D2 - Business Needs in Procurement and Supply

Question 1

What are the overarching strategic and commercial objectives?

Answer 1

What are the overarching strategic and commercial objectives?

• Operate profitability
• Achieve and maintain competitive advantage
• Achieve and maintain cost leadership
• Achieve and maintain differentiation
• Attract and retain high quality employees, supply partners and business allies

Question 2

What is the role of procurement?

Answer 2

What is the role of procurement?

Not merely to fulfill operational and technical requirements but also to contribute to - the bottom line of the unit or enterprise

• the addition of shareholder value and customer value
• the achievement of value of money
• the effective management of organisational cash flows
• the fulfillment of other commercial and strategic objectives

Question 3

How should proposed procurement be?

Answer 3

How should proposed procurement be?

Not just for its own sake or because it is embedded in organisational procedures, processes, customs or assumed technical requirements - should be examined and challenged to demonstrate how they contribute to the commercial and strategic objectives of the business - planned and managed in such a way to maximize their contribution to the commercial and strategic objective of the business

Question 4

Name the 3 types of procurement

Answer 4

Name the 3 types of procurement

• Straight re-buy
• Modified re-buy
• New buy

Question 5

How can business needs influence procurement decisions for a straight re-buy?

Answer 5

How can business needs influence procurement decisions for a straight re-buy?

By suggesting the need to :

• optimize inventory replenishment methods
• periodically review existing specification and arrangements
• periodically re-open existing long-term contracts to competition
• secure additional business benefits in repeat or renewed contracts
• to collaborate with engineering, marketing and user departments in systematic value analysis of products

Question 6

What is a modified re-buy?

p.7

Answer 6

What is a modified re-buy?

Some of the requirements have changed:

1. Same Supplier but need may be re-specified or contract re-negotiated
2. A business case justification of the modification may be required for high value, strategically important or high-risk procurement
3. Modification of requirement may present the opportunity to revisit specifications or contracts to meet business needs more efficiently and effectively

Question 7

How can business needs influence procurement decisions for a modified re-buy?

p.7

Answer 7

How can business needs influence procurement decisions for a modified re-buy?

Suggesting the need or opportunity to

1. review existing specification against supply market developments to ensure that they will represent the optimum solutions
2. tchallenge modified specifications to promote commercial considerations such as
   
   • value (avoid over specification)
   • standardization or variety reduction (reduce inventory costs)
   • environmental sustainability
   • leveraging of supplier relationships+expertise
3. to re-open existing contracts to competition to ensure that the existing supplier remain competitive
4. to justify specification or contract modification on the basis of identified business benefits ie avoiding unnecessary risks and costs of re-specification, variety and stock proliferation, supplier switching.
5. to re-negotiate contract terms to build in additional business benefits such as quality improvements, collaborative waste or cost reductions, or additional KPI’s (such as environmental or social sustainability standards)

Question 8

How can business influence procurement decisions for NEW procurements?

Answer 8

How can business influence procurement decisions for NEW procurements?

By suggesting the need or opportunity to

1. Engage in systematic purchasing research:
   
   • Demand analysis (for accurate demand forecasting to minimise sourcing and inventory waste and risks)
   • Vendor analysis (evaluating capability of potential suppliers and performance of current suppliers to minimise risk)
   • Supply market analysis (appraise market conditions ie factors such as like availability, risk of shortages, disruption to supply, market prices, price fluctuations, etc)
2. Engage in proactive value engineering
3. Promote early buyer involvement
4. Promote early supplier involvement
5. Develop specifications, supplier performance measures and contract terms

Question 9

What are the business needs that might influence procurement decisions for NEW purchases?

p. 8
* May 2014: Describe 5 activities that a procurement function might undertake when contributing to the development of a business case for a new purchase (15 marks)*

Answer 9

What are the business needs that might influence procurement decisions for NEW purchases?

