Introducing a New Purchasing Strategy in a Firm Producing to Order: a Case of Steel Castings

Citation:

Orla Nielsen (1982) ,"Introducing a New Purchasing Strategy in a Firm Producing to Order: a Case of Steel Castings", in NA - Advances in Consumer Research Volume 09, eds. Andrew Mitchell, Ann Abor, MI : Association for Consumer Research, Pages: 80-86.

Advances in Consumer Research Volume 9, 1982      Pages 80-86

INTRODUCING A NEW PURCHASING STRATEGY IN A FIRM PRODUCING TO ORDER: A CASE OF STEEL CASTINGS

Orla Nielsen, Copenhagen School of Business Administration and Economics, Institute of Marketing, September 1981

Introductory remarks.

The firm: A.B. Nielsen & Co. [Pseudonym] is a danish firm engaged in among other things the production and selling of turn-key projects. The firm has at present 4.400 employees. Main office in Copenhagen and subsidiary offices in Europe, North and South America and Japan. Turnover in 1980 more than 6 billion d. crowns (about 825 million US $). Profit shows stagnation in the last two years causing the board to call in a consultant firm to investigate rationalization possibilities. The analysis resulted in among other things a recommendation of a new purchasing strategy for steel castings, which are bought from sub-contractors. The strategy calls for developing framework agreements in order to primarily cut prices, thereby introducing a more aggressive buying behavior on the part of ABN. This case reports on the first results using the new strategy

The purchasing department is managed by a commercially educated purchasing director, who reports to the production director, who reports to the general manager. About 75 employees in the department. All leading personnel have engineering degrees, some also a supplementary commercial education. Purchasing personnel are also employed at the ABN-offices abroad. The department is divided into 7 different sections: Staff, project coordination, ABN-machinery, foreign machinery, steel castings, electrical equipment and service functions. Another important department in this connection is the dep't of quality and inspection. Several employees in purchasing have a past as inspectors.

Steel castings:

Each turn-key project demands several different types of steel castings. In the following these are named A, 3, .... H. Patterns are made from ABN drawings and materials are specified according to different international norms. Patterns remain ABN-property but stay usually by the supplier. The steel castings vary much in size from type H (measured in grams or kilograms) to type A and B (weighing up to 180 tonnes per piece). The high quality demanded creates the need of continuous inspection and the weight demands consideration of transport facilities and, the geographical position of the sub-contractor related to that of the erection place of the Particular turn-key project

The method of research:

The method corresponds to the method described in "Industrial Buying Behavior of Fuel Oil" (Woodside and Vyas, Jan. 1981). In the actual case 24 interviews with five persons in three departments have been made.

The purchasing dep't.: The director of purchasing, the section head and a senior purchasing engineer both of the steel casting sector. The head of the quality and inspection department and, a business engineer of the sales department. Written material has been examined and, a meeting in the purchasing dep't concerning the new procedure has been joined by the author. The final report has been accepted by the respondents as regards its reflection of reality.

The results:

The results are shown in the flow charts. Figure 1 shows the development of RFQ's for frame contracts for steel castings as a whole. Figure 2 shows the selected vendors and the corresponding quantities for the different types of steel casting. Figure 3 and 4 show the actual decision process of awarding frame contracts for types H and B, respectively, figure 1 depicts the decision process as regards the placing of specific orders within or outside the particular frame contracts.

The buy-flows are de as informative as possible in themselves, as there is no room for further explanation of the behavior in this summary of the total report. In this connection "diagnostic comments" will have to suffice. These are followed by a few comments on theoretical implications.

Diagnostics.

The unsatisfactory development of net earnings caused ABN to call in a professional consultant firm in order to investigate rationalization possibilities. It is worth noting that the analysis also covered the purchasing-processes and resulted in recommending a new strategy involving firstly the establishment of frame contracts, secondly a more aggressive purchasing behavior. This development ABN has probably in common with very many firms, and as the past has witnessed rationalization efforts in primarily production and administration it is not surprising that purchasing is now also involved. Particularly, as analyses have shown that managements have often been satisfied with "passive buying" (c.f. Dean S. Ammer). This case indicates that the future will see more aggressive buying, and the emerging strategy may be utilized by other firms in a corresponding situation.

