Purchasing Principles

The success of any manufacturing activity is largely dependent on the procurement of materials of right quality, in the right quantities, from the right source, at right time and at right price – popularly known as five ‘R’s of the art of efficient purchasing .

They are also described as the basic principles of purchasing as under:

1) To purchase the right quality of materials;
2) To purchase the materials in right quantities;
3) To make the materials available at right time;
4) To purchase the material at right price;
5) To purchase the materials from the right source.

They briefly explained as under:

Right quality: The materials are the basic input and the quality of the output. It should be noted that best quality is not always the right quality. The right quality is determined by the cost of the material and the technical characteristics as suited to the specific requirements. The right quality should be defined clearly and should be described in terms of specifications. Generally the quality decisions are made by the technical staff. The quality specifications are controlled before the materials are issued for the manufacturing processes. The quality testing is done through the inspection either at supplier’s plant or at buyer’s plant.

Right quantity: The right quantity of the materials is determined on the basis of economic ordering quantity (E.O.Q). It is advantageous to purchase the materials on the basis of EOQ lots. The EOQ describes the size of the order at which the ordering costs and the inventory carrying cost will be the minimum. The ordering cost consists of the cost of paper processing such as paper, typing, postage, filing, cost of personnel; the costs incidental to order placing such as follow up, receiving, inspection etc. If the size of the order is large, the annual requirements will be met with little of the ordering cost as the number of orders placed would tend to be less. Conversely, storing cost consists of interest on funds locked up in storing, cost of storing, cost of insurance and taxes etc. If few orders involving large quantities are placed, the carrying cost will increase; however, the ordering cost will decrease due to less number of orders. Thus ordering cost and carrying costs are mutually exclusive. At EOQ level both these cots equate each other and at this point, the total inventory cost would be at the minimum. The EOQ is calculated on the basis of the following formula:

EOQ = √2RD /CS

Where R = annual requirements of the materials in units

D = Ordering cost per order

C = Cost per unit

S = Storing cost as the value of materials stored.

Right time: The materials should be purchased at right time so that it may not result in either excess investment in the stocks or may result into stock outs. Efforts must be made to replenish the materials at a point where they are reaching at the reordering level. The purchase action is initiated at a tome when the material reaches to its pre-decided reordering level. The reordering level is decided on the basis of the rate of consumption and the lead time. It should be decided on the basis of the probability of maximum periodic consumption and maximum lead time. As stock holding is directly related with the lead time, efforts should be directed towards the reduction of the lead time so that carrying costs can be reduced to the minimum.

Right price: The investments in inventories are determined by the prices charged for them. All attempts should be made to procure the materials at right price because a slightest reduction in the price results in substantial absolute monetary gain. It should be noted that the low bidder is not always the best bidder. The right price can be availed through searching for the proper sources of supply and comparing all such sources on some scientific basis. The quotations of various suppliers are compared after bringing them all on some common footing. Due considerations are also given to the factors such as regularity of supply, character of the supplier his financial standing etc. The price is an agreement between the buyer and the suppliers the former considers his utility while the latter takes into account his cost of production. The market conditions greatly effect the price determination.

Right source: The right source is a key consideration in purchasing as all other ‘R’s. The suppliers are not only supplying the required materials but they also supply the information such as probable market conditions and the resultant price trends, general industrial climate and the business environment. The selection of right source involves the considerations such as search for the more and more sources, selection of the appropriate source through some scientific analysis, negotiating with the selected supplier and post purchase rating of the supplier.