Purchasing and Negotiation Training

Harry Hough, PhD, founder of the American Purchasing Society

Editor’s note: Dr. Hough is a frequent contributor to this blog.

The objective of the purchasing function is to obtain proper material and services when needed at the lowest obtainable cost. It is usually, although not always, easy to find a supplier to provide what is needed. It is somewhat more difficult to make sure that the products meet all the specifications required. Obtaining delivery when needed may be easy or difficult and is, at least in part, a function of internal planning and procedures. Getting the lowest Total Cost of Ownership is complicated because there is no way of knowing for sure that there is not a lower cost somewhere or by using some other method.

This post describes six of the proven ways of obtaining products at a relatively low cost. The proper cost of products can also be obtained by analysis of the various components of the cost, in particular labor content and the prices of raw material content. (See also post on Cost Analysis)

1. Negotiation

Discussions with a new or existing supplier may lead to a reduction in cost. Obtaining new bids helps the buyer compare present prices and terms with other suppliers and forms the basis for discussions with the present supplier. Asking for new bids from a present source who knows that competitors are also submitting quotes is often all that is needed to obtain concessions from the present supplier. Studies have shown that present suppliers become complacent about existing customers unless they are motivated to remain competitive. Today buyers who concentrate on prices are depicted by many as old fashioned. It is suggested that they are ignoring other more important cost factors. The other cost factors should never be ignored, but prices are the best general indicator of competitive suppliers.

2. Specifications

Requesters mention brand names for a product they need. Other brands may be less expensive or offer more valuable features. Engineers use brand names to avoid the need to prepare elaborate specification details, but the buyer may need to convince the engineer that other less costly brands will do a better job without adding risk of failure.

Changes in the type of material such as a steel, plastic, or chemical may reduce cost significantly if the specification does the job intended. A saving may result by loosening a tolerance of a casting without incurring any product failure or getting any less customer satisfaction. Changing packaging may reduce labor charges. The buyer must convince users, engineers, designers, and sometimes marketing people that such changes are beneficial and cost effective.

3. Inventory

Goods kept in stock add cost. Reducing the amount of inventory saves investment, saves space, and avoids deterioration and obsolescence. Buying the appropriate quantity minimizes inventory. Increasing the quantity ordered provides economies of scale to the supplier who in turn should pass on a portion in the form of quantity discounts. Any increases in quantity ordered must be compared with the cost of any need to keep additional inventory on hand. 

Handbook of Purchasing Management by Dr. Hough

 4. SourcingChanging suppliers is often a good way to obtain a cost reduction; however it has risks. The new supplier may not provide consistent quality, may not provide good service, and may end up asking for a higher price. Changing a source for a key item requires the buyer to carefully check a supplier’s references and inspect the facility.

Savings can be achieved by eliminating multiple sources for the same item. This can obtain a lower price because of the economies of scale. It reduces administrative cost by eliminating multiple transactions for purchasing and accounting. There are risks. Split sourcing provides insurance against one supplier failure. Single sourcing does not.

5. Administration

Reduced transaction cost can be achieved through computerization. Use of the Internet, procurement cards, and blanket orders all contribute to efficiency and reduced cost.

6. Terms and Conditions

Payment discounts reduce purchase costs. Other terms and conditions avoid costly legal problems and protect the company from supplier failure.