CHAPTER THREE

3. PURCHASING

Every organization requires materials that are acquired via procurement, which comprises
purchasing, grants (donation). However, the basic focus of this chapter is purchasing that
involves financial transactions. Purchasing thus involves all decisions including policies and
activities that are concerned with the acquisition of goods and services through exchange of
transactions. Purchasing is growing complex from time to time for two reasons.

1. Purchasing cost is a major cost element of the end product

2. Industries relay on continuous production to employ large-scale operation.

3.1. Definition and Element of Purchasing

Purchasing as an activity of materials management can be defined as the process that consists of
all activities that lead to effective buying of raw materials, parts, components, equipments, spare
parts, tools and supporting items required by any organization to deliver quality products to meet
customer requirements at competitive prices. Effective purchasing can also be described as
buying of materials at the right quality, in the right quantity, at the right price, at the right time,
from the right source.

The emphasis of effective purchasing is doing what is “right” at all stages as discussed below:

A. Right Quality: Right materials means buying materials that meet organization set standard,
fulfill all necessary requirements to meet the final user’s needs for a particular item at the lowest
overall cost. It is pertinent to mention that right quality does not always connote the best or
highest quality or most expensive, nor is it always the lowest or cheapest. The most important
fact is that buying the materials that satisfy the company expectation in terms of increasing
product quality, reducing product cost and overall cost.

B. Right Quantity: This means that the purchasing agent should ensure that there is adequate
inventory of raw materials, parts, components, equipments, spare parts, tools and supporting
items as required by the organization at all times. Materials should be ordered at right quantity
because a too small order repeatedly can lead to higher price per unit and stock out i.e. the risk of

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running out of critical materials. When materials orders are too large than what is required at a
period, inventory “carrying and holding costs” are higher, extra warehouse space and staff may
be needed, and expensive stock may become “spoiled” or obsolete in the store.

C. Right Price: In some organizations, prices of materials are determined through competitive
bidding or inviting suppliers to submit price quotations or other procedures designed to permit
cost comparisons and hold costs to reasonable levels. The prices of materials must be fair and
reasonable to both the buyer and seller. The goal of every purchasing officer, whether
competitive or not, should be that his/her organization and suppliers both realize a “win” or
“satisfy” as a result of the transaction.

D. Right Time: materials management department should ensure that required materials are
available where they are needed at the right time. Effective planning helps in buying optimum
materials at right time while poor planning may result into rushed buying at a premium, or the
quality specified does not meet the organization’s specifications; or, even worse, both.

E. Right Source: purchasing department must select a responsible and responsive supplier who
has a good record of performance and who can provide the best combination of quality, quantity,
and price, at the right time.

Failure of delivery, delays in delivery and delivery of low quality materials and inadequate
service can all contribute to higher product costs.

3.2. Fundamental Objectives of Purchasing

The objectives of purchasing can be divided into four categories:

 Obtaining goods and services of the required quantity and quality.
 Obtaining goods and services at the lowest cost.
 Ensuring the best possible service and prompt delivery by the supplier.
 Developing and maintaining good supplier relations and developing potential suppliers.
To satisfy these objectives, some basic functions must be performed:
 Determining purchasing specifications: right quality, right quantity, and right delivery
(time and place).
 Selecting supplier (right source).

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  Negotiating terms and conditions of purchase (right price).
 Issuing and administration of purchase orders.

3.3. Purchasing Policies

Purchasing Policy refers to general or broad statements that guide purchasing agents’ thinking
which facilitate objective accomplishment. Purchasing department develops policies to provide,
rules of actions, guidance and general support for its staff. Most existing purchasing policy
provides the guidelines and direction in the following categories.
 It defines roles of purchasing
 It clarifies conduct of purchasing personnel
 It defines minority business objectives
 It defines purchasing department-supplier relationship
 It states operational issues

Policies Defining the Role of Purchasing

The purchasing department must set policies that define purchasing authority. The policies
define the objectives of purchasing and responsibilities of various buying levels. These policies
address the following areas:
(i) The limit of purchasing authority of personnel.
(ii) Duties and responsibilities of the corporate purchasing office.
(iii) Process of analyzing make or buy decision across functional departments.
(v) Personnel operating guidelines to negotiate with suppliers.