This case deals with the choice of subcontractors and very big money is involved, the buys of steel castings being important parts of the turn-key projects. The purchasing department has been shown to play an important role in the process. The products, although technically complex, are standardized due to the use of ABN-drawings and patterns, and technical problems are solved with the help of the inspection and quality department, and as regards specifications covering Particular turn-key projects through cooperation between sales department, construction department and the representatives of the customer, resulting in well defined needs submitted to the purchasing department. This division of technical and commercial decisions is probably a necessity for leaving the choice of subcontractors in the hands of the purchasing department. As has been shown, however, sales managers and to a lesser degree the quality and inspection department may fill the role of influencers in particular cases where compensatory buys in a given country is either demanded or interesting in the eyes of the sales department. And in exceptional cases where buys from a new market involving sensitive political areas, the general management may be the final decision maker. The gatekeeper function of the quality and inspection department and sometimes also the business engineers (caring to the wold wide interests of ABN) should also be noted.

The composition of the buying center therefore varies as regards type of decision (technical, commercial and calculation of demand) and due to specific factors, always involving the purchasing department in the critical choice decision.

The buy flow is clearly divided into three parts:

1) The development and choice as regards RfQ's.

2) The choice of suppliers to award frame contracts and

3) The choice of supplier regarding specific orders,

reflecting a hierarchy of decisions.

Based on a demand prognosis two principal decisions are made early in the process, i.e. the validity period of frame contracts and base volume for the different types of steel castings. The "second" decision is developed from the demand prognosis and was 75% of expected demand, leaving 25% as degrees of freedom in order to couple particular turn-key projects with optimally placed suppliers (geographically). This rule was inspired by the consultants firm and does not seem to have been evaluated by the department. In this connection it may be mentioned that not only was the purchasing department reorganized, but simultaneously all employees but the purchasing manager were in fact discharged and had to apply for positions in the department together with possible applicants from outside. No doubt this has put some pressure on the individuals as regards complying to the new procedure. The "first" decision regarding the period of validity to be requested was 1/2 years, the origin of this is not quite clear but it is evident that two factors: l) the quality of the prognosis as regards certainty of expected demand and, 2) the expected degree of inflation and thereby what time period it would be possible to have accepted by the vendors, have played an important role. Still one gets the feeling of a somewhat arbitrary choice, which may later be better argued in accordance with the firms learning process.

The choice of countries as the first step leading to the selection of vendors to be sent RfQ's seems to be guided by past experience and knowledge/impressions as to technological level of steel castings industry, currency rate level and possibilities of gaining financial advantages. However, as it = t be characterized as a low risk decision, no doubt exists that the purchasing department is open for suggestions from both internal and external sources. The procedural rule put forth by the consultants of asking 7 vendors for quotations was not quite complied with. Note especially the case of steel castings, type h. The reasons given were primarily the limitations presented by the market structure (fewer suppliers and their limited capacity in relation to the demand). Probably also the greater difficulties of an exact demand prognosis (type H is also needed for other plants than the particular turn-key projects, and demand may arise rather suddenly) play a role. It is however interesting to note that work has been started to create a "supplier-matrix", containing information on possible suppliers on a world-wide basis about capacities, price levels etc. The matrix calls for continuous information to be processed electronically thereby creating the possibility of getting up to date information on possible suppliers of any type of goods in any given geographical area immediately a purchasing problem arises.

The particular problem of deciding whether RfQ's should be sent by the ABN-head-office or through ABN local office reflects an area of conflict, which does also come through in the later negotiation phase. The process does not exactly show the characteristics of a game for power, it does indicate, however, that distinct rules are probably needed in the future in order to avoid conflicts to develop.

The initial search process described is influenced by past experience, note that only few "new" vendors were asked to quote prices, but as it is shown it is fairly easy both for internal influencers (like the sales department) and from vendors showing initiative and interest in ABN-orders to have the choice possibilities expanded. That is true even if past experience has not been satisfactory, c.f. the vendor in the UK as regards type H, and with "unknown" vendors (provided that the report on technological capabilities etc. is favorable), the last, however, only being granted a trail order. Note also in this connection that unsatisfactory performance does not automatically lead to rejection, but calls for an investigation of the possibility of correcting the mistakes in the future, the result of which rules the decision. The aim of getting 7 bids followed by a recommended 7 rounds [Having finished the report, it was sent to ABN for confirmation. It became evident that the consultants in reality had recommended 3 to 5 rounds of negotiations and the first of these should cover all the bidders. The above "2x7" represents a communication distortion, which has now been corrected, also to the respondents.] of negotiations using a price-squeezing policy is decidedly to be termed "aggressive" buying, also compared to what the purchasing department has done in the past. Still the "2 times 7", being arbitrary (?) high figures, would tend to be interpreted as symbolic and expressing the wish of the management to gain more effective buying, rather than to be accepted as practical rules of thumb. As the buy flows show, they have been interpreted in that way. The case of type B is closest to the recommendation, but the visualizing of the tine needed to negotiate in full with all vendors clearly demands the rejection of some of the bidders early in the process. The differences in the prices quoted support the decision to reject the highest bidders immediately, although not without applying a compensatory decision model. When comparing the buy flows type H and type B it is evident that although the total structures are much alike there is definitely a difference in buying style. In the type H process the initiative to better the bids is primarily left to the competing vendors, whereas in the case of type B counter offers are developed especially in the last phase. This may reflect the differences in the situation as it develops in the course of the process, but the author's impression is that individual characteristics of the buyers primarily in charge of the negotiations are important causes. However, face to face negotiations were applied in both cases, and were in fact considered both necessarY and preferable.

