PURCHASING MANAGEMENT KNEC NOTES

TOPIC 1

INTRODUCTION TO PURCHASING:

Definition and scope of purchasing:

Purchasing is defined as a process of acquiring goods, services and works in return for a price. All organisations invariably need input of goods and services from external suppliers or providers and to this extent therefore, purchasing function plays an integral part in ensuring the goods/services are provided to the company. The role and contribution of purchasing has increased quite steadily over the second half of 20th century with interest in the activity taking place in the last few years.

The reasons behind this paradigm shift based on importance and recognition of purchasing entail:

  1. New management concepts
  2. Advanced technology
  3. Government policies
  4. Fewer but larger suppliers
  5. Competition hence the need for quality

The scope of purchasing function is in line with the following activities:

  1. Coordination with user departments to identify purchase needs
  2. Identification of potential suppliers
  3. The conduct of market studies for important materials
  4. Negotiation with potential suppliers
  5. Analysis of proposals
  6. Selection of suppliers
  7. Issuance of local purchase orders
  8. Administration of contracts and resolution of related problems
  9. Maintenance of a variety of purchasing records
  10. Payment approval and follow up
  11. Inspection and acceptance

Objectives of purchasing:

Purchasing objectives can be seen from two sides:

  • General objectives (managerial level)
  • Functional objectives (operational level)

The general objectives are the five rights:  that is acquiring materials of:

  • The right quality
  • From the right supplier
  • In t he right quantity
  • At the right time
  • At the right place

The perfection of the above purchasing rights invariably creates a desired service level necessary for optimal supply of materials.

The functional or operational level objectives of purchasing:

  1. To support the company operations with uninterrupted flow of materials and services
  2. To buy competitively-keeping abreast of the forces of supply and demand
  3. To buy wisely-Continual search for better values of quality, service, price relative to the buyer’s needs
  4. To keep stock investment and losses at a practical minimum
  5. To develop effective and reliable sources of supply
  6. To develop good relationships with the supplier community and good continued relationship with active suppliers
  7. To achieve maximum integration with other departments of the firm
  8. To handle the purchasing function proactively in a professional and cost effective manner.,

 

Impact of purchasing and supplies management on organisational efficiency and profitability:

The concept of best practices in purchasing and supply management (PSM) has become the focus of much interest in recent years. This concept asserts that successful organizations employ certain activities or processes in line with purchasing that bring forth a high degree of value creation in business transaction. The distinct effects of purchasing and supplies function involve the following:

IMPORTANCE OF PURCHASING

  1. Through negotiation purchasing department enables the company to have enormous direct savings resulting to profitability in the long-run.
  2. Purchasing department does supplier appraisal an attribute that makes the company to deal with the only pre-qualified suppliers who add value in return. This function brings forth some semblance of efficiency/profitability in return.
  3. Purchasing department ensures that the company has supply continuity an aspect that ensures that the production performs its work continuously. To this extent therefore the company gains efficiency/profit in return once all the activities have been made.
  4. Establishment of supplier development the purchasing department enables a company to have the right materials hence this affects the profit margins in the long run. The issue of efficiency is being put forth since the supplier(s) will be reliable.
  5. Purchasing department act as a link between the buying company and the external entities (suppliers) hence provide any useful information for decision making thus this creates efficiency in the business transaction.
  6. Purchasing department prepares proper documentation and procedures based on acquisition of goods and services hence bring forth efficiency, fairness and transparency.
  7. Purchase department coordinates with accounts department to ensure suppliers are paid on time and ensure the right quantities of goods are delivered to the company hence this brings efficiency in the production line.
  8. Purchasing department carries out research in order to increase the knowledge on the market opportunities hence make the right decisions when acquiring goods and services.
  9. Purchasing department initiate purchasing and supply training activities to increase competence of its staff which in turn creates efficiency.
  10. Purchasing department implement proper purchasing policies and other appropriate strategic purchase decisions which bring forth efficiency in return.

 

Relationship between the purchasing and supply function with other departments:

Some issues on which interaction and cooperation may take place between purchasing and other company departments include the following:

 

Purchasing and finance/accounts department:

  • Finance/accounts department prepares budget allocation for goods/services to be purchased in a given time period
  • The purchase department establishes and forwards to finance/accounts department value analysis report for goods/services to be purchased
  • Finance/accounts department briefs the purchasing department on issues based on supplier payment
  • Purchasing department gives accounts department information based on damaged items and obsolete items
  • Purchasing department gives out information based on stock movement to the accounts department
  • Purchasing/supplies department works together with accounts department during stock taking exercise which is based on assessing the variance status of the company’s inventory.
  • Stores personnel who works under purchasing/supplies department works together with the accounts personnel when it comes to the issue of receiving goods from the supplier(s). The accounts personnel checks whether the amount indicated in the invoice correspond with the amount indicated in the local purchase order (LPO).

 

Purchasing and design department:

  • Preparation of specifications for purchase of materials and components
  • Quality assurance or defect prevention
  • Value engineering and value analysis
  • Information to departments regarding availability of materials, suppliers and costs
  • Agreement of alternatives when specified materials are not available
  • Creation of library of books, catalogues, journals and specifications for joint use the design and purchasing departments

 

Purchasing and production (User department)

  • Preparation of material schedules to meet just in time requirements
  • Ensuring that delivery schedules are maintained
  • Control of inventory to meet production requirements
  • Disposal of scrap and obsolete items
  • Quality control or defect detection and correction
  • Approval of ‘first-off samples’
  • Make or buy decisions
  • General involvement in such techniques and systems as optimised production technology, computer integrated technology, materials requirement planning (MRP) and manufacturing resource planning (MRP 2)

 

Purchasing and human resource development:

  • Purchasing professionals gives out technical expertise when a prospective purchasing staff is being interviewed for a job.
  • Human resource personnel liaise with purchasing managers on checking the performance of purchasing employees through job appraisal analysis.
  • Human resource development relates with purchasing department when it comes to issues of arranging training and seminars for the purchasing staffs.
  • Human resource development work hand in hand with purchasing department through provision of motivational incentives for the purchasing staffs. This entail the acknowledgment of best employees through giving out Awards, presents and so on.
  • Purchasing department works also with human resource development on disciplinary matters of the employees.

 

Purchasing and marketing:

  • Provision of sales forecasts on which purchasing can base its forward planning of materials, components etc
  • Ensuring that through efficient buying, purchasing contributes to the maintenance of competitive prices
  • Obtaining materials on time to enable marketing and production to meet promised delivery dates to the end-customer
  • Exchange of information regarding customers and suppliers
  • Mar keting implications on partnership sourcing

 

Purchasing and information technology department (IT):

Purchasing department and IT have an increasing number of interdependencies. In some cases IT function is outsourced the purchasing function. To this extent therefore its performance is evaluated accordingly the purchasing department. Also the manager of IT works closely with purchasing manager to develop automated procedures and reports in line with purchasing. To add on that IT department establishes computer devices to purchase and to this extent the IT manager prepares purchase order requisition (POR) for such items and forwards the same to purchasing department. On the other hand the purchasing department sources for such devices on behalf of the IT department.

 

TOPIC 2

PURCHASING STRUCTURE AND ORGANISATION

  1. Organisation and structures in supply organisation:

Organisational structure can be defined as the pattern of relationships among positions cutting across various departments,  in the organisation and among members of the organisation. Organisation design and structure is concerned with such elements as:

  1. The definition and allocation of specific tasks
  2. The grouping of related tasks into manageable functions, divisions, departments, sections or other units
  3. The allocation of responsibility within the organisation and to constituent functional units.

Purchase organisation structure :

  1. Vertical
  2. Horizontal
  1. Status of Purchasing:
  1. High level
  2. Middle level
  3. Low level

 

Centralization Vs decentralization:

The supply function focus primarily on centralised and decentralized purchasing when building up the structures for the organisation. Centralized purchasing encompass grouping of purchasing tasks and specialist functions or services into one serving unit and under unified control. On the other hand decentralized purchasing en tail division of purchasing function into sections whereeach section is mandated to control the functions within its scope. Here each department or branch is entirely responsible for its own buying.

 

  • Centralized purchasing: The advantages of concentrating purchasing in a strong central department with a responsibility of coordinating across functions include:
  • Economies of scale: Centralized purchasing enables an organisation to use its purchasing power or leverage to the best effect, since:
  • Consolidation of quantities can take place resulting in quantity discounts
  • Suppliers dealing with a central purchasing department have an incentive to compete for the whole proportion of an undertaking’s requirements
  • Cheaper prices enabling suppliers to spread overheads over longer production runs

 

  • Specialist staff can be employed for each of the major categories of purchase

 

  • Lower administration costs e.g. it is cheaper to place and process one order for one million shillings than ten each for one million.

 

         (ii)         Coordinating of activity: 

  • Uniform policies can be adopted e.g. single sourcing, partnership sourcing etc.
  • Uniform purchasing procedures can be followed
  • Competitive buying between departments within the organisation is eliminated
  • Standardization is facilitated the use of company’s wide specification
  • The determination of order quantities and delivery dates is facilitated.
  • Staff training and development can be undertaken on a systematic basis.
  • Purchasing research into sources, quantities and supplier performance is facilitated
  • Suppliers find it more convenient to approach one central purchasing department.

 

  (iii)  Control of activity:

  • The purchasing department may become either a separate cost centre i.e. a location within the organisation in relation to which costs may be ascertained or a profit centre.
  • Budgetary control may be applied both to the purchasing department and to the total expenditure on supplier.
  • Uniformity of purchase prices obtained centralized purchasing assists standard costing.
  • Inventories can be controlled, reduced obsolescence and loss of interest on capital locked up in excessive stocks.
  • Approaches such as Just-in-time and MRP ii can be implemented

Purchasing department performance can be monitored setting objectives and comparing actual results with pre-determined standards.

 

Disadvantages of centralized purchasing:

  1. Centralized can result in many activities that involve expenditure and time without adding value.
  2. Centralization can foster emphasis on functional objectives with a minimum concern for overall organisational goals.
  • User departments will resort to informal procedures if formal purchasing procedures are too slow.
  1. Training of managers with broad perspectives and wide understanding of business may be inhibited.
  2. -Employee identification with a specialist group or function can make it difficult to implement change. It is a more rigid structure.
  3. -Long chain of command.
  • -Slow-decision making.
  • -More bureaucratic.

 

(b)Decentralized Purchasing:

 

Advantages:

  1. The local buyer will have better knowledge of the needs of his/her factory and local suppliers for improved service.
  2. It is more responsive to clients i.e. the user departments.
  3. The buyer will be able to respond more quickly to emergency requirements.
  4. Local purchase will be emphasized and this attribute will save on transport costs.
  5. Local purchase will contribute to local prosperity of the local community etc.
  6. Small and easy to manage.
  7. Easy to instil team spirit.
  8. Fast in decision making

 

   Disadvantages:

  1. -May lead to buying expensively for lack of economies of scale.
  2. -Duplication of purchases may result.
  3. -Standardization of materials and procedures may be difficult to implement.
  4. -Specialized staff training may not be possible
  5. -Rivals can emerge

 

 

  1. New approaches
  • Combined

 

TOPIC 3

TTTI . PM GROUP.

QUALITY ASSURANCE AND CONTROL

Introduction to concepts in quality management:

Quality: ISO 8402 defines quality as the totality of features and characteristics of a product that bears on the ability to satisfy stated or implied needs. In this definition, features and characteristic of product ‘ implies the ability to identify what quality aspects can be measured, or controlled, or constitute an acceptable quality level (AQL) and ability to satisfy given needs relates to the value of the product or service to the customer including economic value as well as safety, reliability, maintainability and other relevant features.

Crosdefines quality as conformity to requirements not goodness. He also stresses that the definition of quality can never make any sense unless it is based on what the customer wants i.e. a product is a quality product only when it conforms to the customer’s requirements.

Juran defines quality as ‘fitness for use’. This definition implies quality of design, quality of conformance, availability and adequate field service. Garvin has identified five approaches to defining quality and eight dimensions of quality.

 Five approaches of quality:

  • The transcendent approach: quality is absolute and universally recognisable.
  • The product-based approach: quality is precise and measurable variable.
  • The user -based approach: quality is defined in terms of fitness for use or how well the product fulfils its intended functions
  • The manufacturing-based approach: quality is conformance to specifications i.e. targets and tolerances determined product designers.
  • The value-based approach: quality is defined in terms of cost and prices. Here, a quality product is one that provides performance at an acceptable price or conformance at an acceptable cost.

  Eight dimensions of quality:

  • Performance: The product’s operating characteristics
  • Reliability: The probability of a product surviving over a specified period of time under stated conditions of use.
  • Serviceability: the speed, accessibility and ease of repairing the item or having it repaired.
  • Conformance: The degree to which delivered products meet the pre determined standards.
  • Durability: Measures the projected use available from the product over its intended operating cycle before it deteriorates.
  • Features: ‘The bells and whistles’ or secondary characteristics which supplement the product the product’s basic functioning.
  • Aesthetics: personal judgements of how a product looks, feels, sounds, tastes or smells.
  • Perceived quality: Closely identified with the reputation of the producer. Like aesthetic, it is a personal evaluation.

Quality control and quality management-ISO 9000, 2000, TQM:

Quality control: Is concerned with defect detection and correction. Inspection activities can be classified as quality control processes, along with other activities which involve monitoring to ensure that defectives or potential defectives are spotted. Quality control can also be defined as a process employed to ensure certain level of quality or service. It may include whatever actions a business deems necessary to provide for the control and verification of certain characteristics of a product or service. The basic goal of quality control is to ensure that the products, service or processes provided meet specific requirements and are dependable, satisfactory and fiscally sound.

C.Quality assurance: Differs from quality control and is defined as all those planned and systematic activities implemented within the quality system and demonstrated as needed to provide adequate confidence that an entity will fulfil requirements for quality.

Quality assurance can also be defined as a planned and systematic production processes that provide confidence in a product’s suitability for its intended purpose. It can also be defined as a set of activities intended to ensure that products and services satisfy customer’s requirements in a systematic and reliable fashion.

Two key principles characteristics of quality assurance entail:’ fit for purpose’’ (the product should be suitable for the intended purpose) and ‘’right first time’’ (mistakes should be eliminated). Quality assurance include regulation of the quality of raw materials, assemblies, products, components, services related to production, management production and inspection processes.

Quality assurance is concerned with defect prevention and has become synonymous with quality systems such as Kenya bureau of standards (KEBS), BS5750 and international counterpart ISO 9000.

Quality assurance includes all activities connected with the attainment of quality such as:

  1. Design, including proving and testing
  2. Specification, which must be clear and unambiguous
  3. Assessment of supplier to ensure that they can perform
  4. Motivation of all concerned parties
  5. Education and training of supplier’s staff
  6. Inspection and testing
  7. Feedback to ensure that all measures are effective

 

Quality Assurance objectives:

  1. Reduction of errors and enhancement of quality
  2. Problem prevention rather than detection and correction
  3. Reduction in product or service costs
  4. Improved productivity
  5. Improved employee involvement, motivation, job satisfaction and commitment
  6. Improved teamwork and working relationships
  7. Development of employee problem-solving ability.