Policies Clarifying the Conduct of Purchasing Personnel

Policies should clarify management’s commitment toward purchasing personnel ethical behavior
in relating to suppliers. Purchasing department must develop policies for its personnel to
cultivate highest standard as stated by top management. This policy must address purchasing
personnel and other department that have direct communication contacts with existing and
potential suppliers. These policies must consider issues concerning employee leaving to work for
a supplier and developing a means of reporting any irregular business dealings. Former

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employees working for a supplier is a serious concern to the management because he/she may
reveal confidential information that can give the current supplier some leverage over other
suppliers. The policy that handles reporting irregular business activities (such as accepting gifts
or bribes, releasing vital information to a supplier, accepting late bids) must specify the right
office and formal of reporting. Whistle blowing concept of reporting illegal business dealings
can be encouraged and they should be arrangement to safeguard whistle blowers.

Policies Defining Social Business Objectives

This policy statement addresses the purchasing position as related to environmental issues.
Policies must be formulated to handle issues of waste materials, recycled materials, disposal of
hazardous wastes, reducing pollution as required by Federal, State and Local government
regulations. Policy should regulate companies to cleanse up the environments where they operate
and make them safe and harmless.

Policies Defining Purchasing Department-Supplier Relationship

These policies contain the guidelines that promote positive relationships between the buyer and
seller. The relationships should be based on honesty, mutual trust and respect for purchasing
process. Some rules that support these positive relationships are:
 Fairness and integrity should be the watchword when dealing with suppliers
 Adopt a fair suppliers’ selection process and purchase contract award.
 Necessary support should be given to suppliers of high reputation in quality
improvement, prompt delivery, cost minimization, etc.
 Have stated and open communication channels
 Effect prompt payment to suppliers.

Policies Stating Operational Issues

As required by Federal, State and Local laws, organizations must have means of disposing their
waste especially hazardous or toxic waste. Waste disposal services are responsibilities of
purchasing departments, so organizations must have policies that state clearly the legal
requirements and conditions for handling waste products. Also, these policies outline in detail
how to manage issues of supplying defective or nonperforming materials. Other operational

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issues that need policy guide are; compliance with general laws and requirement of government
agencies, proper disposal of material assets, etc.

3.4. Purchasing Procedures

The purchasing cycle consists of the following steps:

1. Receiving and analyzing purchase requisitions.
2. Selecting suppliers. Finding potential suppliers, issuing requests for quotations, receiving and
analyzing quotations, and selecting the right supplier.
3. Determining the right price.
4. Issuing purchase orders.
5. Following up to ensure delivery dates are met.
6. Receiving and accepting goods.
7. Approving supplier’s invoice for payment.

1. Receiving and analyzing purchase requisition. Purchase requisitions start with the
department or person who will be the ultimate user. In the material requirements planning
environment, the planner releases a planned order authorizing the purchasing department to go
ahead and process a purchase order. At a minimum, the purchase requisition contains the
following information:

 Identity of originator, signed approval, and account to which cost is assigned.

 Material specification.
 Quantity and unit of measure.
 Required delivery date and place.
 Any other supplemental information needed.

Once all the approvals have been completed, the requisition is sent to the purchasing department
to produce the purchase order without reentering all the information.

2. Selecting suppliers. Identifying and selecting suppliers are important responsibilities of the
purchasing department. For routine items or those that have not been purchased before, a list of
approved suppliers is kept. If the item has not been purchased before or there is no acceptable

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supplier on file, a search must be made. If the order is of small value or for standard items, a
supplier can probably be found on the Internet, in a catalogue, trade journal, or directory.

Requesting quotations. For major items, it is usually desirable to issue a request for quotation.
This is a written inquiry that is sent to enough suppliers to be sure competitive and reliable
quotations are received. It is not a sales order. After the suppliers have completed and returned
the quotations to the buyer, the quotations are analyzed for price, compliance to specification,
terms and conditions of sale, delivery, and payment terms. For items where specifications can be
accurately written, the choice is probably made on price, delivery, and terms of sale. For items
where specifications cannot be accurately written, the items quoted will vary. The quotations
must be evaluated for technical suitability. The final choice is a compromise between technical
factors and price. Usually both the issuing and purchasing departments are involved in the
decision.

