For an organization, purchasing is a window to the outside world. The prime function of purchasing is that of being sensitive to the external supply market situation and also of feeding back this information to the other functions of the organization. However, it is usually understood to be to get the right quantity of material of the right quality at the right time, at the right place, from the right source and at the right cost.
Quite often it is not understood by even top executives, that a considerable profit potential exists in the purchasing activity. In fact, it has been quoted that 20-30% of a company’s profits can come from savings generated in the purchasing department. Suppose a company’s output volume is Rs 20 crore and the cost component of materials is say 50% (that is Rs 10 crore for materials). If the profit margin is taken as 15%, the gross profits will be Rs 3 crore. With a 20% increase in the output volume, the profits will increase by Rs 0.60 crore. The same increase in profits can be achieved by 6% savings in the purchase costs. This example is given to illustrate that there is a lot more potential in reducing the purchasing costs as compared to increasing the sales turnover. Moreover, the increased savings in purchasing require only one or two purchasing executives doing a proper study and analysis of the external market. Whereas an increase in sales volume usually means an increased capital outlay on equipment, an increased sales and marketing expense through increased advertising and promotional expenses, and much more leg work by the salesmen. All this means more efforts, expenses and risks. Compare this with the efforts required in generating equal profit contribution from the purchasing department and one will realize that the latter does not require such enhanced management effort and risk. A point to be noted is that the cost of materials in the production cost of an item, on an average, in the Indian manufacturing industry takes a lion’s share of almost 65%. For some industries this component could be even higher. This only highlights the importance of the attention needed for the purchasing activity.
Links with other Organizational Functions:
Purchasing has important links with most of the organizational functions. The Production Planning and Control or Materials Control sections might have a say in the inventory of raw materials and bought out parts; but the purchasing executive has a first hand knowledge of the market situation for the supply of these items. For instance (1) Is there going to be any shortage in the near future? (2) How will the shortage escalate the prices? (3) Are there any good substitutes available? (4) Will there be an industrial relations problem in the important supplier’s company and how will this affect the company’s production? (5) Which supplier can supply better quality material and better quality component parts at the same or less price? (6) Which are the potentially good vendors who could be developed into reliable suppliers and loyal partners sharing the concerns in the business? All such information regarding the outside market is of much importance to the production, marketing, finance and other departments. If a company buys component parts which are incorporated into its own products, the Purchasing Manager will have to play a role which can perhaps, be described as ‘External Manufacturing Manager’.
Increasing the sales does not always result in increasing profit. Sometimes increase in sales may mean a decrease in profits, because with an increase in volume, the cost of input materials may also rise. This is where the purchasing department’s feedback information is useful. It can apprise the management of what an increase in sales activity will entail. The marketing/sales and purchasing departments have to work hand-in-hand in order to take care of such situations. Purchasing is as much in contact with the external market as the sales department is. The sales department may be concerned with the customer market, whereas the purchase department may be looking at the supply market. In fact, both are looking at the external environment and therefore, exchanging of notes between the two departments is important to the organization.
In cases where the Inventory Control or Production Planning and Control (PPC) departments set certain inventory levels for raw materials, these norms for stocking levels are for average situations. When the external market is other than usual, the purchasing executive’s feel of the supply market should provide valuable input to PPC or Inventory Control. The normal stocking levels and service levels do not mean much in such situations. Purchasing can also provide valuable information regarding substitutes which may be cheaper and functionally better or at least as good.
The purchasing executive may also spot certain extraordinary opportunities to get the raw material at a low cost. The point is that an organization can make use of the valuable market information provided by the purchasing department, and consider it not merely as a department processing purchase requisitions but as a vital link between the external environment and the organization. A purchasing manager should provide this link consistently. This is as much true for a service organization as that for a manufacturing organization.