 

C.Advantages/ Importance of quality Assurance:

Both buyers and sellers gain benefits from a good quality control. The following are the principle advantages:

  1. Minimum possible rejection and wider acceptance of the supply is made possible the supplier’s effective quality control system.
  2. Minimum inspection time and effort help the vendor as well as the purchase in delivery and receiving the supply at a lower cost
  3. Prospect of zero defects increase
  4. Scraps are minimised and wastage is reduced due to good quality assurance system
  5. Goodwill of both vendor and purchaser is enhanced as there are fewer difficult and problems in regard to quality products
  6. Sometimes inspection at the purchaser’s end is eliminated if vendor quality certificate and statistical date regarding the quality of the goods supplied is enclosed.
  7. Quality consciousness is developed resulting in benefit to all concerned.
  8. Accumulation of obsolete material is reduced to the minimum
  9. It results in reduction of lock-up capital due to decrease in inventory.

 

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  1. KENYA BUREAU OF STANDARDS

The Kenya Bureau of Standards (KEBS) is a government agency responsible for governing and maintaining the standards and practices of metrology in Kenya. It was established an Act of Parliament of Kenya’s National Assembly, The Standard Act, and Chapter 496 of the Laws of Kenya. The Bureau started its operations in July 1974. It has main offices in Nairobi, and regional offices throughout Kenya.[1]

The KEBS Board of Directors is known as the National Standards Council (“NSC”) and is the policy-making body for supervising and controlling the administration and financial management of the Bureau. The Bureau’s chief executive is the Managing Director.

The aims and objectives of KEBS include preparation of standards relating to products, measurements, materials, processes, etc. and their promotion at national, regional and international levels; certification of industrial products; assistance in the production of quality goods; quality inspection of imports at ports of entry; improvement of measurement accuracies and dissemination of information relating to standards.

To keep close liaison with and render efficient service to industry, trade and commerce in different parts of the country, KEBS has opened Regional Offices in Mombasa, Kisumu, Nakuru, Garissa, Nyeri and has import inspection offices at all the legal points of entry in Kenya.

ROLES OF KEBS

The functions of`KEBS are to:

  1. Promote standardisation in industry and commerce
  2. Provide facilities for testing and calibration of instruments and scientific apparatus and determine their degree of accuracy or issue of certificates
  3. Provide facilities for examination and testing of commodities, material or substance in which they may be manufactured, produced, processed or treated
  4. Control the use of standardisation and distinctive marks
  5. Prepare, frame, modify or amend specifications and codes of practice
  6. Help the Government, local authority, public institution or person in the preparation and framing of specifications or codes of practice
  7. Cooperate with the Government, representatives industry, local authority, public body or person in adopting and applying standards
  8. Provide testing services on behalf of the Government of locally manufactured and imported goods at the ports of entry or country of origin and determine whether goods comply with the law on standards of quality
  9. Test goods destined for export for purposes of export certification KEBS has approved a Kenyan Standard. It provides for common use, rules, guidelines or characteristics for products, services, processes and production methods aimed at achieving order
  10. lt may also deal exclusively with terminology, symbols, packaging, marking or labelling requirements on products, processes or production methods.

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ISO –  International Standards Organization

The Role of ISO and Its Affiliates

The International Standards Organization (ISO) is well known for its international management standards for quality assurance in a broad range of business and industrial applications. Generally these standards are referred to as ISO-90xx accreditations and they apply to corporations.

Approximately seven years ago, ISO and its state-level affiliates around the world established new standards, 17021 and 17024, for the certification of individual practitioners in various professional disciplines.

The American National Standards Institute (ANSI) is the state-level organization to which U.S. corporations apply for ISO accreditation.

Please note that, while this site refers to “ISO standards,” any formal reference is required to use the full name: ISO/ICE/ANSI Standard 17021 or 17024. For more on this, see: www.ansi.org

In addition to the steps listed in the Key Events graphic above, accreditation requires ongoing reports, audits and a range of other activities that are needed to ensure that this certification program is, and remains, current, comprehensive, effective, predictive, fair and secure.

The rigor involved in qualifying and maintaining ISO accreditation is the basis for our belief that State Regulators will approve this certification as one of the methods they use to test the theoretical knowledge of candidate

BENEFITS

Benefits of International Standards

International Standards bring technological, economic and societal benefits. They help to harmonize technical specifications of products and services making industry more efficient and breaking down barriers to international trade. Conformity to International Standards helps reassure consumers that products are safe, efficient and good for the environment.

Benefits of standards: the ISO Materials

ISO has developed materials describing the economic and social benefits of standards, the ISO Materials. They are intended to be shared with decision makers and stakeholders as concrete examples of the value of standards.

Facts and figures about the benefits of standards

The repository of studies on economic and social benefits of standards provides an insight of the approaches and results of the studies undertaken different authors, such as national and international standards bodies, research institutes, universities and other international agencies.

For business

International Standards are strategic tools and guidelines to help companies tackle some of the most demanding challenges of modern business. They ensure that business operations are as efficient as possible, increase productivity and help companies access new markets.

Benefits include:

  1. Cost savings – International Standards help optimise operations and therefore improve the bottom line
  2. Enhanced customer satisfaction – International Standards help improve quality, enhance customer satisfaction and increase sales
  3. Access to new markets – International Standards help prevent trade barriers and open up global markets
  4. Increased market share – International Standards help increase productivity and competitive advantage
  5. Environmental benefits – International Standards help reduce negative impacts on the environment
  6. Globalisation
  7. Change with technology
  8. Ecologi conformanve

Businesses also benefit from taking part in the standard development process. Read more about the benefits of gettcb

 

Total quality management (TQM):

This is the overall management philosophy. TQM is defined as a way of managing an organisation so that every job, every process is carried out right, first time and every time. This mean each stage of process is carried out right, first time and every time. This also means that each stage of manufacture or service is 100% correct before it proceeds. TQM is also defined as an integrative management concept of continually improving the quality of delivered goods and services through the participation of all levels and functions of the organisation.

TQM principles:

TQM is based on three important tenets:

  • A focus on product improvement from the customer’s view point. The term customer here is associated with concept of quality chains which emphasizes the linkages of suppliers and customers. Quality chains are both internal and external. Internally, purchasing is the customer of design and the supplier of production. Staffs within a function are also suppliers and customers.
  • A recognition that personal at all levels share responsibility for product quality. It is based on team rather than individual performance. Thus, while top management provides leadership, continuous improvement is also understood and implemented at shop floor level (based on Japanese concept of Kaizen-on- going improvement which affects everyone). The characteristic s of this principle include:
  1. Provision of leadership from the top
  2. Creation of quality culture dedicated to continuous improvement
  • Team-work- i.e. quality improvement teams and quality cycles
  1. Adequate resource allocation
  2. Quality training of employees
  3. Measurement and use of statistical concepts
  • Quality feedback
  • Employee recognition

 

It has been stated that ‘’once a culture of common beliefs, principles, objectives and concerns has been established, people will manage their own tasks and will take voluntary responsibility to improve processes they own’’.

  • Recognition of the importance of implementing a system to provide information to managers about quality processes which enable them to plan, control and evaluate performance.

Issues in managing quality in supply chain:

  • Specification and standardization:

 

Specification: A specification for an item has been defined as ‘a statement of the attributes of a product or service. It is basically a description of an item, its dimensions, analysis, performance or other relevant characteristics in sufficient detail to ensure that it will be suitable in all aspects for the purpose for which it is intended.

 

There are two main approaches to specification that are performance and conformance.

  • The idea of performance specification is that a clear indication of the purpose, function, application and performance expected of the supplied material or service is communicated and the supplier is allowed or encouraged to provide an appropriate product. In this case, the detailed specifications is in the hands of the supplier where applicable, performance specifications are to be preferred in that they allow a wider competition and enable suppliers to suggest new or improved ways of meeting the requirements.
  • Conformance specifications apply in situations where the buying organisation lays down clear and unambiguous requirements that must be met (In this case the specification is of the product, not the application). This type of specification is necessary where for example items for incorporation in an assembly are required or where a certain chemical product is to be acquired for a production process. It has been said that specifications restrict innovation.

 

Additional methods of specification:

  • Use of brand or trade name: This will be applicable under the following circumstances:
  • When manufacturing process is secrete or covered a patent
  • When manufacturing process of the vendor call a high degree of skill that cannot be exactly defined in a specification
  • When only small quantities are bought so that the preparation of the specifications the buyer is impracticable
  • By sample: The sample can be provided either buyer or seller and is useful method of specification in relation to printing and some raw materials e.g. cloth. When sample specifications are used:
  • The bulk must correspond with the sample in quality
  • The buyer must have a reasonable opportunity of comparing the bulky with the sample
  • The goods must be free from any defect making their quality unsatisfactory which a reasonable examination of the sample would not reveal.

 

The value of specifications:

Specification will ensure that:

  • All commodities specified will be suitable for their intended purpose when put in place
  • Materials is of a consistent quality at all times
  • The inspection or testing to be applied to goods purchased is notified in advance to the inspection section and to suppliers
  • In respect of the purchase of the specified items, all suppliers will have the same date on which to base the quotations

 

Preparation of specifications:

  • Avoid over-specification: This may lead to goods becoming more expensive and also may be difficult to find a manufacturer willing to quote
  • Avoid under-specification since this may lead to inferior goods and services
  • In order to be practicable, pay attention to convenience in handling and storage
  • If there is to be inspection after delivery, the specifications ought to state what tests are to be applied
  • If any special marking or packing is wanted, include the relevant instructions in the specifications.

Standardization:

This is the process of agreeing and adopting generic specification or descriptions of the items required. Standardization can also be defined as the process of grouping like items together in order to simplify examination of the complete range of any given type of items within the store. A standard differs from specification in that while every standard is a specification not every specification is a standard. Standard may be distinguished according to their subject –matter, purpose and range of application.

Advantages of standardization:

  • There is accurate comparison of quotation since all prospective suppliers are quoting for the same thing.
  • Clear specification helps to achieve reliability and reduce costs
  • Less dependability on specialist suppliers and greater scope for negotiation
  • Facilitation of international sourcing reference to ISO standards.
  • Reduction in error and conflicts thus increasing supplier goodwill.
  • Quality is easier to monitor because visual inspection is easier and use of tried or tested items means that defects are less likely to occur.
  • It gives clear specification and removal of any uncertainty as to what is required on part of both buyer and the supplier.
  • Save time and money eliminating the need to prepare specifications each time and reducing the need for explanatory telephone calls.
  • Easier communication and less room for misunderstanding and disputes between buyers and users.
  • Save inventory cost through variety reduction.

 

After standardization is introduced the following attributes should be observed:

  • Ensure specifications are observed
  • Ensure new specifications are suitably revised and approved.
  • Ensure old specifications are reviewed, replaced, amended or even eliminated if they are not necessary.

 

Variety reduction:

This is the process of reducing the number of varieties stocked to a controlled workable minimum.

Procedure for variety reduction:

Variety reduction involves a complete examination of the list of commodities stocked to determine:

  • The use or users for which each item is intended
  • Which items have similar characteristics and can be used as substitutes for each other
  • What range of sizes is essential
  • Which items can be eliminated
  • What specifications are necessary for retained items

Reasons that lead to variety reduction:

(1)Lack of specification when procuring items

(2) Where there are many suppliers of the same item

(3) Different sizes of containers or packages for items

(4) Lack of guidelines on how to use stocked items

(5) When there are varieties of the same item

 

Advantages of variety reduction:

(1)Reduction of stock holding cost

(2) Release of money tied up in stocks

(3) Easier specification while ordering

(4) Narrow range of inventory which leads to reduction in administrative cost

(5) Reduced supplier base: facilitates the building of long term relationship and supplier development.

Managing service quality:

Service quality is about ensuring customers, both internal and external, get what they want. As the technology brings markets, people and products ever closer, it is the single most effective and sustainable means of differentiation between competing companies. Managing service quality is packed with case histories, insights and guidance to the latest and most insightful academic thought in the field of service quality senior managers and board directors share with junior employees ideas, experience and advice as they strive for excellence in service quality. For an organization to succeed, intensely managing service quality is absolutely essential. It is only through customer alignment that the organization is on track toward a single, shared vision of customer focus and customer value; a vision that energizes people and the organization to accomplish extraordinary things. In order to embrace proper management based on service quality aspects the following concepts should invariably be focussed on:

  • Voice of the customer
  • Customer focus
  • Customer alignment
  • Linking the customer to results

TECHNIQUES  OF QUALITY ASSURANCE:

The traditional tools to help organisations to understand their processes with a view to improving their quality techniques encompass:

  1. Cause and effect diagrams:

The cause-and-effect diagram is a method for analysing process dispersion. The diagram’s purpose is to relate causes and effects. Three basic types are: Dispersion analysis, Process classification and cause enumeration. Effect = problem to be resolved, opportunity to be grasped, result to be achieved. Excellent for capturing team brainstorming output and for filling in from the ‘wide picture’. It helps to organise and relate factors, providing a sequential view. It also deals with time direction but no quantity can become very complex. It can also be difficult to identify or demonstrate interrelationships.

Cause and Effect, Fishbone, Ishikawa Diagram:

  1. Pareto principle:

The Pareto principle suggests that most effects come from relatively few causes. In quantitative terms: 80% of the problems come from 20% of the causes (machines, raw materials, operators etc.); 80% of the wealth is owned 20% of the people etc. Therefore effort aimed at the right 20% can solve 80% of the problems. Double (back to back) Pareto charts can be used to compare ‘before and after’ situations and also can be used to check general use, to decide where to apply initial effort for maximum effect.

 

Pareto principle:

        

  1. Scatter diagram:

A scatter plot is effectively a line graph with no line – i.e. the point intersections between the two data sets are plotted but no attempt is made to physically draw a line. The Y axis is conventionally used for the characteristic whose behaviour is used to predict and use to define the area of relationship between two variables.

Warning: There may appear to be a relationship on the plot when in reality there is none, or both variables actually relate independently to a third variable.

Scatter plots:

  1. Control charts:

Control charts are a method of Statistical Process Control, SPC. (Control system for production processes). They enable the control of distribution of variation rather than attempting to control each individual variation. Upper and lower control and tolerance limits are calculated for a process and sampled measures are regularly plotted about a central line between the two sets of limits. The plotted line corresponds to the stability/trend of the process. Action can be taken based on trend rather than on individual variation. This prevents over-correction/compensation for random variation, which would lead to many rejects.

Control chart:

  1. Histogram or Bar Graph:

A Histogram is a graphic summary of variation in a set of data. It enables us to see patterns that are difficult to see in a simple table of numbers. It can also be analysed to draw conclusions about the data set.

A histogram is a graph in which the continuous variable is clustered into categories and the value of each cluster is plotted to give a series of bars as above. The examples below reveal the skewed distribution of a set of product measurements that remain nevertheless within specified limits. Without using some form of graphic this kind of problem can be difficult to analyse, recognise or identify.

Histogram or bar Graph:

 

 

  1. Check sheets

A Check Sheet is a data recording form that has been designed to readily interpret results from the form itself. It needs to be designed for the specific data it is to gather. It is used for the collection of quantitative or qualitative repetitive data and also it is adaptable to different data gathering situations. Minimal interpretation of results is required. It is easy and quick to use. No control for various forms of bias – exclusion, interaction, perception, operational, non-response, estimation.