Suggest the need or opportunity to

1. To engage in purchasing research
   
   1. ​Demand analysis - aimed at accurate demand forecasting for high-value, high-usage, high-risk materials in or to minimise sourcing and inventory waste and risks
   2. Vendor analysis - evaluate the capability of potential suppliers and hte perofrmance of current suppliers to optimise supplier value and minimise supplier risk
   3. Supply market analysis - appraising conditions of the supply market, in relation to factors such as likely availability and the risks of shortages or disruptions to supply, market prices, price fluctuations
2. ​To engage in proactive value engineering
   
   • ​​value analysis applied at the design, development and specification stage of product development, in order to eliminate wastes, over specification and non value-adding features and processes from the outset
3. To promote early buyer involvement (EBI) in product and development
   
   • ​​in order to ensure that commercial and supply market considerations are taken into account at an early stage
4. To promote early supplier involvement (ESI) in product and development, in order to ensure that commercial and supply market considerations are taken into account at an early stage when they make the greatest whole-life impact
5. To develop specifications, supplier performance measures (KPI’s) and contract terms to maximise business benefits and value to thebuyin organisation

Question 10

Procurement Categories

(Not to be confused with “types of purchase i.e. new, modified re-buy, rebuy”)

p.8

Answer 10

Procurement Categories

1. Capital procurement (assets with long usage, high acquisition cost ie buildings, plant, equipment, etc)
2. Production Materials (ie raw materials, components and assemblies)
3. Maintenance Repair and operating or MRO supplies ( all goods and services, ther than cappital equipment, necessary to transform raw materials and components into end products ie paint, lubricants, packing materials, cleaning products and industrial clothing)
4. Commodities (raw materials ie textile, food and beverage crops, minerals ie coal, iron ore, for incorporation into products
5. Goods for re-sale (ie purchases by retailer, wholsesaler, brokerage for sale to customers)

Question 11

Business Needs for CAPITAL PROCUREMENTS

P.9

Answer 11

Business Needs for CAPITAL PROCUREMENTS

1. Systematic appraisal of cost of benefits, costs and risks of the investment and the likely payback period of the investment ie length of time it will take for business benefits to outweigh the costs)
2. Robust comparison of alternative assets or options to reach the optimal solution ie balancing hthe whole life costs and performance, functionality and quality of the asset
3. Netgotiation, specification and contracting with the chosen suppliernfor a total ‘package’ of benefits sought over the asset’s lifecycle (eg incl installation, user training, finance, maintenance, warranties and/or technical supprt)
4. Analysis and management of lifecycle costs: ie not just price, but ongoing costs of acquisition, operation, maintenance and disposal over the years of the asset’s useful life
5. Management and maintenance of the asset to prolong its useful and maximise its residual value on disposal (eg recycling or resale)

Question 12

Business needs for PRODUCTION MATERIALS

p.9

Answer 12

Business needs for PRODUCTION MATERIALS

Achievement of operational objectives includng the five rights. Operational efficiency may be best servced by the timely and secure flow of inputs (of specified quality) to production processes, in order to minimise the risks and costs of bottlenecks or disruption of production.

Question 13

Business needs of procurement of MAINTENANCE REPAIR AND OPERATING OR MRO SUPPLIES

P.9

Answer 13

Business needs of procurement of MAINTENANCE REPAIR AND OPERATING OR MRO SUPPLIES

1. Avoid stock proliferation
2. Opportunity to manage costs by establishing optimum stock levels based on accurate usage data and replnishment systems
3. Enforce sound procurement disciplines in MRO procurements rather than letting users buy ad hoc basis ie use call off contracts.
4. Opportunity to minimise prices eg by consolrtium or demand aggregation for bulk discounts

Question 14

Business needs for procurement of COMMODITIES

p.9

Answer 14

Business needs for procurement of COMMODITIES

1. securing supply - minimising the risk of scaricty or supply disruption;
2. price/cost management

Question 15

Business needs for GOODS FOR RE-SALE

p. 10

Answer 15

Business needs for GOODS FOR RE-SALE

1. The selection of goods for which there is a sufficient market demand to secure profitable trading

Question 16

Krajlic

Answer 16

Krajlic

1. A tool developed to segment an organisation’s procurement portfolio according to priority
2. It seeks to map:
   
   • The importance to the organisation of the item being purchased
   • The complexity of the supply market

Question 17

PREVIOUS EXAM QUESTION:

May 2014:

Using examples to illustrate, explain the difference between a straight re-buy and a modified re-buy, as types of purchase (10 marks)

Answer 17

Explain the difference between a straight re-buy and a modifed re-buy: (up to 6 marks)

• ​​ A straight re-buy is the purchase of tems already sourced from a supplier and no changes are made to the specification.
• A modifed re-buy is the purchasing of items where some requirements have changed before any further purchases are made involving change in the specification.