3. Determining the right price. This is the responsibility of the purchasing department and is
closely tied to the selection of suppliers. The purchasing department is also responsible for price
negotiation and will try to obtain the best price from the supplier.

4. Issuing a purchase order. A purchase order is a legal offer to purchase. Once accepted by the
supplier, it becomes a legal contract for delivery of the goods according to the terms and
conditions specified in the purchase agreement. The purchase order is prepared from the
purchase requisition or the quotations and from any other additional information needed. A copy
is sent to the supplier; copies are retained by purchasing and are also sent to other departments
such as accounting, the originating department, and receiving.

5. Following up and delivery. The supplier is responsible for delivering the items ordered on
time. The purchasing department is responsible for ensuring that suppliers do deliver on time. If
there is doubt that delivery dates can be met, purchasing must find out in time to take corrective
action. This might involve expediting transportation, alternate sources of supply, working with
the supplier to solve its problems, or rescheduling production.
The purchasing department is also responsible for working with the supplier on any changes in
delivery requirements. Demand for items changes with time, and it may be necessary to expedite

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certain items or push delivery back on some others. The buyer must keep the supplier informed
of the true requirements so that the supplier is able to provide what is wanted when it is wanted.

6. Receiving and accepting goods. When the goods are received, the receiving department
inspects the goods to be sure the correct ones have been sent, are in the right quantity, and have
not been damaged in transit. Using its copy of the purchase order and the bill of lading supplied
by the carrier, the receiving department then accepts the goods and writes up a receiving report
noting any variance. If further inspection is required, such as by quality control, the goods are
sent to quality control or held in receiving for inspection. If the goods are received damaged, the
receiving department will advise the purchasing department and hold the goods for further
action. Provided the goods are in order and require no further inspection, they will be sent to the
originating department or to inventory.
A copy of the receiving report is then sent to the purchasing department noting any variance or
discrepancy from the purchase order. If the order is considered complete, the receiving
department closes out its copy of the purchase order and advises the purchasing department. If it
is not, the purchase order is held open awaiting completion. If the goods have also been
inspected by the quality control department, they, too, will advise the purchasing department
whether the goods have been accepted or not.

7. Approving supplier’s invoice for payment. When the supplier’s invoice is received, there
are three pieces of information that should agree: the purchase order, the receiving report, and
the invoice. The items and the quantities should be the same on all; the prices, and extensions to
prices, should be the same on the purchase order and the invoice. All discounts and terms of the
original purchase order must be checked against the invoice. It is the job of the purchasing
department to verify these and to resolve any differences. Once approved, the invoice is sent to
accounts payable for payment.

3.5. ESTABLISHING SPECIFICATIONS

The first concern of purchasing—what to buy—is not necessarily a simple decision. For
example, someone deciding to buy a car should consider how the car will be used, how often,
how much one is willing to pay, and so on. Only then can an individual specify the type of car

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needed to make the “best buy.” This section looks at the problems that organizations face when
developing specifications of products and the types of specifications that may be used.

In purchasing an item or a service from a supplier, several factors are included in the package
bought. These must be considered when specifications are being developed and can be divided
into three broad categories:
 Quantity requirements.
 Price requirements.
 Functional requirements.
Quantity Requirements
Market demand first determines the quantity needed. The quantity is important because it will be
a factor in the way the product is designed, specified, and manufactured. For example, if the
demand was for only one item, it would be designed to be made at least cost, or a suitable
standard item would be selected. However, if the demand were for several thousand, the item
would be designed to take advantage of economies of scale, thus satisfying the functional needs
at a better price.

Price Requirements
The price specification represents the economic value that the buyer puts on the item— the
amount the individual is willing to pay. If the item is to be sold at a low price, the manufacturer
will not want to pay a high price for a component part. The economic value placed on the item
must relate to the use of the item and its anticipated selling price.