  1. Check list:

A Checklist contains items that are important or relevant to a specific issue or situation. Checklists are used under operational conditions to ensure that all important steps or actions have been taken. Their primary purpose is for guiding operations, not for collecting data. Generally used to check that all aspects of a situation have been taken into account before action or decision making.

 

Value analysis and Value engineering:

Value analysis:

This is a systematic procedure aimed at ensuring that necessary functions are achieved at minimum cost without detriment to quality, reliability, performance and delivery. Value analysis can also be defined as the process of analyzing a product or a process to determine aspects or elements that do not add value and have the same eliminated. Value analysis results in the orderly utilization of alternative materials, newer processes, and abilities of specialist suppliers. It focuses manufacturing and purchasing attention on one objective: equivalent performance at lower cost. Having this focus, it provides step-by-step procedures for accomplishing its objective efficiently and with assurance.

 

Value analysis procedure:

The job plan for value analysis project comprises the following stages:

  • Project selection: what project shows the greatest potential for savings etc
  • Information stage: Obtain essential information relating to the items under consideration, define the functions of the product etc
  • Speculation stage: Have a brain storming session in which many ideas are put forward for achieving the desired function, reducing costs or improving the product
  • Investigation stage: Selects the best ideas produced at the speculation stage and evaluate their feasibility
  • Proposal stage: Recommendations be presented to the level of management able to authorise the suggested changes
  • Implementation stage: When approved the responsibility executive, the agreed recommendations will be progressed through the normal production, purchasing or other procedures.

 

Purchasing and value analysis:

Where no value analysis exists, all buyers should be encouraged to understand and apply the approach. Purchasing can make the following contributions:

  • Provision of information concerning:
  • Materials and components
  • Material cost of bought-out components
  • Use of supplier standard part instead of special

 

2) Suggestions for buying economics such as:

  • Economic order quantities
  • Reduction costs of packing, handling and transportation
  • Alternative reliable suppliers etc

 

3) Encouraging supplier participation: This involves examining with suppliers, the function of the items being analysed and seeking their specialist advice as to how the cost can be reduced.

 

Value engineering:

This is the application of value analysis at the pre-production or development stage. Value engineering can also be defined as a methodological systematic study of all phases of the design of a given item or process in relation to the function (value) of the finished product or processes to perform.

 

It is imperative to note that the terms value analysis and value engineering are invariably used synonymously. However, the distinction may be summarized the statement that value analysis is concerned with cost correction while value engineering is concerned with cost avoidance. The basic organisational approaches to value analysis and value engineering include specialized staff approach (value analyst) the cross-functional team approach (committees members drawn from all departments) and the staff training approach. Developing understanding of the concept and working knowledge of techniques among most professional and operating personnel responsible for specifying purchasing and using production materials plays a significant role in perfection of both value analysis and value engineering.

Failure models and effect analysis (FMEA):

FMEA is defined as a systematic approach that applies a tabular method to aid the thought

process used engineers to identify potential failure modes and their effects.

Types of FMEA:

The analyses take three forms:

1) Systems FMEA is used to analyse systems and subsystems in the early concept and design stages. System function is the design or purpose(s) of the system and is derived from customer wants. It can also include safety requirements, government regulations and constraints.

2) Design FMEA is used to analyse products before they are released to production.

3) Process FMEA is used to analyse products before they are released to the customer.

The preparation of an FMEA:

The Ford motor company which was the first of the UK motor manufacturers to request suppliers to use FMEA in their advance quality planning recommends a team approach led the responsible system, product or manufacturing/assembly engineer who is expected to involve representatives from all affected activities. Team members may be drawn from design, manufacturing, assembly, quality, reliability, service, purchasing, Testing, supplier and other subject experts as appropriate. The team leader is also responsible for keeping the FMEA updated. For proprietary designs, the preparation and updating of FMEAs is the responsibility of the suppliers.

With a design FMEA, for example the team is initially concerned with identifying how a part may fail to meet its intended function. Starting with the failure modes with the highest severity ratings the design FMEA team then ascertains the possible causes of failure based on two assumptions:

-That the part is manufactured/assembled within engineering specifications

-That the part design may include a deficiency that may cause an unacceptable variation in the manufacturing or assembling process

The team then proceeds to ascertain:

  • The cumulative number of failures that could occur over the life of the part
  • Design evaluation techniques that can be used to detect the identified failure causes
  • What design actions are recommended to reduce the severity, occurrence and detection ratings

Advantages of FMEA approach:

  1. Improved quality, reliability and safety of products
  2. Improved image and competitiveness
  3. Increased customer satisfaction
  4. Reduced in the product development timing and cost
  5. Documentation and tracking of actions to reduce risk

Disadvantages of FMEA approach:

FMEA is viewed as hard, slog; more use should be made of computerised aids to reduce the effort of preparing and updating the FMEA. The main difficulties are related to time constraints and lack of understanding of the importance of FMEA, training and commitment.

Quality function deployment:

Quality function deployment (QFD) is a complex technique developed in Japan. QFD is a cross-functional team approach and incorporates the needs of the customer (the whats), which have been prioritised, hence QFD is also known as the voice of the customer. These what’s are recorded on the left of the matrix. The hows are the ways that the team identify hows are recorded in the centre block of the matrix, the strength of the relationship being recorded a designated symbol. The roof of the matrix records the relationship between the various hows that have been identified. These can be strongly or weakly positive or negative and this again is recorded some assigned symbol. The benefits of QFD are said to be a better designed product with fewer design changes, giving a quicker time to market and ultimately a satisfied and loyal customer.

The relationships between the hows

Simplified QFD matrix:

Relationship between whats and hows
The hows
The whats-the Customer’s prioritised needs

 

 

TOPIC 4

SOURCING

Topic 1 : Introduction to sourcing

Definition of sourcing

Sourcing is the process of identifying, selecting and developing suppliers.

The definition of sourcing can be simple or much more complex, the simple definition is “the process involved in identifying potential suppliers, conducting negotiations with them to and then signing purchasing agreements with them to provide goods/or services that meet your company’s needs”

Sourcing generally refers to those decisions determining how components will be supplied for

production and which production units will serve which particular markets. Multinational firms have been pursuing integrated sourcing to a greater extent than before because such an operation allows them to exploit their competitive advantages (Kotabe and Murray, 1990). Sourcing can, next to the above, be defined as ‘the reorganization of tasks, functions and services of an organization, wherethe more effective managing of organizational and operational processes is the main issue (Huibers and Schut, 2006).

Huibers and Schut (2006) also state that ‘with sourcing, organizations can manage their

operational and organizational processes more effectively’. This can be done internally,

externally, national or international. Sourcing can be done concentration of activities, transferring the execution of services or processes to an external party or the transferring business activities abroad. In other words sourcing can have many forms depending on the organization it is applied to.

Types of suppliers

  1. Suppliers of manufacturer brand: These kinds of suppliers are responsible for developing the merchandise and establishing an image for the brand. In some cases, the manufacturer will use its name as part of the brand name for a specific product.
  2. Suppliers of private-label brands: In this case retailer buyers develop specifications for the merchandise and then contract with a supplier to manufacture it. The retailer is given the mandate to promote the brand but not the manufacturer.
  3. Supplier of licensed brands: This applies wherethe owner of a well-known brand name (the licensor) contracts with licensee to develop, produce and sell the branded merchandise.
  4. Suppliers of generic products: This involves suppliers of unbranded, unadvertised merchandise found mainly in grocery and discount stores.

 

Three of the main sourcing options that can be applicable for organizations to enhance their competitive advantage are:

  1. Internal sourcing (in sourcing).
  2. Local sourcing
  • Global sourcing is a term used to describe practice of sourcing from the global market for goods and services a cross geographical, political boundaries. Global sourcing often aim to exploit global efficiencies in the delivery of a product poor service. Some of these efficiencies include:

low cost, skilled lab our, low cost of raw material and other economic factors like tax or low trade tariffs.

Global sourcing is sourcing products and some times services irrespective of national

boundaries, For example it is particularly popular in European Economic countries in Europe and Asia. The rise of Chinese and Indian manufacturing capabilities has meant that sourcing from these countries has greatly increased in the past few years. This is because purchasing companies are seeking lower labor and production cost.

Single sourcing:

Single sourcing of an item means that the company adopts the practise of purchasing all its

requirements for an item or service from one supplier although a number of suppliers may have

the capability to supply. In sole sourcing, only one supplier supplies all the goods.

 

Advantages of single sourcing:

  • Improved communication and understanding between supplier and buyer
  • Supplier is able to respond positively to the buyer’s feedback on quality issues, engineering changes, design changes and suggestions that can reduce cost
  • Elimination of supplier ‘switching’ costs
  • Reduction in total cost of product due to bulk purchases
  • Reduction in supplier communication faxes, telephone calls and paperwork
  • Enhanced ability to implement just-in-time (JIT) procurement, since scheduling
  • communication and planning permits more effective and efficient handling of inventory and orders
  • Personal relationship at various levels between buyer and supplier can be established easily, making communications more effective

 

Disadvantages of single sourcing:

  • If a defect in the supply is noticed after the product is produced and dispatched to the buyer’s plant the cost of quality would be very high
  • A fire, strike or breakdown in the single source supplier’s plant can stop production in the buyer’s plant
  • Less market intelligence and reduced flexibility, being committed to lean, single/sole-source
  • Research and development, technological capability and creativity
  • If the supplier is unable to share competitive pressure and reduce costs of his products concurrently the buyer will be at a competitive disadvantage
  • Constant pressure to improve the quality, delivery and price of a product may frustrate the supplier and make him break the relationship

 

  1. Multiple sourcing:

Multiple sourcing of item(s) means that the company adopts the practice of purchasing all its

requirements from various suppliers in the market. The objective of multiple sourcing is to

maximize benefit on prices and services. In situations of multiple sourcing, both buyers and

suppliers feel a high level of uncertainty and therefore there are multiple controls to ensure

successful transaction.

 

Advantages of multiple sourcing:

  • It allows using various supplier’s creativity, ideas, innovation and newer materials
  • It gives flexibility to the buyer to meet large quantities orders or sudden changes in schedules
  • It allows the buyer to share the risk in uncertainty or crisis
  • The buyer has a stronger negotiation position
  • Insurance against just-in-case situation like fire, strike, poor quality delivery, breakdown of machines
  • No extra tooling cost if the items purchased are standard
  • With many suppliers holding stock, the buyer can reduce inventory levels

 

 Disadvantages of multiple sourcing:

  • Small order quantities sometimes decrease the supplier’s morale
  • In case of non-standard part the tooling cost is adjusted in the price of the product
  • More communication and paper work cost
  • Weak buyer-supplier partnership
  • More waste, scrap levels, rework, maintenance, delays, down-time, warranty claims, resulting from frequent set-ups and variation in supply from multiple suppliers raise the cost of quality.

 

Considerations  of source selection

  1. Flexibility of the Supplier:
  2. The degree of service provision
  3. Effectiveness/efficiency of the supplier
  4. Reliability of the supplier
  5. Delivery capability
  6. Technical support the supplier
  7. Supplier’s capacity
  8. Financial clout
  9. Integrity of the supplier

 

SOURCES OF INFORMATION RELATING TO POTENTIAL SUPPLIERS ENCOMPASS:

  1. Catalogue: This is a booklet containing details of items for sale the supplier. They contain valuable technical information and format of presentation is simple.
  2. Trade directories: These contain new product requirements, special/occasional requirements and emergency items.
  3. Yellow pages: Entail a classified telephone directory, often printed on yellow paper that lists subscribers the business or service provided.
  4. Sales persons: They can provide useful service information regarding suppliers
  5. Exhibition: This is a public display of products/services and it offers a great opportunity to talk with a number of potential suppliers in the same place at the same time.
  6. Trade Journals: This is a periodical containing new developments, discussions etc concerning a trade or profession.
  7. Business advisers: Local business-support organisations, such as chambers of commerce or Enterprise Agencies often point out prospective suppliers to deal with.
  8. Professional peers: This entail informal exchange of information between buyers
  9. Information provided prospective suppliers
  10. Internet search engines
  11. Websites
  12. Local press both printed and electronic
  13. Mobile marketing platform

 

  TOPIC 5 

SUPPLIER AND MARKET BEHAVIOUR

Market Structure

Meaning:

Market structure refers to the nature and degree of competition in the market for goods and services. The structures of market both for goods market and service (factor) market are determined the nature of competition prevailing in a particular market.

The interconnected characteristics of a market, such as the number and relative strength of buyers and sellers and degree of collusion among them, level and forms of competition, extent of product differentiation, and ease of entry into and exit from the market

Determinants:

There are a number of determinants of market structure for a particular good.

They are:

(1) The number and nature of sellers.

(2) The number and nature of buyers.

(3) The nature of the product.

(4) The conditions of entry into and exit from the market.

(5) Economies of scale.

They are discussed as under:

1. Number and Nature of Sellers:

The market structures are influenced the number and nature of sellers in the market. They range from large number of sellers in perfect competition to a single seller in pure monopoly, to two sellers in duopoly, to a few sellers in oligopoly, and to many sellers of differentiated products.

2. Number and Nature of Buyers:

The market structures are also influenced the number and nature of buyers in the market. If there is a single buyer in the market, this is buyer’s monopoly and is called monopsony market. Such markets exist for local labour employed one large employer. There may be two buyers who act jointly in the market. This is called duopsony market. They may also be a few organised buyers of a product.

This is known as oligopsony. Duopsony and oligopsony markets are usually found for cash crops such as rice, sugarcane, etc. when local factories purchase the entire crops for processing.

3. Nature of Product:

It is the nature of product that determines the market structure. If there is product differentiation, products are close substitutes and the market is characterised monopolistic competition. On the other hand, in case of no product differentiation, the market is characterised perfect competition. And if a product is completely different from other products, it has no close substitutes and there is pure monopoly in the market.

4. Entry and Exit Conditions:

The conditions for entry and exit of firms in a market depend upon profitability or loss in a particular market. Profits in a market will attract the entry of new firms and losses lead to the exit of weak firms from the market. In a perfect competition market, there is freedom of entry or exit of firms.

But in monopoly and oligopoly markets, there are barriers to entry of new firms. Usually, governments have a monopoly in public utility services like postal, air and road transport, water and power supply services, etc. By granting exclusive franchises, entries of new supplies are barred. In oligopoly markets, there are barriers to entry of firms because of collusion, tacit agreements, cartels, etc. On the other hand, there are no restrictions in entry and exit of firms in monopolistic competition due to product differentiation.

5. Economies of Scale:

Firms that achieve large economies of scale in production grow large in comparison to others in an industry. They tend to weed out the other firms with the result that a few firms are left to compete with each other. This leads to the emergency of oligopoly. If only one firm attains economies of scale to such a large extent that it is able to meet the entire market demand, there is monopoly.

