits sales to alter its distribution schedule in a manner that will not alienate customers. Procurement must immediately transmit to Sales, as well as to other management groups, information concerning increases in materials prices. This permits sales to evaluate the effect of price rises in price estimates given for future sales quotations, on current selling prices, and on plans for future product lines.
Procurement and Sales must wisely blend their interest in the delicate area of reciprocity (buying from customers). If satisfactory legal reciprocal transactions are to be developed, they must be pursued with an understanding of the true costs of reciprocity. Buying from customers can be good business, but not when it is done at the expense of product quality or organisation profit. In the zest for increased sales, an organisation can lose sight of the fact that increased sales do not always result in increased profit. Sometimes, increased sales result in decreased profit if they simultaneously require a greater increase in procurement costs.
4. Procurement and Finance
Procurement’s relationship with Finance is different from its relationships with Production, Engineering and Sales. The difference stems from the fact that cost determinations cannot be hidden in the Procurement-Finance relationship as they often can in the other relationships. The importance of good financial planning is highlighted by the fact that poor financial planning is one of the major causes of business failure. Among the basic data needed by an organisation for proper planning of its working capital and cash flow positions are accurate sales forecasts and accurate procurement schedules. It is just as important for Procurement to inform Finance of changes in its schedule, as it is to inform Production and Sales of these changes.
There are many economic factors that periodically bring about favourable and completely unexpected buying opportunities. For example, a supplier may momentarily have excess capacity because of the cancellation of a large order. During the period that this condition exists, the supplier may sell products at prices designed to recover only out-of-pocket costs. This may be done because it is in the long-term interest of the organisation not to reduce its labour force. The potential income from such unexpected buying opportunities must be weighed against the potential income from other alternative uses of the organisation’s capital. Acquiring new equipment, adding to plant facilities, and increasing sales and promotional efforts are some of the alternative uses of capital that an organisation must consider. Usually, the alternative offering the greatest income in the long run should be selected, since no organisation has enough capital to satisfy all requirements.
Regardless of the price advantage obtainable, the right time to buy from the standpoint of business conditions is not always the right time to buy from the standpoint of the organisation’s treasury. If the Procurement function makes commitments to take advantage of unusually low prices without consulting the finance function, the organisation could find itself paying these procurements with funds needed for other purposes. On the other hand, if the Finance function does not strive diligently to make funds available for such favourable buying opportunities, the organisation may have to pay higher prices later for the same material.
Prompt payment to suppliers is a key contributor to good supplier relations. During material shortage periods, an organisation with a preferred customer status has a much better chance of avoiding shortage problems experienced by most others. Hence, a cooperative relationship between Procurement and Finance clearly can impact the development of good supplier relations.
|Question to activity 1.2
||Suggested answer to activity 1.2