Procurement Function and Competitiveness

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Why some companies are outstanding success
others dismal failures?

Successful ones adopted a good competitive

strategy

Competitive strategy is relating the firm to the

environment i.e the industry structure.

Competitive advantage when the profit of the

firm is above the average profit of the industry

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 Potential
Entrants

Threat of
New Entrants

Industry
Bargaining Power Competitors Bargaining Power
of Suppliers of Buyers
Suppliers Buyers
Rivalry Among
Existing Firms

Threat of
Substitute Products
or Service

Substitutes

The Five Competitive Forces Determines the INTENSITY of competition in an Industry

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At the most basic level how profitable a company
becomes depends on these factors
The amount of value customers place on the
companys products
The price that a company charges for its products

The cost of creating that value

VP>C

Value is something that customers assign to a

product
It is a function of attributes of the product 4
Consumers willingness to pay is Rs 12

Cost to firm A is Rs 8
Cost to Firm B is Rs 9

Who is competitive?

Why one firm in the same industry is able to make

more profit compared to others?

Value activities can be divided into two broad types

of primary activities and support activities
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6
Firms profitability could be through
--cost leadership low cost product
--product differentiation
Segmentation

S Segment 3 (High Quality/Premium)

e
g
m Segment 2 (Differentiation)
e
n
t Segment 1 (Commodity)
s

Industry

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 Arms Length Collaborative Relationship
Relationship
Vendor/Tradi Contract Partnership Strategic
tional Supplier Type Alliance
Supplier Relationship

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Procurement

Procurement is a crucial management function

It helps in determining the profitability and

competitiveness of the firm

The basic goal of any business activity is the

development and manufacture of products
that can be marketed at a profit

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The goal is accomplished by the appropriate
blending of what is called the five Ms

Machines, Manpower, Materials, Money, and

Management.

Materials of the appropriate quality must be

available at the right time, in the proper quantity
at the needed location at an acceptable cost.

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Material is the major cost in most of the
Industries.

Any reduction in cost improves the profit

potential

A firms profit margin reflects managements

ability to control costs relative to revenues

Profit can be increased by reducing cost

Every rupee saved is a rupee of profits

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Return on investment can be increased by
three ways:

By reducing costs
By getting more sales from available asset
By the combination of the two

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 Operating Cost Heads
Current Scenario 1 Scenario 2 Scenario 3
Situation (3% reduction (5% reduction) (10%
in material reduction)
cost
Labour 100000 100000 100000 100000
Materials 230000 223100 218500 207000
Overheads 70000 70000 70000 70000
Sales 500000 500000 500000 500000
Cost of 400000 393100 388500 377000
Goods sold
Other 60000 60000 60000 60000
costs
Net 40000 46900 51500 63000
Income
Profit 8% 9.38% 10.3% 12.6%
Margin
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 Current Assets
Inventories 50000 48500 47500 45000
Accounts 30000 30000 30000 30000
Receivables

Cash 30000 30000 30000 30000

Current Assets 110000 108500 107500 108500
Fixed Assets 290000 290000 290000 290000
Sales 500000 500000 500000 500000
Total Assets 400000 398500 397500 395000
Asset Turnover 1.25 1.254 1.257 1.265
ROI 10 11.769 12.95 15.95

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For achieving same level of profit through
increase in sales, it has to increase by

17.25%, 28.75% and 57.5%

Reducing cost is relatively easy compared to

increase in sales

Whereas additional sale of a rupee does not

become a profit as expenses should be
deducted. Not sure of competitors reaction

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Reduction in cost is possible in many ways
Better communicate with the suppliers your
requirements
Work with them to attain the necessary
quality

Negotiate a better deal with the transporters

to have reduced landing cost at your premises

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Purchasing

At operational level routine

administration ordering and receiving
materials and supplies

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Procurement departments aim is to get the
materials in

The right quality

The right quantity
The right time
The right price (least cost)
The right supplier

Identification of requirements, assessing risks,

awarding contract, monitoring the supply

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The procurement process or concept
encompassed a wide range of supply activities
than those included in the purchasing function

The major difference is participation in the

development of material and service requirement
and their specification

e.g. solids in tomato

Responsibility for performance of units beyond

ones own
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 Characteristics of Buyer Seller Relationship
Traditional Approach Collaborative Approach
Suppliers Multiple sources played off One of a few preferred
against each other suppliers for each major
item
Cost Sharing Buyer takes all cost savings; Win-win shared rewards
supplier hides cost savings