Forms of Market Structure:

On the basis of competition, a market can be classified in the following ways:

  1. Perfect Competition
  2. Monopoly
  3. Duopoly
  4. Oligopoly
  5. Monopolistic Competition

1. Perfect Competition Market:

A perfectly competitive market is one in which the number of buyers and sellers is very large, all engaged in buying and selling a homogeneous product without any artificial restrictions and possessing perfect knowledge of market at a time. In the words of A. Koutsoyiannis, “Perfect competition is a market structure characterised a complete absence of rivalry among the individual firms.” According to R.G. Lipsey, “Perfect competition is a market structure in which all firms in an industry are price- takers and in which there is freedom of entry into, and exit from, industry.”

Characteristics of Perfect Competition:

The following are the conditions for the existence of perfect competition:

(1) Large Number of Buyers and Sellers:

The first condition is that the number of buyers and sellers must be so large that none of them individually is in a position to influence the price and output of the industry as a whole. The demand of individual buyer relative to the total demand is so small that he cannot influence the price of the product his individual action.

Similarly, the supply of an individual seller is so small a fraction of the total output that he cannot influence the price of the product his action alone. In other words, the individual seller is unable to influence the price of the product increasing or decreasing its supply.

Rather, he adjusts his supply to the price of the product. He is “output adjuster”. Thus no buyer or seller can alter the price his individual action. He has to accept the price for the product as fixed for the whole industry. He is a “price taker”.

(2) Freedom of Entry or Exit of Firms:

The next condition is that the firms should be free to enter or leave the industry. It implies that whenever the industry is earning excess profits, attracted these profits some new firms enter the industry. In case of loss being sustained the industry, some firms leave it.

(3) Homogeneous Product:

Each firm produces and sells a homogeneous product so that no buyer has any preference for the product of any individual seller over others. This is only possible if units of the same product produced different sellers are perfect substitutes. In other words, the cross elasticity of the products of sellers is infinite.

No seller has an independent price policy. Commodi­ties like salt, wheat, cotton and coal are homogeneous in nature. He cannot raise the price of his product. If he does so, his customers would leave him and buy the product from other sellers at the ruling lower price.

The above two conditions between themselves make the average revenue curve of the individual seller or firm perfectly elastic, horizontal to the X-axis. It means that a firm can sell more or less at the ruling market price but cannot influence the price as the product is homogeneous and the number of sellers very large.

(4) Absence of Artificial Restrictions:

The next condition is that there is complete openness in buying and selling of goods. Sellers are free to sell their goods to any buyers and the buyers are free to buy from any sellers. In other words, there is no discrimination on the part of buyers or sellers.

Moreo­ver, prices are liable to change freely in response to demand-supply conditions. There are no efforts on the part of the producers, the government and other agencies to control the supply, demand or price of the products. The movement of prices is unfettered.

(5) Profit Maximisation Goal:

Every firm has only one goal of maximising its profits.

(6) Perfect Mobility of Goods and Factors:

Another requirement of perfect competition is the perfect mobility of goods and factors between industries. Goods are free to move to those places where they can fetch the highest price. Factors can also move from a low-paid to a high-paid industry.

(7) Perfect Knowledge of Market Conditions:

This condition implies a close contact between buyers and sellers. Buyers and sellers possess complete knowledge about the prices at which goods are being bought and sold, and of the prices at which others are prepared to buy and sell. They have also perfect knowledge of the place where the transactions are being carried on. Such perfect knowledge of market conditions forces the sellers to sell their product at the prevailing market price and the buyers to buy at that price.

(8) Absence of Transport Costs:

Another condition is that there are no transport costs in carry­ing of product from one place to another. This condition is essential for the existence of perfect compe­tition which requires that a commodity must have the same price everywhere at any time. If transport costs are added to the price of the product, even a homogeneous commodity will have different prices depending upon transport costs from the place of supply.

(9) Absence of Selling Costs:

Under perfect competition, the costs of advertising, sales-promotion, etc. do not arise because all firms produce a homogeneous product.

Perfect Competition vs Pure Competition:

Perfect competition is often distinguished from pure competition, but they differ only in degree. The first five conditions relate to pure competition while the remaining four conditions are also required for the existence of perfect competition. According to Chamberlin, pure competition means, competi­tion unalloyed with monopoly elements,” whereas perfect competition involves perfection in many other respects than in the absence of monopoly.” The practical importance of perfect competition is not much in the present times for few markets are perfectly competitive except those for staple food products and raw materials. That is why, Chamberlin says that perfect competition is a rare phenomenon.”

Though the real world does not fulfil the conditions of perfect competition, yet perfect competi­tion is studied for the simple reason that it helps us in understanding the working of an economy, where competitive behaviour leads to the best allocation of resources and the most efficient organisation of   production. A hypothetical model of a perfectly competitive industry provides the basis for appraising the actual working of economic institutions and organisations in any economy.

2. Monopoly Market:

Monopoly is a market situation in which there is only one seller of a product with barriers to entry of others. The product has no close substitutes. The cross elasticity of demand with every other product is very low. This means that no other firms produce a similar product. According to D. Salvatore, “Monopoly is the form of market organisation in which there is a single firm selling a commodity for which there are no close substitutes.” Thus the monopoly firm is itself an industry and the monopolist faces the industry demand curve.

The demand curve for his product is, therefore, relatively stable and slopes downward to the right, given the tastes, and incomes of his customers. It means that more of the product can be sold at a lower price than at a higher price. He is a price-maker who can set the price to his maximum advantage.

However, it does not mean that he can set both price and output. He can do either of the two things. His price is determined his demand curve, once he selects his output level. Or, once he sets the price for his product, his output is determined what consumers will take at that price. In any situation, the ultimate aim of the monopolist is to have maximum profits.

Characteristics of Monopoly:

The main features of monopoly are as follows:

  1. Under monopoly, there is one producer or seller of a particular product and there is no differ­ence between a firm and an industry. Under monopoly a firm itself is an industry.
  2. A monopoly may be individual proprietorship or partnership or joint stock company or a co­operative society or a government company.
  3. A monopolist has full control on the supply of a product. Hence, the elasticity of demand for a monopolist’s product is zero.
  4. There is no close substitute of a monopolist’s product in the market. Hence, under monopoly, the cross elasticity of demand for a monopoly product with some other good is very low.
  5. There are restrictions on the entry of other firms in the area of monopoly product.
  6. A monopolist can influence the price of a product. He is a price-maker, not a price-taker.
  7. Pure monopoly is not found in the real world.
  8. Monopolist cannot determine both the price and quantity of a product simultaneously.
  9. Monopolist’s demand curve slopes downwards to the right. That is why, a monopolist can increase his sales only decreasing the price of his product and theremaximise his profit. The marginal revenue curve of a monopolist is below the average revenue curve and it falls faster than the average revenue curve. This is because a monopolist has to cut down the price of his product to sell an additional unit.

3. Duopoly:

Duopoly is a special case of the theory of oligopoly in which there are only two sellers.

Characteristics

  1. Both the sellers are completely independent and
  2. no agreement exists between them.
  3. Even though they are inde­pendent, a change in the price and output of one will affect the other, and may set a chain of reactions.
  4. A seller may, however, assume that his rival is unaffected what he does, in that case he takes only his own direct influence on the price.

If, on the other hand, each seller takes into account the effect of his policy on that of his rival and the reaction of the rival on himself again, then he considers both the direct and the indirect influences upon the price. Moreover, a rival seller’s policy may remain unaltered either to the amount offered for sale or to the price at which he offers his product. Thus the duopoly problem can be considered as either ignoring mutual dependence or recognising it.

4. Oligopoly:

Oligopoly is a market situation in which there are a few firms selling homogeneous or differenti­ated products. It is difficult to pinpoint the number of firms in ‘competition among the few.’ With only a few firms in the market, the action of one firm is likely to affect the others. An oligopoly industry produces either a homogeneous product or heterogeneous products.

The former is called pure or per­fect oligopoly and the latter is called imperfect or differentiated oligopoly. Pure oligopoly is found primarily among producers of such industrial products as aluminium, cement, copper, steel, zinc, etc. Imperfect oligopoly is found among producers of such consumer goods as automobiles, cigarettes, soaps and detergents, TVs, rubber tyres, refrigerators, typewriters, etc.

Characteristics of Oligopoly:

In addition to fewness of sellers, most oligopolistic industries have several common characteris­tics which are explained below:

(1) Interdependence:

There is recognised interdependence among the sellers in the oligopolistic market. Each oligopolist firm knows that changes in its price, advertising, product characteristics, etc. may lead to counter-moves rivals. When the sellers are a few, each produces a considerable fraction of the total output of the industry and can have a noticeable effect on market conditions.

He can reduce or increase the price for the whole oligopolist market selling more quantity or less and affect the profits of the other sellers. It implies that each seller is aware of the price-moves of the other sellers and their impact on his profit and of the influence of his price-move on the actions of rivals.

Thus there is complete interdependence among the sellers with regard to their price-output policies. Each seller has direct and ascertainable influences upon every other seller in the industry. Thus, every move one seller leads to counter-moves the others.

(2) Advertisement:

The main reason for this mutual interdependence in decision making is that one producer’s fortunes are dependent on the policies and fortunes of the other producers in the indus­try. It is for this reason that oligopolist firms spend much on advertisement and customer services.

As pointed out Prof. Baumol, “Under oligopoly advertising can become a life-and-death matter.” For example, if all oligopolists continue to spend a lot on advertising their products and one seller does not match up with them he will find his customers gradually going in for his rival’s product. If, on the other hand, one oligopolist advertises his product, others have to follow him to keep up their sales.

(3) Competition:

This leads to another feature of the oligopolistic market, the presence of com­petition. Since under oligopoly, there are a few sellers, a move one seller immediately affects the rivals. So each seller is always on the alert and keeps a close watch over the moves of its rivals in order to have a counter-move. This is true competition.

(4) Barriers to Entry of Firms:

As there is keen competition in an oligopolistic industry, there are no barriers to entry into or exit from it. However, in the long run, there are some types of barriers to entry which tend to restraint new firms from entering the industry.

They may be:

(a) Economies of scale enjoyed a few large firms; (b) control over essential and specialised inputs; (c) high capital requirements due to plant costs, advertising costs, etc. (d) exclusive patents and licenses; and (e) the existence of unused capacity which makes the industry unattractive. When entry is restricted or blocked such natural and artificial barriers, the oligopolistic industry can earn long-run super normal profits.

(5) Lack of Uniformity:

Another feature of oligopoly market is the lack of uniformity in the size of firms. Finns differ considerably in size. Some may be small, others very large. Such a situation is asymmetrical. This is very common in the American economy. A symmetrical situation with firms of a uniform size is rare.

(6) Demand Curve:

It is not easy to trace the demand curve for the product of an oligopolist. Since under oligopoly the exact behaviour pattern of a producer cannot be ascertained with certainty, his demand curve cannot be drawn accurately, and with definiteness. How does an individual seller s de­mand curve look like in oligopoly is most uncertain because a seller’s price or output moves lead to unpredictable reactions on price-output policies of his rivals, which may have further repercussions on his price and output.

The chain of action reaction as a result of an initial change in price or output, is all a guess-work. Thus a complex system of crossed conjectures emerges as a result of the interdependence­ among the rival oligopolists which is the main cause of the indeterminateness of the demand curve.

If the oligopolist seller does not have a definite demand curve for his product, then how does he affect his sales. Presumably, his sales depend upon his current price and those of his rivals. However, a number of conjectural demand curves can be imagined.

For example, in differentiated oligopoly where each seller fixes a separate price for his product, a reduction in price one seller may lead to an equivalent, more, less or no price reduction rival sellers. In each case, a demand curve can be drawn the seller within the range of competitive and monopoly demand curves.

Leaving aside retaliatory price movements, the individual seller’s demand curve under oligopoly for both price cuts and increases is neither more elastic than under perfect or monopolistic competition nor less elastic than under mo­nopoly. It may still be indefinite and indeterminate.

This situation is shown in Figure 1 where KD1 is the elastic demand curve and MD is the less elastic demand curve. The oligopolies’ demand curve is the dotted kinked KPD. The reason is quite simple. If a seller reduces the price of his product, his rivals also lower the prices of their products so that he is not able to increase his sales.

So the demand curve for the individual seller’s product will be less elastic just below the present price P (where KD1and MD curves are shown to intersect). On the other hand, when he raises the price of his product, the other sellers will not follow him in order to earn larger profits at the old price. So this individual seller will experience a sharp fall in the demand for his product.

Thus his demand curve above the price P in the segment KP will be highly elastic. Thus the imagined demand curve of an oligopolist has a comer or kink at the current price P. Such a demand curve is much more elastic for price increases than for price decreases.

(7) No Unique Pattern of Pricing Behaviour:

The rivalry arising from interdependence among the oligopolists leads to two conflicting motives. Each wants to remain independent and to get the maximum possible profit. Towards this end, they act and react on the price-output movements of one another in a continuous element of uncertainty.

On the other hand, again motivated profit maximisation each seller wishes to cooperate with his rivals to reduce or eliminate the element of uncertainty. All rivals enter into a tacit or formal agreement with regard to price-output changes. It leads to a sort of monopoly within oligopoly.

They may even recognise one seller as a leader at whose initiative all the other sellers raise or lower the price. In this case, the individual seller’s demand curve is a part of the industry demand curve, having the elasticity of the latter. Given these conflicting attitudes, it is not possible to predict any unique pattern of pricing behaviour in oligopoly markets.

5. Monopolistic Competition:

Monopolistic competition refers to a market situation where there are many firms selling a differ­entiated product. “There is competition which is keen, though not perfect, among many firms making very similar products.” No firm can have any perceptible influence on the price-output policies of the other sellers nor can it be influenced much their actions. Thus monopolistic competition refers to competition among a large number of sellers producing close but not perfect substitutes for each other.

It’s Features:

The following are the main features of monopolistic competition:

(1) Large Number of Sellers:

In monopolistic competition the number of sellers is large. They are “many and small enough” but none controls a major portion of the total output. No seller chang­ing its price-output policy can have any perceptible effect on the sales of others and in turn be influenced them. Thus there is no recognised interdependence of the price-output policies of the sellers and each seller pursues an independent course of action.

(2) Product Differentiation:

One of the most important features of the monopolistic competi­tion is differentiation. Product differentiation implies that products are different in some ways from each other. They are heterogeneous rather than homogeneous so that each firm has an absolute monopoly in the production and sale of a differentiated product. There is, however, slight difference between one product and other in the same category.

P roducts are close substitutes with a high cross-elasticity and not perfect substitutes. Product “differentiation may be based upon certain characteristics of the prod­ucts itself, such as exclusive patented features; trade-marks; trade names; peculiarities of package or container, if any; or singularity in quality, design, colour, or style. It may also exist with respect to the conditions surrounding its sales.”

(3) Freedom of Entry and Exit of Firms:

Another feature of monopolistic competition is the freedom of entry and exit of firms. As firms are of small size and are capable of producing close substitutes, they can leave or enter the industry or group in the long run.

(4) Nature of Demand Curve:

Under monopolistic competition no single firm controls more than a small portion of the total output of a product. No doubt there is an element of differentiation neverthe­less the products are close substitutes. As a result, a reduction in its price will increase the sales of the firm but it will have little effect on the price-output conditions of other firms, each will lose only a few of its customers.

Likewise, an increase in its price will reduce its demand substantially but each of its rivals will attract only a few of its customers. Therefore, the demand curve (average revenue curve) of a firm under monopolistic competition slopes downward to the right. It is elastic but not perfectly elastic within a relevant range of prices of which he can sell any amount.