Functional Requirements
Functional specifications are concerned with the end use of the item and what the item is
expected to do. By their very nature, functional specifications are the most important of all
categories and govern the others. In a sense, functional specifications are the most difficult to
define. To be successful, they must satisfy the real need or purpose of an item. In many cases, the
real need has both practical and aesthetic elements to it. A coat is meant to keep one warm, but
under what circumstances does it do so and what other functions is it expected to perform? How
cold must it get before one needs a coat? On what occasions will it be worn? Is it for working or
dress wear? What color and style should it be? What emotional needs are it expected to fill? In

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the same way, we can ask what practical and aesthetic needs a door handle or side-view mirror
on a car is expected to satisfy.

Functional specifications and quality. Functional specifications are intimately tied to the
quality of a product or service. Everyone knows, or thinks he or she knows, what quality is, but
there are several misconceptions about what it is and what it is not. Ask someone what is meant
by quality, and you will get replies such as “The best there is,” “Perfection,” “Degree of
excellence,” and “Very good.” All sound great but do not mean very much.
There are many definitions of quality, but they all center on the idea of user satisfaction. On this
basis, it can be said that an item has the required quality if it satisfies the needs of the user. that
organizations face when developing specifications of products and the types of specifications
that may be used.

3.5.1. FUNCTIONAL SPECIFICATION DESCRIPTION

Functional specification can be described in the following ways or by a combination of them:

 By brand.
 By specification of physical and chemical characteristics, material and method of
manufacture, and performance.
 By engineering drawings.
 Miscellaneous.
Description by Brand
Description by brand is most often used in wholesale or retail businesses but is also used
extensively in manufacturing. This is particularly true under the following circumstances:
Items are patented, or the process is secret.
The supplier has special expertise that the buyer does not have.
The quantity bought is so small that it is not worth the buyer’s effort to develop
specifications.
The supplier, through advertising or direct sales effort, has created a preference on the
part of the buyer’s customers or staff.
When buying by brand, the customer is relying on the reputation and integrity of the supplier.
The assumption is that the supplier wishes to maintain the brand’s reputation and will maintain

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and guarantee the quality of the product so repeat purchases will give the buyer the same
satisfaction.
Most of the objections to purchasing by brand center on cost. Branded items, as a group, usually
have price levels that are higher than non branded items. It may be less costly to develop
specifications for generic products than to rely on brands. The other major disadvantage to
specifying by brand is that it restricts the number of potential suppliers and reduces competition.
Consequently, the usual practice, when specifying by brand, is to ask for the item by brand name
or equivalent. In theory, this allows for competition.

Description by Specification
There are several ways of describing a product, but they usually include one or more of the
following. Whatever method is used, description by specification depends on the buyer
describing in detail exactly what is wanted:
 Physical and chemical characteristics. The buyer must define the physical and chemical
properties of the materials wanted. Petroleum products, pharmaceuticals, and paints are
often specified in this way.
 Material and method of manufacture. Sometimes the method of manufacture determines
the performance and use of a product. For example, hot- and cold rolled steels are made
differently and have different characteristics.
 Performance. This method is used when the buyer is primarily concerned with what the
item is required to do and is prepared to have the supplier decide how performance is to
be attained. For example, a water pump might be specified as having to deliver so many
gallons per minute. Performance specifications are relatively easy to prepare and take
advantage of the supplier’s special knowledge.
Whatever the method of specification, there are several characteristics to description by
specification:
 To be useful, specifications must be carefully designed. If they are too loosely drawn,
they may not provide a satisfactory product. If they are too detailed and elaborate, they
are costly to develop, are difficult to inspect, and may discourage possible suppliers.
 Specifications must allow for multiple sources and for competitive bidding.

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  If performance specifications are used, the buyer is assured that if the product does not
give the desired results, the seller is responsible. They provide a standard for measuring
and checking the materials supplied.
 Not all items lend themselves to specification. For example, it may not be easy to specify
color schemes or the appearance of an item.
 An item described by specification may be no more suitable, and a great deal more
expensive, than a supplier’s standard product.
 If the specifications are set by the buyer, they may be expensive to develop. They will be
used only when there is sufficient volume of purchases to warrant the cost or where it is
not possible to describe what is wanted in any other way.
Sources of specifications. There are two major sources of specifications:
I. Buyer specifications.
II. Standard specifications.

Buyer specifications. Buyer-developed specifications are usually expensive and time

consuming to develop. Companies usually do not use this method unless there is no suitable
standard specification available or unless the volume of work makes it economical to do so.