Joint Improvement Efforts Little or none Joint Improvement driven

by mutual interdependence

Dispute Resolution Buyer unilaterally resolves Existence of conflict

disputes resolution mechanisms

Communication Minimal or two way Open and complete

exchange of information exchange of information

Marketplace Adjustments Buyer determines response Buyer and seller work

to changing conditions together to adapt to a
changing marketplace

Quality Buyer inspects at receipt Designed into the product

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An illustrative supply chain for Luma Ice Creams

Fruits and
Sugar Flavours
Nuts

Processing
Farmers Packaging Distributors Retailers
Unit

Card board
Cups box Labels

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 Operating Cost Elements

Labour 100000
Materials 230000 223100
Overheads 70000
Other costs 60000
Cost 460000 453100

Sales 500000 Assets 398500

Net Income 40000 46900 Asset 1.25 1.254
turnover
rate
Profit Margin 8% 9.38
Return on 10% 11.769%
Investment

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Current ROI through sales
Assets
Inventories 50000 48500 6900 = New sales*0.08

Accounts 30000 30000 =6900/ 0.08

Receivables = 86250

Cash 30000 30000 Sales Increase =

Total 110000 108500

86250/ 500000*100

Fixed Assets 290000 290000 =17.25 percent

Total Assets 400000 398500

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6900=New Sales*0.08
= 6900/0.08 = 86250
86250/500000= 0.1725
=0.1725*100 = 17.25%

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Decide to make or buy

The buying decisions

What product/variety to purchase
When to purchase
How much to purchase
From where
Through whom
At what cost

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 Make vs Buy
Buy Make
FACTOR Outsourcing/ In-House
Market
Frequency Infrequent Frequent
Asset Specificity General Specific
Uncertainty/Dur Low/Short High/Long
ation
Complexity Less More
Opportunism Big issue Small Issue
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PROCUREMENT ENVIRONMENT
Nature of raw materials
Seasonality
Raw material for agro industries is biological, its supply
seasonal, available at the end of the crop or livestock
reproduction cycle.
Though supply is for one or two crop season demand is
throughout the year.
Implication
Proper inventory management to meet processing and
marketing requirement
Requirement of working capital peak during procurement
season
Cost of carrying inventory
If not properly handled there may be shortages of raw
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Perishability
Agricultural raw materials are perishable immediate
processing vs semi processing hiring or investing in cold
storage
They have to be properly handled while transporting and
storage
Bulkiness implications on transportation and storage
Variability
Variability in quantity as well as quality is another
characteristic of agricultural commodities
Changes in weather or pest or disease attack might affect
quantity and quality available
Agricultural raw materials are biological therefore, high
degree of variability
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ENVIRONMENT
PREDOMINANTLY SMALL HOLDINGS (SMALL SURPLUSES AND
INCREASES THE TRANSACTION COSTS)

Category of Holdings Number of Area'000 Average Size of

Holdings('000 Hectares) Holdings
Number) Hectares)
2005- 2010- 2005- 2010-11 2005-06 2010-11
06 11 06
Marginal 83694 92826 32026 35908 0.38 0.39
(Less than 1 hectare) (64.8) (67.1) (20.2) (22.5)
Small 23930 24779 33101 35244 1.38 1.42
(1.0 to 2.0 hectares) (18.5) (17.9) (20.9) (22.1)
Semi-Medium 14127 13896 37898 37705 2.68 2.71
(2.0 to 4.0 hectares) (10.9) (10.0) (23.9) (23.6)
Medium 6375 5875 36583 33828 5.74 5.76
(4.0 to 10.0 hectares) (4.5) (4.2) (23.1) (21.2)
Large 1096 973 18715 16907 17.08 17.38
(10.0 hectares and above) (0.8) (0.7) (11.8) (10.6)

All Holdings 129222 138348 158323 159592 1.23 1.15

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Note: Figures in parentheses indicate the percentage to total.
Environment continued

Different Agro climatic conditions

(Possibility to grow many different crops in
different seasons)

Geographical spread procurement may be

challenging

Poor infrastructure in some statesoffsets the

production advantage

Marketing channel is lengthy with several intermediaries

(increase the cost, low share to the farmers, quality of

the material affected)
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Govt Policies

Agro industries deals in products that are

necessities government intervention is
higher social and political necessities may
compel them to intervene (setting the price,
canalizing trade through state institutions,
completely banning)

International market and prices also have a

bearing on the agro processing firm

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