(5) Independent Behaviour:

In monopolistic competition, every firm has independent policy. Since the number of sellers is large, none controls a major portion of the total output. No seller changing its price-output policy can have any perceptible effect on the sales of others and in turn be influenced them.

(6) Product Groups:

There is no any ‘industry’ under monopolistic competition but a ‘group’ of firms producing similar products. Each firm produces a distinct product and is itself an industry. Chamberlin lumps together firms producing very closely related products and calls them product groups, such as cars, cigarettes, etc.

(7) Selling Costs:

Under monopolistic competition where the product is differentiated, selling costs are essential to push up the sales. Besides, advertisement, it includes expenses on salesman, allowances to sellers for window displays, free service, free sampling, premium coupons and gifts, etc.

(8) Non-price Competition:

Under monopolistic competition, a firm increases sales and profits of his product without a cut in the price. The monopolistic competitor can change his product either varying its quality, packing, etc. or changing promotional programmes.

The features of market structures are shown in Table 1.

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  1. Pricing strategies
  1. Fixed price

The term fixed price is a phrase used to mean the price of a good or a service is not subject to bargaining. The term commonly indicates that an external agent, such as a merchant or the government, has set a price level, which may not be changed for individual sales. In the case of governments, this may be due to price controls.

Bargaining is very common in many parts of the world, outside of retail stores in Europe or North America or Japan, this makes this an exception from the general norm of pricing in these areas.

Mitsui Takatoshi that it was begun the world and a fixed price was used.

A fixed-price contract is a contract where the contract payment does not depend on the amount of resources or time expended the contractor, as opposed to cost-plus contracts. These contracts are often used in military and government contractors to put the risk on the side of the vendor, and control costs.

Historically, when fixed-price contracts are used for new projects with untested or developmental technologies, the programs may fail if unforeseen costs exceed the ability of the contractor to absorb the overruns. In spite of this, such contracts continue to be popular. Fixed-price contracts tend to work when costs are well known in advance

  1. Cost Price

This is your own calculation of how much it cost you to actually produce your products. It includes your time x hourly rate, material and marketing costs, but also overheads such as studio rent, telephone and transport. Costing your product or service correctly is the foundation of how you will price your work.

You need to keep your cost price confidential, and do not share with others such as your retailers or competitors.

3.     Target pricing business

Pricing method wherethe selling price of a product is calculated to produce a particular rate of return on investment for a specific volume of production. The target pricing method is used most often public utilities, like electric and gas companies, and companies whose capital investment is high, like automobile manufacturers.

Target pricing is not useful for companies whose capital investment is low because, according to this formula, the selling price will be understated. Also the target pricing method is not keyed to the demand for the product, and if the entire volume is not sold, a company might sustain an overall budgetary loss on the product.

4.     Psychological pricing

Pricing designed to have a positive psychological impact. For example, selling a product at $3.95 or $3.99, rather than $4.00. There are certain price points where people are willing to buy a product. If the price of a product is $100 and the company prices it as $99, then it is called psychological pricing. In most of the consumers mind $99 is psychologically ‘less’ than $100. A minor distinction in pricing can make a big difference in sales. The company that succeeds in finding psychological price points can improve sales and maximize revenue.

5.     Contribution margin-based pricing

Contribution margin-based pricing maximizes the profit derived from an individual product, based on the difference between the product’s price and variable costs (the product’s contribution margin per unit), and on one’s assumptions regarding the relationship between the product’s price and the number of units that can be sold at that price. The product’s contribution to total firm profit (i.e. to operating income) is maximized when a price is chosen that maximizes the following: (contribution margin per unit) X (number of units sold).

In cost-plus pricing, a company first determines its break-even price for the product. This is done calculating all the costs involved in the production, marketing and distribution of the product. Then a markup is set for each unit, based on the profit the company needs to make, its sales objectives and the price it believes customers will pay. For example, if the company needs a 15 percent profit margin and the break-even price is $2.59, the price will be set at $2.98 ($2.59 x 1.15).[2]

6.     Decoy pricing

Method of pricing where the seller offers at least three products, and where two of them have a similar or equal price. The two products with the similar prices should be the most expensive ones, and one of the two should be less attractive than the other. This strategy will make people compare the options with similar prices, and as a result sales of the most attractive choice will increase.

7.     High-low pricing

Method of pricing for an organization where the goods or services offered the organization are regularly priced higher than competitors, but through promotions, advertisements, and or coupons, lower prices are offered on key items. The lower promotional prices are designed to bring customers to the organization where the customer is offered the promotional product as well as the regular higher priced products.[4]

8.     Limit pricing

A limit price is the price set a monopolist to discourage economic entry into a market, and is illegal in many countries. The limit price is the price that the entrant would face upon entering as long as the incumbent firm did not decrease output. The limit price is often lower than the average cost of production or just low enough to make entering not profitable. The quantity produced the incumbent firm to act as a deterrent to entry is usually larger than would be optimal for a monopolist, but might still produce higher economic profits than would be earned under perfect competition.

The problem with limit pricing as a strategy is that once the entrant has entered the market, the quantity used as a threat to deter entry is no longer the incumbent firm’s best response. This means that for limit pricing to be an effective deterrent to entry, the threat must in some way be made credible. A way to achieve this is for the incumbent firm to constrain itself to produce a certain quantity whether entry occurs or not. An example of this would be if the firm signed a union contract to employ a certain (high) level of labor for a long period of time. In this strategy price of the product becomes the limit according to budget.

9.     Loss leader

A loss leader or leader is a product sold at a low price (i.e. at cost or below cost) to stimulate other profitable sales. This would help the companies to expand its market share as a whole.

10.Marginal-cost pricing

In business, the practice of setting the price of a product to equal the extra cost of producing an extra unit of output. By this policy, a producer charges, for each product unit sold, only the addition to total cost resulting from materials and direct labor. Businesses often set prices close to marginal cost during periods of poor sales. If, for example, an item has a marginal cost of $1.00 and a normal selling price is $2.00, the firm selling the item might wish to lower the price to $1.10 if demand has waned. The business would choose this approach because the incremental profit of 10 cents from the transaction is better than no sale at all.

11.Market-oriented pricing

Setting a price based upon analysis and research compiled from the target market. This means that marketers will set prices depending on the results from the research. For instance if the competitors are pricing their products at a lower price, then it’s up to them to either price their goods at an above price or below, depending on what the company wants to achieve.

12.Odd pricing

In this type of pricing, the seller tends to fix a price whose last digits are odd numbers. This is done so as to give the buyers/consumers no gap for bargaining as the prices seem to be less and yet in an actual sense are too high, and takes advantage of human psychology. A good example of this can be noticed in most supermarkets where instead of pricing at $10, it would be written as $9.99.

13.Pay what you want/ONO

Pay what you want is a pricing system where buyers pay any desired amount for a given commodity, sometimes including zero. In some cases, a minimum (floor) price may be set, and/or a suggested price may be indicated as guidance for the buyer. The buyer can also select an amount higher than the standard price for the commodity.

Giving buyers the freedom to pay what they want may seem to not make much sense for a seller, but in some situations it can be very successful. While most uses of pay what you want have been at the margins of the economy, or for special promotions, there are emerging efforts to expand its utility to broader and more regular use.

14.Penetration pricing

Penetration pricing includes setting the price low with the goals of attracting customers and gaining market share. The price will be raised later once this market share is gained.[5]

15.Predatory pricing

Main article: Predatory pricing

Predatory pricing, also known as aggressive pricing (also known as “undercutting”), intended to drive out competitors from a market. It is illegal in some countries.

16.Premium decoy pricing

Method of pricing where an organization artificially sets one product price high, in order to boost sales of a lower priced product.

17.Premium pricing

Main article: Premium pricing

Premium pricing is the practice of keeping the price of a product or service artificially high in order to encourage favorable perceptions among buyers, based solely on the price. The practice is intended to exploit the (not necessarily justifiable) tendency for buyers to assume that expensive items enjoy an exceptional reputation, are more reliable or desirable, or represent exceptional quality and distinction.

18.Price discrimination

Main article: Price discrimination

Price discrimination is the practice of setting a different price for the same product in different segments to the market. For example, this can be for different classes, such as ages, or for different opening times.

19.Price leadership

An observation made of oligopolistic business behavior in which one company, usually the dominant competitor among several, leads the way in determining prices, the others soon following. The context is a state of limited competition, in which a market is shared a small number of producers or sellers.

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 TOPIC 6

PURCHASES AND CONTRACTS

CONTRACT

A voluntary, deliberate, and legally binding agreement between two or more competent parties. Contracts are usually written but may be spoken or implied, and generally have to do with employment, sale or lease, or tenancy.

A contractual relationship is evidenced by

(1) an offer,

(2) acceptance of the offer, and a

(3) valid (legal and valuable)

  1. consideration.

Each party to a contract acquires rights and duties relative to the rights and duties of the other parties. However, while all parties may expect a fair benefit from the contract (otherwise courts may set it aside as inequitable) it does not follow that each party will benefit to an equal extent. Existence of contractual-relationship does not necessarily mean the contract is enforceable, or that it is not void (see void contract) or voidable (see voidable Contract). Contracts are normally enforceable whether or not in a written form, although a written contract protects all parties to it. Some contracts, (such as for sale of real property, installment plans, or insurance policies) must be in writing to be legally binding and enforceable. Other contracts (see implied in fact contract and implied in law contract) are assumed in, and enforced by, law whether or not the involved parties desired to enter into a contract

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law is a contract. An agreement which is enforceable at law cannot be contract. Thus, the term agreement is more wider in scope than contract. All Contracts are agreements  but all agreements are not contracts.

An agreement, to be enforceable law, must posses the essential elements of a valid contract as contained in section 10 of the Indian Contract Act.

ESSENTIALS  ELEMENTS OF A VALID CONTRACT :

1. Offer and Acceptance.  In order to create a valid contract, there must be a ‘lawful offer’ one party and ‘lawful acceptance’ of the same the other party. Offer must be capable of creating legal relations. The offeror must intend the creation of legal relations. Acceptance must be absolute and unconditional. An acceptance must be unconditional and unqualified.

2. Intention to Create Legal Relationship.  In case, there is no such intention on the part of parties, there is no contract. Agreements of social or domestic nature do not contemplate legal relations.

3.Lawful Consideration. Consideration has been defined in various ways. According to Blackstone,”Consideration is recompense given the party contracting to another.” In other words of Pollock, “Consideration is the price for which the promise of the another is brought.”
consideration is known as quid pro-quo or something in return.

4. Capacity of parties. The parties to an agreement must be competent t contract. If either of the parties does not have the capacity to contract, the contract is not valid.
According the following persons are incompetent to contract.
(a) Miners,                 (b) Persons of unsound mind, and
(c) persons disqualified law to which they are subject.

5. Free Consent. ‘Consent’ means the parties must have agreed upon the same thing in the same sense.
According to Section 14, Consent is said to be free when it is not caused by-
(1) Coercion, or                   (2) Undue influence, or          (3) Fraud, or
(4) Mis-representation, or         (5) Mistake.
An agreement should be made the free consent of the parties.

6. Lawful Objective . The object of an agreement must be valid. Object has nothing to do with consideration. It means the purpose or design of the contract. Thus, when one hires a house for use as a gambling house, the object of the contract is to run a gambling house.

The Object is said to be unlawful if-

(a) it is forbidden law;
(b) it is of such nature that if permitted it would defeat the provision of any law;
(c) it is fraudulent;
(d) it involves an injury to the person or property of any other;
(e) the court regards it as immoral or opposed to public policy.

7. Certainty of Meaning. According to Section 29,”Agreement the meaning of which is not Certain or capable of being made certain are void.”

8. Possibility of Performance. If the act is impossible in itself, physically or legally, if cannot be enforced at law. For example, Mr. A agrees with B to discover treasure magic. Such Agreements is not enforceable.

9. Not Declared to be void or Illegal. The agreement though satisfying all the conditions for a valid contract must not have been expressly declared void any law in force in the country. Agreements mentioned in Section 24 to 30 of the Act have been expressly declared to be void for example agreements in restraint of trade, marriage, legal proceedings etc.

10. Legal Formalities. An oral Contract is a perfectly valid contract, expect in those cases where writing, registration etc. is required some statute. In India writing is required in cases of sale, mortgage, lease and gift of immovable property, negotiable instruments; memorandum and articles of association of a company, etc. Registration is required in cases of documents coming within the scope of section 17 of the Registration Act.

All the elements mentioned above must be in order to make a valid contract. If any one of them is absent the agreement does not become a contract.

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ACTIVITIESINVOLVED IN CONTRACT FORMATION

TYPES OF CONTRACT

Types of contracts can include:

  1. Written contracts
  2. Verbal contracts
  3. Standard form contracts
  4. Period contracts

1.   Written contracts

Written contracts provide more certainty for both parties than verbal contracts. They clearly set out the details of what was agreed. Matters such as materials, timeframes, payments and a procedure to follow in the event of a dispute, can all be set out in a contract.

A written contract helps to minimise risks as it is much safer to have something in writing than to rely on someone’s word. A written contract will give you more certainty and minimise your business risks making the agreement clear from the outset.

Benefits of a written contract

A written contract can:

  1. provide proof of what was agreed between you and the hirer
  2. help to prevent misunderstandings or disputes making the agreement clear from the outset
  3. give you security and peace of mind knowing you have work, for how long and what you will be paid
  4. clarify your status as an independent contractor stating that the contract is a ‘services contract’ and not an ’employment contract’. This will not override a ‘sham’ contract, but a court will take the statement into account if there is any uncertainty about the nature of the relationship reduce the risk of a dispute detailing payments, timeframes and work to be performed under the contract
  5. set out how a dispute over payments or performance will be resolved
  6. set out how the contract can be varied
  7. serve as a record of what was agreed
  8.  specify how either party can end the contract before the work is completed.

Risks of not having a written contract

When a contract is not in writing, you are exposing yourself and your business to a number of risks:

  • the risk that you or the hirer misunderstood an important part of the agreement, such as how much was to be paid for the job or what work was to be carried out
  • the risk that you will have a dispute with the hirer over what was agreed because you are both relying on memory
  • the risk that a court won’t enforce the contract because you may not be able to prove the existence of the contract or its terms.

Get advice before you sign

Before you sign a contract, it is a good idea to seek advice from your industry association, lawyer, business adviser or union.

When a written contract is essential

It is always better to have your contract in writing, no matter how small the job is. Any contract with a hirer that involves a significant risk to your business should always be carefully considered and put in writing. This is advisable even if it means delaying the start of the work. A written contract is essential:

  • when the contract price is large enough to make or break your business if you don’t get paid
  • where there are quality requirements, specifications or specific materials that must be used
  • where there is some doubt that the hirer has enough money to pay you
  • when you must have certain types of insurance for the type of work you are doing
  • where the contract contains essential terms, such as a critical date for the completion of the work before payment can be made
  • where you or the hirer need to keep certain information confidential
  • when it is required your insurance company for professional indemnity purposes
  • where there is a legal obligation to have a written contract (eg. trade contracts for building work in Queensland).