1. Explain with examples:

• Straight re-buy examples are: (
  
  • steel industry ie coal, iron ore,limestone that are unlikely to ever change
  • cellophane uses wood pulp which is always available
• Modified re-buy examples are:
  
  • IT equipment where improvements to technology change frequently due to industry advancements
  • Motor vehicle dealership may purchase additional and newer models as they are released from the manufacturer

Question 18

What are the main objectives of a formal business case process (developing and presenting the business case for a procurement, proposal or project)?

p.12

Answer 18

What are the main objectives of a formal business case process (developing and presenting the business case for a procurement, proposal or project)?

1. Fostering strategic, business focused thinking: requiring people with the authority to recommend projects or proposals to pre-evaluate their value, risk and priority
2. Improving the efficiency and quality of decision making by weeding out (or sel culling) proposals that cannot demonstrate business value
3. Enabling management to evaluate proposals for feasibility, suitability and acceptability
4. Enabling management to compare alternatives and options on objective business cost/benefit criteria
5. Establishing measurable yardsticks to be able to evaluate performance, deliverables or outcomes of projects at key review points
6. Is the project or asset achieving in the business case benefits anticipated?
7. Are the assumptions made in the business case turning out to be accurate?
8. Is the business case justification for the project still valid?

Question 19

Business case: formal

p.13

Answer 19

Business case: formal

• Used in the case of high value, high risk procurement or capital procurements

1. Executive summary
2. Reference: project name or reference, backeround and current statis
3. Context: business objectives and strategic alignment, threats and opportunities, and the priority of the project
4. Value proposition: the desired business outcomes or deliverables; business benefits(by outcome); quantified or monetised value of the benefits; cost estimates; financial modelling and return on investment calculations; risks and costs of not proceeding: and risks of the project (project risks, business risks, risks of the benefits not being realised)
5. Scope: the problem or solution scope, assumptions and constraints, options identified and evaluated assessment of scale and complexity
6. .Delverables: outcomes, delivereables and benefits planned (with KPl measures against which results can be evaluated at key review or decision points
7. Impacts: functions, activities and relationships impacted (internally and within the supply chain): key stakeholders; dependencies
8. Work planning: approach; project stage definitions; workload estimate or breakdown; sourcing or project plans and schedules critical path analysis
9. Resource requirements: managerial and team resources; fufunding or budget allocation
10. Risk management and contingency plans
11. Commitments: project controls and reporting processes, schedule of de

Question 20

Business case: Informal

p.13

Answer 20

Business case: Informal

• Used in the case of low value, low risk procurement

1. Introduction/Background
   
   • Overview of business need: objective to be met, problem to be solved, threat to be countered or opportunity to be explored
   • Priority of the need/sissue
   • The current situation
2. Options
   
   • Options considered (if any)
3. Business Benefits
   
   • Expected outcomes of the proposed solution and its associated business benefits (must be quantifiable and qualitative)
   • Alignment of the proposed solution with objectives, strategies, policies and values
4. Costs and Risks
   
   • Estimated costs of the proposed solution
   • Anticipated risks of the proposed solution
   • Anticipated impacts on activities and relationships (both internal and external supply chain)
   • Anticipated risks and csts of not pursuing the proposed solution (or doing nothing)
5. Recommendation
   
   • Net (on-balance) cost/benefit assessment
   • Return on investment or payback period (if data is available)
6. KPI’s (if data is available)
   
   1. Target costs and results which will be used to evaluate performace at key decision points in the project/procurement lifecycle to indicate anticipated bsuiness benefits are being realised.

Question 21

What are the commercial or business benefits of a given procurement?

p.14

Answer 21

What are the commercial or business benefits of a given procurement?

1. Fullfillment of a specific objective or to fulfill a specific business strategy (eg improving quality, where the organisation’s competitive strategy is one of quality leadership, or harnessing the innovation capability of a supplier where the organisation has the objective of new product development
2. Increased revenue (eg through increased customer satisfaction, brand loyalty and product sales as a result of improved performance pr product quality
3. Reduced costs (eg through elimination of wastes, increased efficiency and productivity, price leverage though negotiation or competition
4. Enhanced profitibility (as a result of increased revenue and/or reduced costs)
5. Enhanced value for money (especially in public sector contexts) as a result of reduced costs without compromise on quality or service dlivery standards
6. Enhanced shareholder value (through enhanced profits ie transformed as dividends to shareholders)
7. Competitive advantage to enable organisation to capture markt and sales revenue share from competitors though lost leadership, enabling competitive pricing, product and brand differentiation)
8. Leverage of key resources such as technology or supplie relationships: maximisingf the value added by the resource
9. Increased capacity, capability or flexibility though developing quality suppliers and supply chains that offers potential for ehnhaced profitability (greater production volumes, responsiveness to fluctuations in demand) and competitive advantage (more capabale performance, innovation and design capability)
10. Improved brand or reputational equity though consistent quality performance, corporate social responsibility, ethical sourcing and trading, environmental sustainability)