Standard specifications. Standard specifications have been developed as a result of much

study and effort by governmental and nongovernmental agencies. They usually apply to raw or
semi finished products, component parts, or the composition of material. In many cases, they
have become de facto standards used by consumers and by industry.

There are several advantages to using standard specifications. First, they are widely known and
accepted and, because of this, are readily available from most suppliers. Second, because they
are widely accepted, manufactured, and sold, they are lower in price than nonstandard items.
Finally, because they have been developed with input from a broad range of producers and users,
they are usually adaptable to the needs of many purchasers.

Engineering Drawings
Engineering drawings describe in detail the exact configuration of the parts and the assembly.
They also give information on such things as finishes, tolerances, and material to be used. These
drawings are a major method of specifying what is wanted and are widely used because often

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there is no other way to describe the configuration of parts or the way they are to fit together.
They are produced by the engineering design department and are expensive to produce, but they
give an exact description of the part required.

Miscellaneous
Sometimes samples are used, for example, when colors or patterns are to be specified. Often a
variety of methods can be used, and the buyer must select the best one. The method of
description is communication with the supplier. How well it is done will affect the success of the
purchase and sometimes the price paid.

3.6. SELECTING SUPPLIERS

The objective of purchasing is to get all the right things together: quality, quantity, delivery, and
price. Once the decision is made about what to buy, the selection of the right supplier is the next
most important purchasing decision. A good supplier is one that has the technology to make the
product to the required quality, has the capacity to make the quantities needed, and can run the
business well enough to make a profit and still sell a product competitively.

Sourcing
There are three types of sourcing: sole, multiple, and single.
1. Sole sourcing implies that only one supplier is available because of patents, technical
specifications, raw material, location, and so forth.
2. Multiple sourcing is the use of more than one supplier for an item. The potential
advantages of multiple sourcing are that competition will result in lower price and better
service and that there will be a continuity of supply. In practice there is a tendency
toward an adversarial relationship between supplier and customer.
3. Single sourcing is a planned decision by the organization to select one supplier for an
item when several sources are available. It is intended to produce a long term partnership.
Factors in Selecting Suppliers
The previous section discussed the importance of function, quantity, service, and price
specifications. These are what the supplier is expected to provide and are the basis for selection
and evaluation. Considering this, there are several factors in selecting a supplier.

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o Technical ability. Does the supplier have the technical ability to make or supply the
product wanted? Does the supplier have a program of product development and
improvement? Can the supplier assist in improving the products? These questions are
important since, often, the buyer will depend upon the supplier to provide product
improvements that will enhance or reduce the cost of the buyer’s products. Sometimes
the supplier can suggest changes in product specification that will improve the product
and reduce cost.
o Manufacturing capability. Manufacturing must be able to meet the specifications for
the product consistently while producing as few defects as possible. This means that the
supplier’s manufacturing facilities must be able to supply the quality and quantity of the
products wanted. The supplier must have a good quality assurance program, competent
and capable manufacturing personnel, and good manufacturing planning and control
systems to ensure timely delivery. These are important in ensuring that the supplier can
supply the quality and quantity wanted.
o Reliability. In selecting a supplier, it is desirable to pick one that is reputable, stable, and
financially strong. If the relationship is to continue, there must be an atmosphere of
mutual trust and assurance that the supplier is financially strong enough to stay in
business.
o After-sales service. If the product is of a technical nature or likely to need replacement
parts or technical support, the supplier must have a good after-sales service. This should
include a good service organization and inventory of service parts.
o Supplier location. Sometimes it is desirable that the supplier be located near the buyer,
or at least maintains an inventory locally. A close location helps shorten delivery times
and means emergency shortages can be delivered quickly.
o JIT capabilities. Companies competing in a just-in-time (JIT) environment depend on
suppliers to quickly deliver small quantities of product. Modern companies operate with
very little inventory of raw materials and require accurate, on-time deliveries from their
suppliers. JIT suppliers who simply keep extra inventory to meet these demands will soon
have increased costs and pressures to increase their prices. Buyers in a JIT environment
need suppliers who value their new relationship, working in partnership to remove waste
from the system. As a result, JIT suppliers need to have in place information and delivery