2.   Verbal contracts

Many independent contracting arrangements use verbal contracts, which only work well if there are no disputes. A handshake agreement may still be a contract and may (though often with difficulty) be enforced a court. However, verbal contracts can lead to uncertainty about each party’s rights and obligations. A dispute may arise if you have nothing in writing explaining what you both agreed to do.

Part verbal, part written contracts

Some ag reements may be only partly verbal. For example, there may be supporting paperwork such as a quote or a list of specifications that also forms part of the contract. At the very least, you should write down the main points that you agreed with the hirer to avoid relying on memory. Keep any paperwork associated with the contract. The paperwork can later be used in discussions with the hirer to try to resolve a problem. If the dispute becomes serious, it may be used as evidence in court.

The most important thing is that each party clearly understands what work will be done, when it will be completed and how much will be paid for the work.

Examples of paperwork that may support a verbal contract

  • E-mails
  • Quotes with relevant details
  • Lists of specifications and materials
  • Notes about your discussion—for example, the basics of your contract written on the back of an envelope (whether signed both of you or not).

If the contract is only partly written or the terms of the work are set out in a number of separate documents (e-mail, quote etc.), it is to your benefit to make sure that any formal agreement you are being asked to sign refers to or incorporates those documents. At the very least, make sure the contract does not contain a term to the effect that the formal document is the ‘entire agreement’.

3.   Standard form contracts

A ‘standard form’ contract is a pre-prepared contract where most of the terms are set in advance and little or no negotiation between the parties occurs. Often, these are printed with only a few blank spaces for filling in information such as names, dates and signatures.

Standard form contracts often include a lot of legal ‘fine print’ and terms that you may not understand. They tend to be one-sided documents that mostly benefit the person who prepared the contract (for example, shifting as much risk as possible to the contractor). If you don’t understand the fine print or any other part of the contr act, you should get advice. If you sign the contract, you will be required to comply with the fine print even if you didn’t actually read it.

Tips for standard form contracts

Read every word before you sign

Read the fine print carefully and get advice about any terms you don’t understand before you sign. Once you sign a contract you are bound all of its terms. If there is an indemnity clause, don’t sign until you understand the risks you are agreeing to accept if something goes wrong.

Cross out any blank spaces

Don’t leave any spaces blank. If you don’t need to fill in a blank space, always cross it out so the contract can’t be changed after you sign it.

Negotiate

You have the right to negotiate any contract before signing, including a standard form contract. But remember that both parties must agree to any changes and record them in the contract you sign. Your union or industry association or a lawyer can help you prepare for negotiations.

Keep a copy

You should always have a copy of any contract you sign. It is best if you and the hirer sign two copies of the contract, so that you can both keep an original. If this isn’t possible, ask for a photocopy and check that it is an exact copy. Remember to keep your copy somewhere safe for future reference.

A lawyer, your union or industry association might be able to provide you with information about some common standard terms used in contracts in your industry. They may also be able to provide you with a standard form contract for you to use.

4.   Period contracts

Some independent contractors and hirers use a ‘period contract’, which is a contract template that sets out the terms for a business relationship where the contractor is engaged to perform work from time to time.  In the building and construction industry, these contracts are called ‘period trade contracts’.

The contract template will apply each time the hirer offers work to the contractor and the contractor accepts it.  This c an occur when the contractor provides a quote and receives a work order from the hirer, or the parties might sign an addendum (an addition to the contract) that sets out the specific work to be done or result to be achieved. Once the work starts, the contract template and the work order or addendum will form the total contract for the specific work.

Period contracts can work well for both parties. They allow for the flexibility of performing intermittent work over an agreed period.  However, you should check the terms of the agreement to do each new job. Are they the same as those set out in the original contract template? Any term or condition that is different for a particular job, may change the terms of the original contract template.

If you are unsure about anything related to a period contract, get advice before you sign or agree to new work, even if you have performed work for that hirer previously.

RIGHTS ,OBLIGATIONS AND RESPONSIBILITIES

METHODS OF CONTROLING & EXCECUTION OF CONTRACS

Procurement Methods

Generally speaking, there are six procurement methods used the procurement team in a company. The actual names of these could vary depending on your company and industry, but the process remains the same. The six times of procurement are open tendering, restricted tendering, request for proposal, two-stage tendering, request for quotations and single-source procurement.

Open Tendering

Open tendering is shorthand for competitive bidding. It allows companies to bid on goods in an open competition or open solicitation manner. Open tendering requirements call for the company to:

  1. Advertise locally
  2. Have unbiased and coherent technical specifications
  3. Have objective evaluation measures
  4. Be open to all qualified bidders
  5. Be granted to the least cost provider sans contract negotiations

Arguably, the open tendering method of procurement encourages effective competition to obtain goods with an emphasis on the value for money. However, considering this is a procedures based method a lot of procurement experts feel that this method is not very suitable for large or complex acquisitions due to the intense focus on the output process instead of stringent obedience to standards. In this Quality Management course learn about the ways to evaluate quality products on incoming orders, and to create quality products for sale.

There are course also disadvantages to this kind of procurement method including:

  1. Complex requirements are typically not suited for this method
  2. The timeline for needing the goods
  3. Complications in defining the exact needs of the requirement the procuring company

Restricted Tendering

Unlike open tendering, restricted tendering only places a limit on the amount of request for tenders that can be sent a supplier or service provider. Because of this selective process, restricted tendering is also sometimes referred to as selective tendering. Like open tendering, restricted tendering is considered a competitive procurement method, however, the competition is limited to agencies that are invited the procuring team. The procuring entity should establish a set of guidelines to use when selecting the suppliers and service providers that will be on the invitation list. Randomized selections will not bode well for procuring. This method is selective to find the best-suited and most qualified agencies to procure goods and services from. It’s also employed as a way for the procuring team to save time and money during the selection process.

Request for Proposals (RFP)

Request for Proposal is a term that is used all across the business world. Social media managers receive RFP’s from potential clients all the time when a client is seeking a new manager of their venture. This kind of proposal is a compelling and unique document stating why the business is the best fit for the type of project at and. Similarly, in the procurement world, a RFP is a method used when suppliers or service providers are proposing their good or service to a procurement team for review. If you’re a supplier, understanding the in’s and out’s of quality service management is key to winning your bid. Read more about this in service quality management.

Procurement teams are often on the hunt for the best valued, most marketable items to bring into circulation. A client may feel they have all of the qualifications to fit the needs of fulfilling a specific requirement of a procurement team – but they have to prove it. The agencies writing the RFP’s should submit a two-envelope proposal to the procurement manager. The two-envelope process allows the procurers’ to review the proposal through and through without knowing the financial component. The financial proposal is sealed in the second envelope and should only be opened after the content of the first-envelope proposal is approved or rejected. This eliminates any persuasion cost and allows an objective lens to look through when analyzing a good fit. The proposal with the best fit qualifications and best price will be selected. If a lesser qualified (yet still qualified) selection has a lesser price, no contract should be negotiated. The most qualified and appropriate proposal, regardless of price, should be selected. Are you a supplier? Learn how to price your goods based on value in the course Value Centric Selling.

Two Stage Tendering

There are two procedures that are used under the two stage tendering method. Each one of the procedures has a two stage process. This can be disadvantageous for some procurement teams if there is a time limit on securing a contract. In the same vein, this option is more flexible for both parties, allowing more room for discussion to meet mutual needs.

The first procedure is very similar to the RFP method as discussed above. The procurement team receives a proposal with two envelopes – one with the proposal itself and one with the associated financial information. The difference is the bidder is required to submit a technical proposal that highlights their solutions to fulfilling the requirements as specified the procuring department. This proposal is scored according to the relevance of the solution to the needs of the procurer. The highest scored proposal is invited for further discussion in an attempt to reach an agreement. After the final agreement for the technical proposal is reached, the bidder is invited to submit their financial proposal and then further discussions ensue to negotiate a contract.

The second procedure is much like the above, however, instead of the bidder submitting a fully-completed technical proposal, a partial proposal is submitted. The methodology and technical specifications will be included but not to the fullest extent. This allows room for even more customization and discussion. Once the highest qualified bidder is selected, they will be invited to submit a thorough technical proposal along with a financial proposal. The technical proposal will be evaluated and only then will the financial proposal be opened. The combined score of both the technical proposal and the financial proposal are the grounds on which a bidder is contracted.

Request for Quotations

This procurement method is used for small-valued goods or services. Request for quotation is far the least complex procurement method available. If you have the option, use this method to ensure a fast procurement process and not a lot of paperwork. There is no formal proposal drafted from either party in this method. Essentially, the procurement entity selects a minimum of three suppliers or service providers that they wish to get quotes from. A comparison of quotes is analyzed and the best selection determined requirement compliance is chosen.

Single-Source

Single source procurement is a non-competitive method that should only be used under specific circumstances. Single source procurement occurs when the procuring entity intends to acquire goods or services from a sole provider. This method should undergo a strict approval process from management before being used. The circumstances which call for this method are:

  • Emergencies
  • If only one supplier is available and qualified to fulfill the requirements
  • If the advantages of using a certain supplier are abundantly clear
  • If the procurer requires a certain product or service that is only available from one supplier
  • For the continuation of work that cannot be reproduced another supplier

In the end, the type of procurement method you choose to use is highly relative to the conditions of the procurement effort and the type of good or service being acquired. All procurement methods follow tight legal frameworks to ensure all standards are being met and quality

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 TOPIC 7 

SUPPORT TOOLS FOR PURCHASING DECISION MAKING

Tendering process

Invitation to Tender

The procuring entity/firm shall prepare an invitation to tender that sets out the following:

  1. The name and address of the procuring entity;
  2. The tender number assigned to the procurement proceedings the procuring entity;
  3. A brief description of the goods works or services being procured including the time limit for delivery or completion;
  4. An explanation of how to obtain the tender documents, including the amount of any fee;
  5. An explanation of where and when tenders must be submitted and where and when the tenders will be opened; and a statement that those submitting tenders or their representatives may attend the opening of tenders.

 

Tender Documents

The procuring entity/firm shall prepare tender documents in accordance with this section and the regulations. The tender documents shall contain enough information to allow fair competition among those who may wish to submit tenders.

The tender documents shall set out the following:

  1. The specific requirements prepared under relating to the goods, work or service being procured and the time limit for completion
  2. If works are being procured, relevant and bills of quantities
  3. The general and specific conditions to contract will be subject, including any requirement that performance security be provided before the contract is entered into
  4. The tender number assigned to the procurement proceedings the procuring entity
  5. Instructions for the preparation and submission of tenders including;

 

  • The forms for tenders
  • The number of copies to be with the original tender

iii) Any requirement that tender security be provided and the form and any such security

  1. iv) Any requirement that evidence provided of the qualification person submitting the tender
  2. v) An explanation of where and when tenders must be submitted, a statement that the tenders will be opened immediately after the deadline for submitting them and an explanation of where the tenders will be opened
  3. vi) A statement that those submitting to their representatives may attend the o tenders

vii) A statement of the period during which tenders must remain valid

viii) The procedures and criteria to be used to evaluate and compare the tenders; a statement that the procuring entity may, at any time, terminate the procurement proceedings without entering into a contract; and

 

Modifications to tender

  1. A procuring entity may amend the tender documents at any time before the deadline for submitting tenders issuing an addendum.
  2. An amendment may be made on the procuring entity’s own initiative or in response to an inquiry.
  3. The procuring entity shall promptly provide a copy of the addendum to each person to whom the procuring entity provided copies of the tender documents.
  4. The addendum shall be deemed to be part of the ‘tender documents.

 

Advertisement of Tender

The procuring entity shall take steps reasonable to bring the invitation to tender to the attention of those who may wish to submit tenders. If the estimated value of the goods, works or services being procured is equal to, or more than the prescribed threshold for national advertising, the procuring entity shall advertise, at least twice in a newspaper of general nationwide circulation which has been regularly published for at least two years before the date of issue of the advertisement, and on its website in instances where the procuring entity has a website, the advertisement shall also be posted at any conspicuous place reserved for this purpose in the premises of procuring entity as certified the head of procurement unit.

 

Time for Preparing Tenders

The time allowed for the preparation tenders must not be less than the minimum period of prescribed for the purpose of this subsection

If the tender documents are amended when the time remaining before the deadline for submitting tenders is less than one third of the time allowed for the preparation of tenders, the procuring entity shall extend the deadline as necessary to allow amendment of t he tender documents to be taken in account in the preparation or amendment of tenders.

 

Provision of Tender Documents

The procuring entity shall provide copies of the tender documents expeditiously and in accord with the invitation to tender.

The procuring entity may charge such fees may be prescribed for copies of the tender documents.

 

Tender security

A procuring entity may require that tender security be provided with tenders.

The procuring entity may determine the form and amount of the tender security, subject to such requirements or limits as may be prescribed.

Tender security shall be forfeited if the person submitting the tender:

  1. Withdraws the tender after the deadline for submitting tenders but before the expiry of the period during which tenders must remain valid;
  2. Rejects a correction of an arithmetic error
  3. Refuses to enter into a written contract or fails to furnish any required performance security.

 

The procuring entity shall immediately release any tender security if :

  1. The procurement proceedings are terminated;
  2. The procuring entity determines that none of the submitted tenders is responsive; or
  3. A contract for the procurement is entered into.

 

Opening of Tenders

The accounting officer shall appoint a tender opening committee specifically for the procurement in accordance with the following requirements and such other requirements as may be prescribed –

(a) The committee shall have at least three members; and

(b) At least one of the members shall not be directly involved in the processing or evaluation of the tenders.

  • Immediately after the deadline for submitting tenders, the tender opening committee shall open all tenders received before that deadline.
  • Those submitting tenders or their representatives may attend the opening of tenders.
  • The tender opening committee shall assign an identification number to each tender.
  • As each tender is opened, the following, shall be read out loud and recorded in a document to be called the tender opening register –
  1. i) The name of the person submitting the tender;
  2. ii) The total price of the tender including any modifications or discounts received before the deadline for submitting tenders except as may be prescribed; and

iii) If applicable, what has been given as tender security.

  1. iv) The procuring entity shall, on request, provide a copy of the tender opening register to a person submitting a tender.

 

 Each member of the tender opening committee shall –

  1. i) Sign each tender on one or more pages as determined the tender opening committee; and
  2. ii) Initial, in each tender, Indicate against the quotation or the price and any modifications or discounts.

iii) The tender opening committee shall prepare tender opening minutes which shall set out –

  1.  A record of the procedure followed in opening tenders; and
  2.  The particulars of those persons submitting tenders, or their representatives, who attend the opening of the tenders.
  3. Each member of the tender opening committee shall sign the tender opening minutes.
  4. Extension of Tender Validity Period

Before the expiry of the period during which   tenders must remain valid the procuring entity extend that period.

  1. The procuring entity shall give notice of an extension under subsection (1) to each person who submitted a tender.
  2. An extension under subsection (1) is subject to such restrictions and requirements as may be prescribed.
  3. For greater certainty, tender security shall be forfeited if a tender is withdrawn during an extension under subsection (1).

 

Clarifications

The procuring entity may request a clarification of a tender to assist in the evaluation and comparison of tenders. A clarification may not change the substance of the tender.

 

Corrections of Arithmetic Errors

The procuring entity may correct an arithmetic error in a tender.