Question 22

PREVIOUS EXAM QUESTION

JAN 2014

1. A car manufacturing company is preparing a business case for the purchase of a new machine to be used in the assembly of vehicles
   
   1. Describe FOUR commercial benefis that might be used as criteria to justify the business case (16 marks)
   2. Describe ONE cost and ONE risk that could be included in the business case remarks (9 marks)

Answer 22

1. A car manufacturing company is preparing a business case for the purchase of a new machine to be used in the assembly of vehicles
   
   1. Describe FOUR commercial benefis that might be used as criteria to justify the business case (16 marks)
   2. Describe ONE cost and ONE risk that could be included in the business case remarks (9 marks)
2. Typical examples included
   
   1. reduced costs through time saving or eliminational of waste
   2. inreased revenues
   3. higher quality products
   4. increased profitibility from lower costs and/or increased revenues
   5. innovation
   6. enhanced shareholder value and increased manufacturing capacity
   • Good contextualisation to the scenario was important for higher marks
3. ..
   
   1. Costs:
      
      • Purchase price and/or acquisition costs
      • maintenance and operation costs
      • disposal costs
      • warranty and servicing costs
      • training costs
      • ‘downtime’ costs
   2. Risks:
      
      • Operational disruption as a result of the change
      • the risk that the machine might not achieve the desired ojectives or might fail to operate as expected

Question 23

Estimated COSTS to be included in a business case

p.15

Answer 23

Estimated COSTS to be included in a business case

1. Financial costs
   
   1. Purchase price
   2. Costs of acquisition and ownership
   3. Fees and charges
   4. costs associated with risk events such as failure costs, teething trouble costs and contingency plan costs
2. Non-Financial costs
   
   1. operational disruptions and learning curves as a result of change
   2. impacts on other functions and the supply chain
   3. reputational damage
   4. loss of knowledge or capability
   5. damage to supplier relationships and goodwill
3. Opportunity costs of choosing one option over another ie benefits that will be foregone by devoting resources to one plan rather than an alternative path

Question 24

Estimated RISKS to be included in a business case

p.15

Answer 24

Estimated RISKS to be included in a business case

1. Must take into account internal and external risks
2. Risks arising from, or as a result of the proposed procurement and the associate costs of those risks if they occur.
3. Risks which might affect the proposed project/procurement and might jeopardice the anticipated benefits, ie
   
   • exchange rate fluctuation & transport risks will reduce cost advantages anticipated from purchasing from low-cost labour countries
   • the financial instability ofa key supplier might place at risk all the benefits of a procurement if in the event of supplier failure
   • The risk of a system breakdown or data theft would similarly jeopardise the benefits of ICT development
4. Risks should be assessed for the likelihood and impact. The costing of a business case should include the costs of:
   
   • Risk management: identification, assessment and mitigation (eg insurances, monitoring and control)
   • risk events occuring (if they are highly probable and cannot be adequately mitigated): such costs, if significant may deter the organisation frompursuing the proposal
   • contingency planning (for high impact risks, however improbable): that is, alternative or back up arrangements to be implemented if risk events occur.

Question 25

What is the distinction between PRICE and COST

p.23

Answer 25

What is the distinction between PRICE and COST

PRICE

is what the sellect charges fora package of benefits offered to a buyer and includes an element of profit. The price charged by a supplier is higher than the costs to manufacutre the goods. Price is an output

COST

is what the buyer pays to acquire the goods/services purchased. This includes labour, materials, overheads.Cost is an input

Question 26

PREVIOUS EXAM QUESTION

Nov 2014

Explain the difference between the terms ‘cost’ and ‘price’

Answer 26

Explain the difference between the terms ‘cost’ and ‘price’

Cost is the money paid out by an organisation to acquire goods or services that it requires, including materials, labour, overheads; whereas price is what th eorgansiation charges it custoemrs ad sowill normally have an element of profit.

Therefore the the price charged byan organisation will normally be higher than its costs, unless it is selling its product or service as a ‘loss-leader’or at a price which deliberately is set to only cover costs.

Essentiallytherefore cost is an input and price is an output.