The incident of only one negotiation, which occurred for small B's in the case of the East European vendor, which succeeded in getting a one year contract of 600 tons by introducing the not expected offer of firm prices for such a long period, is probably to be viewed as an exception. Considering the expected rate of inflation it is understandable that the buyers accepted an awarded the contract, but it must be noted that simultaneously the decision cutted out the possibility of negotiation for the total tonnage of both small and big type B's with other vendors.

In this connection it is also to be noted the fact that the buying process seems to be carried through for each type of steel castings, and not for the total or even a combined tonnage of different steel castings. Figure 2 shows that this should be a possibility at least in relation to some of the vendors. The reasons are difficult to assess. It may be that it is due to characteristics of the different types of steel castings and costumes of the industry, but it may also be that as yet unused ways of aggressive buying are to be found here.

A total evaluation of the new buying strategy of ABN cannot be made now. All in all, however it represents the most aggressive and professional buying the author has experienced up to now, and it has resulted in better agreements according to the purchasing department. The question of working out an effective tool of measuring the effectiveness of the department's work is still unsolved. The consultant firm has recommended to construct a price-index as basis for comparing the actual prices obtained by ABN. It is considered at the moment but it is evident that the work will present not easily overcome difficulties, also regarding keeping such price indexes up to date. One disadvantageous effect of the frame-contract strategy, at least at short sight, is the discrepancy between the challenge to the purchasing assistants and their capabilities. A secondary beneficial effect may be experienced due to the fact that the existence of frame contracts presents the possibility of raising the level of relevant information needed for more accurate calculation of costs when offering turn-key projects, which is certainly important.

Theoretical implications.

The author is not prepared to draw many conclusions from this analysis, it being restricted to one firm in one industry and to the persons in this plant in their decisions and actions related to the buy flow of two types of steel castings in a specific period of time, when a new buying strategy is applied for the first time. The result as such is but one bit of information (Compare Woodside: "The fuel 6 case").

The method represents a challenge to the analyst, and this author does believe that it has been beneficial as regards creating a better understanding of the complexities of buying in a situation like the described. There is also no doubt that the author is going to analyze corresponding buying behavior in other firms in order to compile experiences.

However, the approach presents very big problems as regards the probabilities of generalizing the results. They are not to be considered easily overcome even when it is only a question of one author and his own peculiar "bits of information" like what is recorded in this case, but it is certainly even more difficult when a mass of cases done by different analysts are to be integrated.

The buy-flows are probably the key of the matter, and consequently the IBB-group may have to develop a more precise and general "alphabet" for constructing buy-flows, even if this means cutting out some of the details. However, such an "alphabet" can only be constructed on the basis of accurate, specific pictures of reality, which are not possible to deduct at a writing-table. This then becomes the prime reason for studies like this, allowing for the fact that the descriptions may be valuable in their own right also to the firma analyzed and as case material in teaching courses.

FIGURE 1

BUY FLOW: DEVELOPMENT OF RfQ'S

FIGURE 2

LIST OF VENDORS TO BE ASKED FOR RfQ'S

FIGURE 3

BUYFLOW OF STEEL CASTINGS, TYPE H.  THE DECISION PROCESS OF AWARDING FRAME CONTRACTS

FIGURE 4

THE DECISION PROCESS OF AWARDING FRAME CONTRACTS: THE CASE OF STEEL CASTINGS, TYPE B

FIGURE 5

BUY FLOW - THE DECISION PROCESS AS REGARDS PLACING SPECIFIC ORDERS

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