The procuring entity shall give prompt notice of the correction of an error to the person who submitted the tender.

If the person who submitted the tender rejects the correction, the tender shall be rejected and the person’s tender security shall be forfeited.

 

Responsiveness of Tenders

A tender is responsive if it conforms to all the mandatory requirements in the tender documents.

The following do no  t affect whether a tender is responsive –

  1. i) Minor deviations that do not materially depart from the requirements set out in the tender documents; or
  2. ii) Errors or oversights that can be corrected without affecting the substance of the tender.
  3. A deviation described in subsection(2)(a) shall –
  4. i) Be quantified to the extent possible; and
  5. ii) Be taken into account in the evaluation and comparison of tenders.

 

Notification If No Responsive Tenders

If the procuring entity determines that none of the submitted tenders is responsive, the procuring entity shall notify each person who submitted a tender.

 

Evaluation of tenders

  1. The procuring entity shall evaluate, compare the responsive tenders other than tend rejected under section 63(3).
  2. The evaluation and comparison shall be d using the procedures and criteria set out in the tender documents and no other criteria shall be used.
  3. The following requirements shall apply respect to the procedures and criteria referred to subsection (2) –
  4. i) The criteria must, to the extent possible, objective and quantifiable; and
  5. ii) Each criterion must be expressed so that applied, in accordance with the procedures taking into consideration price, quality service for the purpose of evaluation.
  6. The successful tender shall be the tender with lowest evaluated price.
  7. The procuring entity shall prepare an evaluation report containing a summary of the evaluation and comparison of tenders.
  8. The evaluation shall be carried out within such period as may be prescribed.

 

 

Notification of Award of Contract.

  1. Before the expiry of the period during which tenders must remain valid, the procuring entity shall notify the person submitting the successful tender that his tender has been accepted.
  2. At the same time as the person submitting the successful tender is notified, the procuring entity shall notify all other persons submitting tenders that their tenders were not successful.
  3. For greater certainty, a notification under subsection (2) does not reduce the validity period for a tender or tender security.

 

Creation of Contract

  1. The person submitting the successful tender and the procuring entity shall enter into a written contract based on the tender documents, the successful tender, any clarifications under section 62 and any corrections under section 63.
  2. The written contract shall be entered into within the period specified in the notification under section 67(l) but not until at least fourteen days have elapsed following the giving of that notification.
  3. No contract is formed between the person submitting the successful tender and the procuring entity until the written contract is entered into

 

Debriefing

It involves explaining to unsuccessful suppliers why they lost their bids.

Benefits of debriefing

  1. It establishes a reputation of being fair, honest, and ethical.
  2. The information provided can help the unsuccessful suppliers to improve in future.
  3. It provides them with some benefits from time and money spent on preparing their tender.

Post – tender negotiations (P.T.N)

It is negotiation after receiving formal tenders but before making contracts with suppliers, so as to obtain improvement in price, delivery etc. However, this should not put other suppliers at a disadvantage. P.T.N is recommended for expensive orders where evidence is not clear and adequate or where doubt exists on quality and performance of supplier. Also applicable in cases of long term contracts.

 

Forecasting Techniques

Hand outs on forecasting

Quantitative techniques

Qualitative techniques

Investment appraisal techniques

  1. Traditional methods (Undiscounted methods)

Basic investment appraisal techniques

What is investment appraisal?

Before committing to high levels of capital spend, companies normally undertake investment appraisal.

Investment appraisal has the following features:

  • assessment of the level of expected returns earned for the level of expenditure made
  • estimates of future costs and benefits over the project’s life.

When a proposed capital project is evaluated, the costs and benefits of the project should be evaluated over its foreseeable life.This is usually the expected useful life of the non-current asset to be purchased, which will be several years. This means that estimates of future costs and benefits call for long-term forecasting.

A ‘typical’ capital project involves an immediate purchase of a non-current asset. The asset is then used for a number of years, during which it is used to increase sales revenue or to achieve savings in operating costs. There will also be running costs for the asset. At the end of the asset’s commercially useful life, it might have a ‘residual value’. For example, it might be sold for scrap or in a second-hand market. (Items such as motor vehicles and printing machines often have a significant residual value.)

A problem with long-term forecasting of revenues, savings and costs is that forecasts can be inaccurate. However, although it is extremely difficult to produce reliable forecasts, every effort should be made to make them as reliable as possible.

  • A business should try to avoid spending money on non-current assets on the basis of wildly optimistic and unrealistic forecasts.
  • The assumptions on which the forecasts are based should be stated clearly. If the assumptions are clear, the forecasts can be assessed for reasonableness the individuals who are asked to authorise the spending.

 

Accounting profits and cash flows

In capital investment appraisal it is more appropriate to evaluate future cash flows than accounting profits, because:

 

  • profits cannot be spent
  • profits are subjective
  • cash is required to pay dividends.

 

 

Return on Capital Employed (ROCE)

ROCE is also known as accounting rate of return (ARR).

Formula

The formula for calculating ROCE is:

The initial capital cost could comprise any or all of the following:

  • cost of new assets bought
  • net book value (NBV) of existing assets to be used in the project
  • investment in working capital
  • capitalised R&D expenditure

Decision rule

The decision rule for ROCE is:

If the expected ROCE for the investment is greater than the target or hurdle rate (as decided management) then the project should be accepted.

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Example using ROCE

A project requires an initial investment of $800,000 and then earns net cash inflows as follows:

In addition, at the end of the seven-year project the assets initially purchased will be sold for $100,000.

Required:

Determine the project’s ROCE using:

(a)initial capital costs

(b)average capital investment.

Solution:

Advantages and disadvantages of ROCE

Advantages of ROCE as an investment appraisal technique include:

  • simplicity
  • links with other accounting measures.

Disadvantages include:

  • no account is taken of project life
  • no account is taken of timing of cash flows
  • it varies depending on accounting policies
  • it may ignore working capital
  • it does not measure absolute gain
  • there is no definitive investment signal.

Payback

The payback period is the time a project will take to pay back the money spent on it. It is based on expected cash flows and provides a measure of liquidity.

Formula

Constant annual cash flows:

Uneven annual cash flows:

Where cash flows are uneven, payback is calculated working out the cumulative cash flow over the life of the project.

Decision rule

When using Payback, the company must first set a target payback period.

  • Select projects which pay back within the specified time period
  • Choose between options on the basis of the fastest payback

Example using Payback

Constant annual cash flows

An expenditure of $2 million is expected to generate net cash inflows of $500,000 each year for the next seven years.

What is the payback period for the project?

Uneven annual cash flows

A project is expected to have the following cash flows:

What is the expected payback period?

Payback is between the end of Year 3 and the end of Year 4. This is the point at which the cumulative cash flow changes from being negative to positive. If we assume a constant rate of cash flow throughout the year, we could estimate that payback will be three years plus ($500/800) of Year 4. This is because the cumulative cash flow is minus $500 at the start of the year and the Year 4 cash flow would be $800. Therefore payback is after 3.625 years.

Advantages and disadvantage of Payback

Advantages include:

  • it is simple
  • it is useful in certain situations:
    • rapidly changing technology
    • improving investment conditions
  • it favours quick return:
    • helps company growth
    • minimises risk
    • maximises liquidity
  • it uses cash flows, not accounting profit.

Disadvantages include:

  • it ignores returns after the payback period
  • it ignores the timings of the cash flows. This can be resolved using the discounted payback period.
  • it is subjective as it gives no definitive investment signal
  • it ignores project profitability

 

  1. Modern methods (Discounted methods)

Hand out

 

 

 

Costing  techniques (lysons kim)

  1. MARGINAL COSTING :

Marginal costing may be defined as the technique of presenting cost data wherein variable costs and fixed costs are shown separately for managerial decision-making. It should be clearly understood that marginal costing is not a method of costing like process costing or job costing. Rather it is simply a method or technique of the analysis of cost information for the guidance of management which tries to find out an effect on profit due to changes in the volume of output.

There are different phrases being used for this technique of costing. In UK, marginal costing is a popular phrase whereas in US, it is known as direct costing and is used in place of marginal costing. Variable costing is another name of marginal costing.

Marginal costing technique has given birth to a very useful concept of contribution where contribution is given by: Sales revenue less variable cost (marginal cost)

Contribution may be defined as the profit before the recovery of fixed costs. Thus, contribution goes toward the recovery of fixed cost and profit, and is equal to fixed cost plus profit (C = F + P).

In case a firm neither makes profit nor suffers loss, contribution will be just equal to fixed cost (C = F). this is known as break even point.

The concept of contribution is very useful in marginal costing. It has a fixed relation with sales. The proportion of contribution to sales is known as P/V ratio which remains the same under given conditions of production and sales.

The principles of marginal costing

The principles of marginal costing are as follows.

  1. For any given period of time, fixed costs will be the same,
  2. for any volume of sales and production (provided that the level of activity is within the ‘relevant range’). Therefore, selling an extra item of product or service the following will happen.
  • Revenue will increase the sales value of the item sold.
  • Costs will increase the variable cost per unit.
  • Profit will increase the amount of contribution earned from the extra item.
  1. Similarly, if the volume of sales falls one item, the profit will fall the amount of contribution earned from the item.
  2. Profit measurement should therefore be based on an analysis of total contribution. Since fixed costs relate to a period of time, and do not change with increases or decreases in sales volume, it is misleading to charge units of sale with a share of fixed costs.
  3. When a unit of product is made, the extra costs incurred in its manufacture are the variable production costs. Fixed costs are unaffected, and no extra fixed costs are incurred when output is increased.

Features of Marginal Costing

The main features of marginal costing are as follows:

  1. Cost Classification
    The marginal costing technique makes a sharp distinction between variable costs and fixed costs. It is the variable cost on the basis of which production and sales policies are designed a firm following the marginal costing technique.
  2. Stock/Inventory Valuation
    Under marginal costing, inventory/stock for profit measurement is valued at marginal cost. It is in sharp contrast to the total unit cost under absorption costing method.
  3. Marginal Contribution
    Marginal costing technique makes use of marginal contribution for marking various decisions. Marginal contribution is the difference between sales and marginal cost. It forms the basis for judging the profitability of different products or departments.

Advantages and Disadvantages of Marginal Costing Technique Advantages

  1. Marginal costing is simple to understand.
  2. By not charging fixed overhead to cost of production, the effect of varying charges per unit is avoided.
  3. It prevents the illogical carry forward in stock valuation of some proportion of current year’s fixed overhead.
  4. The effects of alternative sales or production policies can be more readily available and assessed, and decisions taken would yield the maximum return to business.
  5. It eliminates large balances left in overhead control accounts which indicate the difficulty of ascertaining an accurate overhead recovery rate.
  6. Practical cost control is greatly facilitated. By avoiding arbitrary allocation of fixed overhead, efforts can be concentrated on maintaining a uniform and consistent marginal cost. It is useful to various levels of management.
  7. It helps in short-term profit planning breakeven and profitability analysis, both in terms of quantity and graphs. Comparative profitability and performance between two or more products and divisions can easily be assessed and brought to the notice of management for decision making.

Disadvantages

  1. The separation of costs into fixed and variable is difficult and sometimes gives misleading results.
  2. Normal costing systems also apply overhead under normal operating volume and this shows that no advantage is gained marginal costing.
  3. Under marginal costing, stocks and work in progress are understated. The exclusion of fixed costs from inventories affect profit, and true and fair view of financial affairs of an organization may not be clearly transparent.
  4. Volume variance in standard costing also discloses the effect of fluctuating output on fixed overhead. Marginal cost data becomes unrealistic in case of highly fluctuating levels of production, e.g., in case of seasonal factories.
  5. Application of fixed overhead depends on estimates and not on the actuals and as such there may be under or over absorption of the same.
  6. Control affected means of budgetary control is also accepted many. In order to know the net profit, we should not be satisfied with contribution and hence, fixed overhead is also a valuable item. A system which ignores fixed costs is less effective since a major portion of fixed cost is not taken care of under marginal costing.
  7. In practice, sales price, fixed cost and variable cost per unit may vary. Thus, the assumptions underlying the theory of marginal costing sometimes becomes unrealistic. For long term profit planning, absorption costing is the only answer.

 

  1. STANDARD COSTING

Standard costing is a key element of performance management with a particular emphasis on budgeting and variance analysis.

The uses of standard costs

The main purposes of standard costs are:

  1. control: the standard cost can be compared to the actual costs and any differences investigated.
  2. performance measurement: any differences between the standard and the actual cost can be used as a basis for assessing the performance of cost centre managers.
  3. variances: as well as being the basis for preparing budgets, standard costs are also essential for calculating and analysing variances. Variances provide ‘feedback’ to management indicating how well, or otherwise, the company is doing.
  4. to value inventories: an alternative to methods such as LIFO and FIFO.
  5. to simplify accounting: there is only one cost, the standard.

 

Types of standard

There are four main types of standard:

  1. Attainable standards
  • They are based upon efficient (but not perfect) operating conditions.
  • The standard will include allowances for normal material losses, realistic allowances for fatigue, machine breakdowns, etc.
  • These are the most frequently encountered type of standard.
  • These standards may motivate employees to work harder since they provide a realistic but challenging target.
  1. Basic standards
  • These are long-term standards which remain unchanged over a period of years.
  • Their sole use is to show trends over time for such items as material prices, labour rates and efficiency and the effect of changing methods.
  • They cannot be used to highlight current efficiency.
  • These standards may demotivate employees if, over time, they become too easy to achieve and, as a result, employees may feel bored and unchallenged.
  1. Current standards
  • These are standards based on current working conditions.
  • They are useful when current conditions are abnormal and any other standard would provide meaningless information.
  • The disadvantage is that they do not attempt to motivate employees to improve upon current working conditions and, as a result, employees may feel unchallenged.
  1. Ideal standards
  • These are based upon perfect operating conditions.
  • This means that there is no wastage or scrap, no breakdowns, no stoppages or idle time; in short, no inefficiencies.
  • In their search for perfect quality, Japanese companies use ideal standards for pinpointing areas where close examination may result in large cost savings.
  • Ideal standards may have an adverse motivational impact since employees may feel that the standard is impossible to achieve

 

  1. ABSORPTION

What is absorption costing?

Absorption costing means that all of the manufacturing costs are absorbed the units produced. In other words, the cost of a finished unit in inventory will include direct materials, direct labor, and both variable and fixed manufacturing overhead. As a result, absorption costing is also referred to as full costing or the full absorption method.
Absorption costing is often contrasted with variable costing or direct costing. Under variable or direct costing, the fixed manufacturing overhead costs are not allocated or assigned to (not absorbed by) the products manufactured. Variable costing is often useful for management’s decision-making. However, absorption costing is required for external financial reporting and for income tax reporting. Each job while moving through the production department should get its share of overhead. This process of distribution of overheads is called absorption. There can be a number of methods of absorption of overheads, consideration should be given to the type of industry, manufacturing process, nature of industry etc.

The various methods of absorption are

  1. Direct material cost percentage rate
  2. Direct labour cost percentage rate
  3. Prime cost percentage rate
  4. Labour hour rate
  5. Machine hour rate

 

  1. LIFECYCLE COSTING

Rather than simply looking at a product’s costs for one period, lifecycle costing seeks to understand costs over the whole lifecycle.

