One of the key department to success for controlling cost (and maximizing profit as the main goal of companies) is the purchasing department. Purchasing is the first stage company spends monies (funds) to achieve the goal (profit & return to the stockholder). Purchasing directly impacts profitability and the financial success of the overall business enterprise. Savings iniative by purchasing department reduces purchases to a lower dollar, which causes a chain reaction as it flows through the cost accounting system; first by reducing total cost that increases profit, and then profit margin, and ultimately return-on-investment (ROI).A significant lowering change in purchasing expenditures is the key to swing the return on invested capital dramatically.

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The most basic but effective way to drop the purchase dollar without bothering continuity of company’s operation is to get the lowest cost among the available sources. Purchasing managers and staffs [under a controller] have to use their knowledge of the in-and-out of sourcing, both domestic and offshore.

 
Comparing The Wages (Labor Cost) Rate

The decision whether to offshore or purchase in domestic resources, purchasing people would need to compare both choices [offshore vs. domestic] to lead to the lowest cost [and finally drops the purchase amount for the same quantity of supplies].

To offshore itself, purchasing would still need to compare several countries to get the most competitive offer by ranking the countries [where the supplies are available]. While material costs are often nearly the same in various countries, it is the labor content that makes the major difference in manufacturing costs. If you come from accounting background, I believe you know that labor cost is the second-biggest portion of a product cost (cost of goods sold) after the raw material. To compare the labor content of each country, purchasing can check wages rate of each country.

Example: Let say you are attempting to source bulk of fabrics. After doing a short research, you found that; India, China and Thailand are countries where the fabrics are available. Next you would need to compare labor rate of each the three countries. The lowest labor rate should offer the best price. If it is not, then it is a sign for you to bargain.

 

Okay, let say India is the winner. But what if it is compare to the domestic resources? You would need to know the landed cost of the offshore acquisition choice. How to calculate landed cost? Read on…

 

How To Calculate Total Landed Cost of Offshore Acquisition

A key criterion to consider in making any source selection relates to total landed cost of acquisition. Following are several examples that demonstrate the importance of considering total costs:

[1]. Cost of Quality – Two suppliers who have comparable prices cotton fabrics. However, Supplier B has experienced a higher rejection rate and as such appears inferior to Supplier A on the company’s quality report. It might cost an extra $5 each to cover inspection, which should be accounted for in Supplier B’s total cost. However, on the production line, Supplier A’s fabrics require sorting, and extra machine time to overcome machining difficulties because of “hard crease marks,” which again enters the total cost equation for Supplier A. So, when the total cost of quality alone is included, it is possible supplier B’s sewing may actually be more economical than A’s.

[2]. Lifecycle Cost – Lifecycle costs should be considered as another factor in total landed cost. If Brand A wears out in an average of 5 years, and the alternate Brand B lasts 15, three Brand A’s will be needed in the course of the lifetime of one Brand B. So if the product will be needed for that span of time, A’s lifecycle cost will be three times its acquisition cost, which should be compared to the original cost of B. The professional buyer knows the price of the item alone is not all that must be analyzed, but also the costs associated with acquiring the product as well. The following checklist may be helpful to the purchasing department in identifying, analyzing, and quantifying total landed cost, assuming an offshore buy. Many of the items will be relevant to a domestic purchase as well:

  • The FOB dollar price
  • Packaging, marking, and container costs
  • Commissions to Customs broker/freight forwarder
  • Fees for consultants or inspectors
  • Terms of payment costs and finance charges
  • Letter of Credit fee
  • Translation costs
  • Exchange rate differentials
  • Insurance premiums
  • Customs or other documentation charges
  • Import duties
  • Transportation costs
  • Taxes imposed, such as foreign VAT

 

Added inventory carrying costs if the purchase requires safety stock Extra man-hours needed based on greater documentation Costs of overseas business travel, international postage, telex, FAX, and telephone charges Miscellaneous and hidden costs: obsolescence, spoilage, damage and theft, and longer delivery time.

Once you got the landing cost number, you want to compare the number with domestic purchase figure. If you see significant lower of purchase cost, most likely you can keep buying offshore to good advantage. However, the pendulum of costs has shifted. Any decision to source overseas should be made based on the best ultimate value.

 

Post-Selection Supplier Evaluation

So you have seen a productive value-added indication and plan for execution. But, do you know; if the company doesn’t manage its suppliers, it is managing only about half of the cost of products sold, and this won’t hack it in a competitive environment. Throughout the performance period, buyers must tell suppliers what is expected. How high is high?

A Purchasing Manager can manage suppliers by using a variety of day-to-day options, such as:

  1. Increasing or decreasing purchase volume
  2. Getting local stocking of items, for faster shipments and lower inventory
  3. Using competition to get the best package of price, leadtime, and quality
  4. Giving incentives for better supplier performance
  5. Dropping a supplier for poor service
  6. Taking legal action—as a last resort, hopefully (rather drastic)
  7. Reporting performance—quality, delivery, and other performance data

The term “managing suppliers” may bother some in the purchasing profession. Management may be defined as, “the art of making things go right” to properly address this concern. With good job performance, the following desirable results are signs of effective supplier management:

  1. Near-zero rejection rates—at receipt and forward through the life of the end item delivered (today some buyers seek six-sigma quality levels, equivalent to a defect rate of only 3.4 defects per million pieces).
  2. Lowest total cost incurred
  3. Good supplier relations, with ongoing joint productivity improvement efforts
  4. Reputation ofFirm but fair!” with suppliers anxious to expand the business relationship
  5. The ultimate test—high customer satisfaction level

 

Some people resist the tracking of supplier post-award performance on the grounds that it’s the supplier’s job to perform, and they therefore only list the suppliers they plan to eliminate. Underlying this approach is often the concern that an elaborate system is needed, but this need not be the case.

There is value in knowing a supplier’s performance throughout the performance period, and with the ability of the Internet to quickly transmit information around the world, this has become much easier and less expensive to achieve.

If purchasing people are to award business based on performance there has to be some standard of judgment. We are interested in a moderate, reasonable way to identify those suppliers that perform well and those that perform poorly. How we use the system is key. The focus is not on punishment, initially, but on communication to improve performance for the benefit of both parties.

Consider the case of a supplier who has performed poorly, yet makes a commitment to get back on track. Surely, there is nothing more discouraging to such a supplier upon inquiry to be told that you still think they are doing poorlyConversely, nothing is more gratifying than to have the buyer formally acknowledge a positive turnaround. The emphasis, then, is a positive approach that can bring about improvement. Good suppliers can be superior ones, but for this to happen both the buyer and the supplier have to know how they’re doing to help them to achieve superior results.