Overview
This lecture covers how to define business needs in procurement, devise a business case for external sourcing, estimate costs, and interpret financial budgets for effective purchasing control.
Understanding Business Needs
- Business needs are inputs required to achieve organizational objectives.
- Needs can be common (e.g., facilities) or specific to business type, size, and complexity.
- Three business need types: straight rebuy (repeat purchase), modified rebuy (changed specification), new buy (new requirement).
- Procurement’s role is to meet needs by achieving the five rights: right quality, quantity, time, price, and source.
Approaches to Procurement
- Straight rebuy: repeat orders, minimal effort, existing terms.
- Modified rebuy: updated needs/specs, requires new sourcing strategies and benefit tracking.
- New buy: involves specification writing, market research, stakeholder involvement, risk mitigation.
Building a Business Case
- Business case justifies actions, secures approvals and funding for projects.
- Includes opportunity/problem, benefits, risks, mitigation, timelines, responsibilities, strategic alignment, cost analysis, and implementation plan.
- Must demonstrate value to senior management (ROI, time to market, productivity).
Gathering Market Data & Cost Estimation
- Market intelligence (benchmarking, trends) essential for informed procurement.
- Research types: primary (new data, e.g., surveys) and secondary (existing data, e.g., reports).
- Quantitative research = numeric data; qualitative = opinions/feelings.
- Request for Information (RFI) gathers market data without committing to suppliers.
Cost Types & Analysis
- Direct costs: traceable to a product/service (materials, labor).
- Indirect costs/overheads: not directly linked to production (administration).
- Fixed costs: unchanged by volume; variable costs: change with activity level.
- Total cost base = direct + indirect costs.
- Break-even analysis identifies when revenue equals costs.
- Purchase cost analysis benchmarks prices to manage supplier relationships and reduce costs.
Procurement Segmentation & Life Cycle Costing
- Craddock matrix segments purchases (leverage, strategic, low impact, critical) by need and relationship.
- Cost reduction via competitive bidding (for leverage) or cooperation (for strategic alliances).
- Life Cycle Costing includes pre-production, production, post-production, and all associated costs over item life.
Evaluating Business Cases & Managing Risk
- Assess objectives, issues, market trends, options, and use cost-benefit analysis.
- Consider commercial and non-commercial factors (e.g., public sector mandates).
- Major risks assessed by probability and impact; top risks must be terminated or mitigated.
- ACAT (Avoid, Control, Accept, Transfer) and 4Ts (Tolerate, Transfer, Terminate, Treat) are risk response methods.
Financial Budgets & Control
- Budgets plan/control income and spending; variances need action.
- Budgeting methods: incremental (based on past) and zero-based (start from zero, justify all costs).
- Budgets can be fixed (set volume) or flexible (change with activity).
- The plan-do-review cycle: plan (set budget), do (monitor), review (evaluate performance).
Cash Flow & Accounting Principles
- Cash flow cycle: paying for materials, producing, storing, selling, and receiving funds.
- Accruals match costs and revenues to correct periods for profit/loss statements.
- Depreciation spreads asset costs over their useful life.
- Positive cash flow ensures business liquidity, prevents overstocking.
Key Terms & Definitions
- Straight Rebuy — Repeat purchase with no change in specification.
- Modified Rebuy — Purchase with changes to specification.
- New Buy — First-time purchase of a new item.
- Business Case — Document justifying a procurement action/project.
- Direct Costs — Costs directly attributable to production.
- Indirect Costs/Overheads — Operational costs not directly tied to output.
- Break-even Analysis — Identifies sales volume where revenues equal costs.
- Life Cycle Costing — Total cost of ownership throughout item’s life.
- Accruals — Accounting adjustments matching costs/revenues to correct periods.
- Depreciation — Allocating asset cost over its useful life.
Action Items / Next Steps
- Review investment appraisal methods: ARR, payback period, NPV, IRR, DCF.
- Consult finance colleagues to understand your organization’s budgeting process.
- Practice applying cost-benefit and risk assessment frameworks to sample business cases.