Question 27

PREVIOUS EXAM QUESTION

JULY 2014

Explain the following types of pricing arrangements and their use:

1. Cost plus fixed fee (5 marks)
2. Cost plus incentive fee (5 marks)
3. Cost plus award fee (5)

Answer 27

Explain the following types of pricing arrangements and their use:

Cost plus fixed fee (5 marks)

Cost plus incentive fee (5 marks)

Cost plus award fee (5)

1. Cost plus fixed fee:
   
   • costs are covered in full, and the extra fee is based on a predetermined fixed amount on successful completion of the contract.
   • The costs are unknown although they can be capped; but the fixed fee remains constant.
   • This pricing arrangement may be used in particular where the supplier’s costs cannot easily be estimated eg for some Research and Development contracts but there is no incentive on the supplier to reduce their costs with this arrangement
2. Cost plus incentive:
   
   • Costs are covered as for ‘fixed fee’. but then an additional incentive fee is offered if the supplier should meet or exceed predetermined KPIs perhaps especially those aimed at making cost reductions or achieving high measurable performance level.
   • Both parties may then share the cost savings.
   • This pricing arrangement may be used particularly where there is plenty of scope for cost reductions and performance improvements by the suppliers
3. Cost plus award:
   
   • Costs are covered as for ‘fixed fee’ but then an additional incentive award fee is offered if the supplier should meet or exceed some predetermined aspects of contractual perofrmance that are not easy to measure quantitatively.
   • The award fee may be paid to the supplier in recognition of qualitative assessment of the supplier’s application of effort to meet the buyer’s needs, probably on a subjective evaluation.
   • This pricing arrangement may be used particularly for service contracts, such as cleaning, catering, software development, etc. where the contractor’s performance in qualitatively satisfying the demans of internal customers may be the driver for the amount of the award fee

Question 28

PREVIOUS EXAM QUESTION

NOV 2013

Explain the differences between these pricing arrangements

1. Cost plus arrangements (10 marks) p.140
2. Target costing arrangements (5 marks) p.141

Answer 28

1. Cost Plus arrangements
2. Target costing arrangements

Question 29

Explain/Discuss pricing strategies that Suppliers use

p.36

Answer 29

Explain/Discuss pricing strategies that Suppliers use

They are likely to be based on (a) costs or (b) market factors

1. Cost based Pricing
   
   • Full cost pricing
   • Cost-plus or mark-up pricing
   • Marginal pricing
   • Rate of retun or ‘target return’ pricing
   • Contribution pricing
2. Market driven pricing
   
   • Price volume
   • Market share pricing (or penetration pricing)
   • Market skimming
   • Current revenue pricing (or contribution pricing)
   • Promotional pricing
   • Market-segment pricing (also called differential pricing or price discrimination)
   • Competition pricing (ord dynamic pricing)

Question 30

Factors that influence how buyers decide what prices to aaccept

p.27

Answer 30

1. The buying organisation’s relative bargaining power in the market and relationship
2. The number of suppliers in the market and the possibility of substitute products enabling the buyer to exploit competition to force prices down
3. The type of purchase
   
   • Critical/Non routine purcases - buyer will want to secure bes tprice by competitive purchasing
   • Critical/Strategic products - may pay more for service and security of supply
4. The prices paid by competitors (if info is available) so that the buyer keeps his material costs competitive
5. The total package of benefits offered for te price and whether ‘value’ is better at a higher price (given the need for quality, supplier relationsip, etc)
6. What the buyer can afford, geiven the quantities likely to be involved overa given period
7. What is the reasonable price based on price analysis
8. What is a fair (ethical and sustainable) price from the buyer’s and supplier’s perspective

Question 31

What approaches can the buyer use to decide whether ‘the price is right”

p.28

Answer 31

1. Price Analysis
   
   • Seeks to determine if price is fair and appropriate
   • The right price is advantageous or reasonable compared to othe rprice offered byother suppliers
   • prices previously paid for by the buyer for the same goods
   • the market or going rate
   • and/or the price of any alternative or substitute goods
2. Cost Analysis
   
   • A more specialised technique often used to support negiotiations where supplier justifies its price by the need to cover its costs (cost based pricing)
   • it looks specifically at how the quoted prices relates to the suppliers costs of production.
   • Supplilers may be asked to include cost breakdows with their pcie quotations so that:
     
     • Differencees between supplier’s cost breakdowns and the buyer’s own analysis or estimate of the suppliers costs can be examined to arrive at an agreed cost figure
     • Buyers can identify when suppliers are claiming higher-than-average or unjustifiable profit margins
     • Buyers can calcuoate a target price or price range for use in negotiatons (based on suppliers covering their costs plus a reasonable profit margin