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 systems that allow them to quickly ship exactly what the customer needs without
increased cost or effort.
o Other considerations. Sometimes other factors such as credit terms, reciprocal business,
and willingness of the supplier to hold inventory for the buyer should be considered.
o Price. The supplier should be able to provide competitive prices. This does not
necessarily mean the lowest price. It is one that considers the ability of the supplier to
provide the necessary goods in the quantity and quality wanted, at the time wanted, as
well as any other services needed.
Identifying Suppliers
One major responsibility of the purchasing department is to continue to research all available
sources of supply. Some aids for identifying sources of supply follow:
 Salespersons of the supplier company.
 Internet.
 Catalogues.
 Trade magazines.
 Trade directories.
 Information obtained by the salespeople of the buyer firm.
Final Selection of Supplier
Some factors in evaluating potential suppliers are quantitative, and a dollar value can be put on
them. Price is the obvious example. Other factors are qualitative and demand some judgment to
determine them. These are usually set out in a descriptive fashion. The supplier’s technical
competence might be an example.
The challenge is finding some method of combining these two major factors that will enable a
buyer to pick the best supplier. One method is the ranking method, described next.
1. Select those factors that must be considered in evaluating potential suppliers.
2. Assign a weight to each factor. This weight determines the importance of the factor in
relation to the other factors. Usually a scale of 1 to 10 is used. If one factor is assigned a
weight of 5 and another factor a weight of 10, the second factor is considered twice as
important as the first. When developing the factors and their weights, the buyer can use
input from the people who will be affected by the supplier selection. This will help the

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 buyer in making a more informed decision and will improve the acceptance of the new
supplier by the users.
3. Rate the suppliers for each factor. This rating is not associated with the weight. Rather,
suppliers are rated on their ability to meet the requirements of each factor. Again, usually
a scale of 1 to 10 is used.
4. Rank the suppliers. For each supplier, the weight of each factor is multiplied by the
supplier rating for that factor. For example, if a factor had a weight of 8 and a supplier
was rated 3 for that factor, the ranking value for that factor would be 24. The supplier
rankings are then added to produce a total ranking. The suppliers can then be listed by
total ranking and the supplier with the highest ranking chosen.
Figure 3.1 shows an example of this method of selecting suppliers. Supplier B has the highest
total of 223; however, supplier D comes in a very close second with 222. The normal practice
when using the ranking method is to eliminate the bottom ranking suppliers from consideration,
allowing management to make a simpler decision.
The ranking method is an attempt to quantify those things that are not quantified by nature. It
attempts to put figures on subjective judgment. It is not a perfect method, but it forces the buying
company to consider the relative importance of the various factors. When the method includes
the input of many people in determining the relative weights, agreement on the final selection
will be improved.
Factors Weight Rating of suppliers Ranking of Supplier
A B C D A B C D
Function 10 8 10 6 6 80 100 60 60
Cost 8 3 5 9 10 24 40 72 80
Service 8 9 4 5 7 72 32 40 56
Technical 5 7 9 4 2 35 45 20 10
Assistance
Credit 2 4 3 6 8 8 6 12 16
Terms
Total (rank of suppliers) 219 223 204 222

Figure 3.1 Supplier rating

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 3.8. Make or Buy Decision

Companies producing goods from assembled parts usually earn more profit on components they
make “in-house” than on components they buy from outside suppliers. Nevertheless, if they tried
to produce all their own needed components, they would probably lose money. This is because
they would lack the diversified skills and facilities needed to do an effective job.

Some items, such as supplies and low-valued components that are not within the main line of
expertise of the firm, are obvious candidates for purchase.

Make or buy decisions made on a day-to-day basis relate largely to the use of existing capacity.
They may require the joint evaluation of the purchasing, operations, engineering, accounting, and
other departments of the firm because numerous considerations come into play. One approach is
to first establish the economic feasibility and then follow with a consideration of more value-
based, “less economic” factors.
Economically, an item is a candidate for in-house production if the firm has sufficient capacity
and if the component’s value is sufficient to cover all the variable costs that go into it as well as
make some contribution to fixed costs. The variable cost of production is usually less than the
purchase cost because its purchase price includes a profit for the supplier (and other members of
the marketing channels). Fixed costs of production include plant and equipment investment plus
setup and overhead charges.

Low volumes of production tend to favor buying, whereas high volumes favor making. This is
because the cost to buy involves little or no fixed component, even though the slope of the total-
cost line (that is, the purchase price per unit) is steeper than for the cost-to-make situation. After
sufficient volume is produced to cover the fixed cost of making, then it is more profitable to
produce the product in-house.

Uncertainties of supply, demand, or product quality complicate the make versus buy decision.
However, if historical or market information is available, it may sometimes be converted into a
probabilistic form which can be used to reach a better decision.

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Economic Factors Influencing Make versus Buy Decisions
Inputs

 Availability of funds and skilled personnel

 Availability and volume of supply from others
 Desire for alternative sources of supply
Processing

 Employee preferences and stability concerns

 Desire to develop R&D facilities
 Need to control trade secrets
 Desire to expand into new product line
 Need to control delivery lead times
 Impact upon production flexibility
Outputs

 Need to control quality or reliability

 Goodwill and reciprocity impact on customers

3.9. Value Analysis/Engineering

Value analysis/engineering had its birth during the Second World War. It was really the right
time for its growth due to worldwide shortage of essential materials. Larry D. Miles was
responsible for developing the technique and naming it. Value analysis is defined as “an
organized creates approach, which has, as its objective, the efficient identification of unnecessary
cost –cost that provides neither quality nor use nor life appearance, nor customer features. Value
analysis focuses on engineering, manufacturing and purchasing attention to one objective i.e.
equivalent performance at a lower cost where by functional performance remains unaffected.
Other techniques are as follows:”

 Organized cost reduction analysis by which accountants analyze cost in products, the
ranking of their elements in a descending order of magnitude and informed challenge to
each starting with the most important.

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  Substituting standards which is less costly
 Purchasing analysis, which systematically searches for cheaper bought – out components
or services, probably by seeking alternatives or a fresh basis for price negotiation.
 Method study refers to part of the work –study that studies and analyzes work of any kind
in a disciplined manner that leads to improvement in method.

Generally speaking, value analysis is concerned with the costs added due to inefficient or
unnecessary specifications and features. Value analysis is also applied by Miss Technique i.e.
Modify, improving, Sub-Divide, Substitute with regard to the product under study. Value
analysis requires the following questions to be answered for the successful implementation of the
technique.

- What is the item?

- What does it do?
- How much does it cost?
- What else would do the job?
- What would be the alternative cost be?

In order to answer the above questions, three basic steps are necessary

1. Identifying the function: any useful product has some functions, which must be
identified. Example, A bulb to give a refrigerator to preserve food etc.
2. Evaluation of the function by comparison, value being a relative term, the comparison
approach must be used to evaluate functions. The basic question here is “does the
function accomplish reliability at the best cost?” and can be answered only by
comparison with other products which perform the same function.
3. Develop alternative: in order to develop effective alternatives and identify unnecessary
cost, the following value analysis principles must be used.
Avoid generalities
Get all available costs
Use information from the best sources
Conduct brain storm sessions
Create and refine the information obtained

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 Use industry specialists to extend specialized knowledge

Implementation

In order to implement a value analysis program successfully, Larry D. Miles formulate a job
plan, which consists the following implementation phases:

1. The orientation phase: the orientation stage is set by asking relevant questions like: what
is to be accomplished? What really customers want? What are the durable characteristics
regarding weight size, color, etc.
2. Information phase: all pertinent information regarding costs, quantities, vendors and
specializations is collected. The basic methods of manufacturing process are studied.
3. The creative phase: creative thinking and imagination are used to generate alternative
methods of performing the function.
4. The analysis and evaluation phase: suggested alternatives are analyzed and evaluated
regarding costs, probability of applicability etc.
5. The program-planning phase: studying the various alternatives in grater depth etc is laid
down.
6. The execution process phase: all the alternatives, the cost and benefits are studied
according to the plan or program to finally arrive at the best alternative.
7. The final phase: deals with the presentation and implementation phase. All the relevant
data are presented to the decision-making body or authority. The accepted ideas are then
implemented and closely followed to study the actual benefits derived.

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