Product lifecycles

Most products have a distinct product life-cycle:

Specific costs may be associated with each stage.

(1) Pre-production/Product development stage

  • A high level of setup costs will be incurred in this stage (preproduction costs), including research and development (R&D), product design and building of production facilities.

(2) Launch/Market development stage

  • Success depends upon awareness and trial of the product consumers, so this stage is likely to be accompanied extensive marketing and promotion costs.

(3) Growth stage

  • Marketing and promotion will continue through this stage.
  • In this stage sales volume increases dramatically, and unit costs fall as fixed costs are recovered over greater volumes.

(4) Maturity stage

  • Initially profits will continue to increase, as initial setup and fixed costs are recovered.
  • Marketing and distribution economies are achieved.
  • However, price competition and product differentiation will start to erode profitability as firms compete for the limited new customers remaining

(5) Decline stage

  • Marketing costs are usually cut as the product is phased out
  • Production economies may be lost as volumes fall
  • Meanwhile, a replacement product will need to have been developed, incurring new levels of R&D and other product setup costs.
  • Alternatively additional development costs may be incurred to refine the model to extend the life-cycle (this is typical with cars where ‘product evolution’ is the norm rather than ‘product revolution’).

Managing Lifecycle Costs

A product’s costs are not evenly spread through its life.

According to Berliner and Brimson (1988), companies operating in an advanced manufacturing environment are finding that about 90% of a product’s lifecycle costs are determined decisions made early in the cycle. In many industries, a large fraction of the life-cycle costs consists of costs incurred on product design, prototyping, programming, process design and equipment acquisition.

This had created a need to ensure that the tightest controls are at the design stage, i.e. before a launch, because most costs are committed, or ‘locked-in’, at this point in time.

Management Accounting systems should therefore be developed that aid the planning and control of product lifecycle costs and monitor spending and commitments at the early stages of a product’s life cycle.

 

  1. Target Costing

Target costing is a way of deriving a target cost to set production managers and is best viewed as the opposite of cost-plus pricing.

Problems with cost-plus pricing

In a traditional cost-plus pricing system,

  • The cost of the item is established first.
  • A profit per unit is added.
  • This results in the selling price.

 

However, cost-­plus pricing ignores the following:

  • The price that customers are willing to pay ­
  • The price charged competitors for similar products ­
  • Cost control

Target costing

A firm could address the problems discussed above through the implementation of target costing:

(1) The first step is to establish a competitive market price. The company would consider how much customers are willing to pay and how much competitors are charging for similar products.

 

(2) Determine the required profit

 

(3) A target cost is arrived at deducting the required profit from the selling price

 

(4) Steps must then be taken to close the target cost gap from the current cost per unit if higher.

 

Model and simulation approaches

  1. Modeling
  2. Simulation

Xxxx

1a) Define simulation

Simulation is the process of experimenting or using a model and noting the results which occur. In business context the process of experimenting with model usually consist of inserting different input values and observing the resulting output values. For example, in a simulation of queuing situation the input values might be the number of arrivals and/or service points and the output values might be the number and/or times in the queue.

  1. Advantages of simulation
  2. Can be applied in areas where analytical techniques are not available or would be too complex
  3. Constructing the model inevitably must involve management and this may enable deeper insight into a problem.
  • A well constructed model does enable the results of various policies and decisions be examined without any irreversible commitment being made.
  1. Simulation is cheaper and less risky than altering the real system.
  2. Study the behavior of a system without building it.
  3. Results are accurate in general, compared to analytical model.
  • Help to find un-expected phenomenon, behavior of the system.
  • Easy to perform “What-If” analysis

Disadvantages of simulation

  1. Although all models are simplifications of reality, they may still be complex and require a substantial amount of managerial and technical time.
  2. Practical simulation inevitably requires the use of computers thus considerable amount of additional expertise is required to obtain worthwhile results from simulation exercise. This expertise is not always available
  • Simulation do not produce optimal results
  1. Expensive to build a simulation model.
  2. Expensive to conduct simulation.
  3. Sometimes it is difficult to interpret the simulation results.
  4. Explain Monte- Carlo method of simulation pointing out its uses in operations research.

This involve  a broad class of computational algorithms that rely on repeated random sampling to obtain numerical results i.e. running simulations many times over in order to calculate those same probabilities heuristically just like actually playing and recording your results in a real casino situation: hence the name. They are often used in physical and mathematical problems and are most suited to be applied when it is impossible to obtain a closed-form expression or infeasible to apply a deterministic algorithm.

Monte Carlo methods are mainly used in three distinct problems: optimization, numerical integration and generation of samples from a probability distribution. Monte Carlo methods are especially useful for simulating systems with many coupled degrees of freedom, disordered materials, strongly coupled solids, and cellular structures. They are used to model phenomena with significant uncertainty in inputs, such as the calculation of risk in business. They are widely used in mathematics, for example to evaluate multidimensional definite integrals with complicated boundary conditions. When Monte Carlo simulations have been applied in space exploration and oil exploration, their predictions of failures, cost overruns and schedule overruns are routinely better than human intuition or alternative “soft” methods.

 

TOPIC 8 

NEGOTIATION

Meaning of negotiation

Negotiation:

Definition: This is the process wheretwo or more parties decide what each will give and take in an exchange between them. Negotiation can also be defined as any form of verbal communication in which the participants seek to exploit their relative competitive advantages and needs to achieve explicit objectives within the overall purpose of seeking to resolve problems which are barriers to agreement.

Importance of negotiation:

  1. Certainty

The aim of contract negotiation is firstly to achieve certainty, to record what is being supplied, when, in what quantities and to what standard, and what are the consequences of delay or failure to meet the agreed requirements. Many disputes are caused the failure of the parties to define at the beginning of their relationship exactly what is going to happen in case of a dispute.

  1. The best deal

Seeking clarity does not conflict with the view that negotiations should achieve the best deal, it merely points out that both parties to a negotiation have to understand what it is that they have agreed to. Many disputes have their origins in a lack of clarity. Careful discussions of each element of the deal also ensure that each party’s objectives are acknowledged and dealt with. Negotiators should aim for a win-win solution which benefits both parties.

  1. Achievement of an Organization’s objectives

The goal of every negotiation must be to achieve a result which, even if it falls short of the original objective can be considered a satisfactory advancement towards it. Compromise is an essential feature of most successful negotiations: each party needs to walk away afterwards feeling that he or she has gained. Although most people, when asked, will say that money is the most important element in negotiation in practice it may be only one of a number  of elements. In most markets, quality, reliability of supply, the transform of “know-how” and the creation of a long-term relationship will be of equal or greater importance.

  1. Creation of a long-term relationship between the parties

Whilst this is not always possible, and some cultures, such as the Japanese, place more emphasis on this aspect of negotiation this is increasingly important as companies build networks of alliance partners. Partnering in industries like aerospace and IT is essential, due to the complexity of the products and related projects. As the supply chain evolves into a virtual organization partnering is becoming increasingly important in all industries.

Other objectives of negotiation:

  1. To exert some control over the manner in which the contract is performed
  2. To persuade the supplier to give maximum cooperation to the buyer’s company
  3. To develop a sound and continuing relationship with competent suppliers: Buyers must maintain a proper balance between their concern for a supplier’s immediate interest and long-run performance.
  4. To obtain a fair and reasonable price.

 

Approaches/ Strategies of Negotiation:

Approaches to negotiation may be classified as adversarial and partnership

  1. Adversarial negotiation:

Also referred   to as distributive or win-lose negotiation, is an approach in which the focus is on ‘positions’ staked out the participants in which the assumption is that every time one party wins the other loses. As a result the other party is regarded as an adversary.

The characteristics of adversarial negotiation entail:

  1. Parties have competing goals
  2. Involves use of threats
  3. In case of deadlock, negotiation is terminated
  4. The approach is rigid
  5. The attitude is that of we must win, they must lose.

 

  1. Partnership negotiation:

Also referred to as integrative or win-win negotiation, is an approach in which the focus is on the merits of the issues identified the participants in which the assumption is that through creative problem solving one or both parties can gain without the other having to lose. Since the other party is regarded as a partner rather than an adversary the participants may be more willing to share concerns, ideas and expectations.

The characteristics of partnership negotiation entail:

  1. Common goals emphasized upon.
  2. Negotiation is friendly and based on openness
  3. In case of a deadlock, negotiation results to further problem solving
  4. The approach is flexible
  5. The attitude is we both must win.

 

Styles to negotiation:

Negotiation styles vary with the person, their beliefs and skills, as well as the general context in which they occur. Here are a number of different styles considered from different viewpoints.

  1. Belief-based styles:

There is a common spectrum of negotiation that ranges from collaborative to competitive. The approach taken is generally based on:

  1. The spectrum of negotiation styles from concession to competition.
  2. Collaborative negotiation: Negotiating for win-win.
  • Competitive negotiation Negotiating for win-lose.
  1. Balanced negotiation walking between collaborative and competitive.
  2. Professional styles:

Professional styles are those used people who have a significant element of negotiation in their roles. Here is a selection of different contexts in which such negotiation takes place.

  1. Industrial relations: Confrontational bargaining.
  2. Managing board: Together and competing.
  • International: Diplomatic dancing.
  1. Political: Scheming horse-trading.
  2. Selling and buying: Professional sellers and buyers.
  3. Hostage: Emotional big-stakes exchanges.
  4. Contextual styles:

Negotiation often happens within non-professional contexts, where the people either do not know that they are negotiating or they are not skilled at it.

  1. Domestic: Discussions and arguments at home.
  2. Every day: Everybody, every day, negotiates.

Although negotiation styles can be classified as competitive or collaborative, in practice there are a ran ge of styles, based on the degree to which a person thinks about them self or thinks about the other person.

  1. Consideration for self:

Considering yourself in negotiation is natural and reasonable — after all, the main point is to get something that you want. In particular, if you care little about the other person or the relationship, then you will prioritize your needs actions above those of others.

Excessive consideration for self leads to a Machiavellian approach, where the end justifies the means. Overt aggression, intimidation and coercive deception are considered normal and necessary and destroying the other person in some way may be a symbol of your victory over them.

  1. Consideration for others

Consideration for others will depend on your values, which are often based on your beliefs about people. In particular, if you put yourself down (for example if you have low self-esteem) or you escalate the importance of others too highly, then you will think considerably more about the other person and prioritize their needs well above your own.

Excessive consideration for others leads to relentless concession, where you create a lose-win situation with you as the loser. You may even lose elements of the relationship as giving away too much can just end up in you losing respect. Some people like being the victim, but it is no way to conduct a negotiation.

  1. A middle way

Between concession and competition lies balance, although in practice this may be more dynamic and variable than may be expected. Thus, what should be a highly collaborative negotiation may become a balanced negotiation even with competitive elements. Shared values are commonly used, however, to protect the relationship and ensure fair play. At worst, some third  person is called in to ensure a reasonable balance.

Ploys of Negotiation:

A ploy is defined in the Oxford English Dictionary as ‘a cunning act performed to gain an advantage’.  A  ploy can also be defined a manoeuvre in a negotiation aimed at achieving a particular result. A number of standard ploys are often used in commercial negotiations. They are worth knowing about – you may not wish to use such tactics yourself but you will certainly wish to know you’re your opponent is using a ploy against you.

 

Here are some of the more common ploys:

 

  1. The bogey: This is a buyer’s ploy. The buyer assures the seller that he or she loves the product but has a very limited budget, so that in order for a sale to occur the seller must reduce the price.

The idea is to test the credibility of the seller’s price. The seller might react positively revealing information about costing, so that you can force the price downwards. It may also provoke the seller to look at your real needs.

  1. Minimum order ploy:

This is a ploy used the seller wherethe seller maximises the value of the order placing restrictions or conditions on the order the buyer has placed.

  1. Over and under ploy:

This ploy is a handy response to a demand made your opponent. For example, your opponent might demand that you reduce your price 5% if they pay your invoice within seven days. You could respond with an ‘over and under’: ‘if you agree to a 5% premium for late payment’.

  1. Quivering quill:

This is a ploy used buyers in which the buyer demands concessions at the very point of closing the deal. At this point, the buyer is about to sign the contract and suddenly demands, for example, 3% off the purchase price. When the seller expresses unwillingness to agree, the buyer threatens not to sign the contract. A typical result is that the seller is pressured into giving a 1.5% reduction on the purchase price.

  1. Shock opening:

This is a negotiation ploy designed to pressure the opponent. The other negotiator starts with a price that is much higher than you expected. If they back up their opening price with a credible reason for it, one has to review his/her expectations.

 

 

Negotiation Cycle

This shows the cyclical nature of events in the process of negotiation ie Get the facts, determine the bargaining strengths, set objectives, plan strategies/tactics, negotiate and review performance.

 

Phases/Stages  of Negotiation:

Negotiation falls into three distinct phases: pre-negotiation, the actual negotiation and post-negotiation.

  1. Pre-negotiation: In this phase the matters to be determined are as follows:

Who is to negotiate, what is to be negotiated, determination of venue, gathering intelligence and most importantly tactic and strategy.

 

  1. The actual negotiation (meeting phase):
  2. Stage one: Introductions, agreement of an agenda and rules of procedure

The major aim of this stage is to establish atmosphere conducive to agreement. This may include an impression of wishing to work to a mutually advantageous goal, the physical arrangement of venue, restating areas of agreement and so on.

  1. Stage two: Ascertaining the negotiation range: This is the start of the debate stage where the issues which the negotiation will attempt to resolve are ascertained. With adversarial negotiations this may be a lengthy stage since the participants often overstates their opening positions. However with partnership negotiation, there is more openness that saves time.
  • Stage three: Agreement of common goals which must be met if the negotiation is to reach a successful outcome: This will usually require some movement of both sides from the original negotiating range but the movement will be less or unnecessary in partnership negotiations.
  1. Identification of and, when possible, removal of barriers that prevent attainment of agreed common goals: At this stage there will be:
  • Problem solving
  • Consideration of solutions put forward each party
  • Discertainment of what concessions can be made

It may be useful to: review what has been agreed, allow recess for each side to reconsider

Its position and make proposals or concessions which may enable further progress to be made.

If no progress can be made it may be decided to:

  • Refer the issue back to higher management
  • Change the negotiators
  • Abandon the negotiations with the least possible damage to relationships
  1. Agreement and closure: Drafting of a statement setting out as clearly as possible the agreement(s) reached and circulating it to all parties for comment and signature.
  2. Post-negotiation:

Post-negotiation involves the following activities:

  • Drafting a statement detailing as clearly as possible the agreements reached and circulating it to all parties for comment and signature
  • Selling the agreement to the constituents of both parties i.e. what has been agreed, why it is the best possible agreement, what benefits will accrue.
  • Implementing the agreements, e.g. planning contracts, setting up joint implementation teams, etc
  • Establishing procedures for monitoring the implementation of the agreements and dealing with any problems that may arise.

 

Composition of effective negotiation team.

  1. User department
  2. Accounting officer
  3. head of procurement and staff
  4. Sales department

 

Qualities  of a good  negotiator.

  1. Communication skills
  2. Planner
  3. Listener
  4. Market intelligence
  5. Good understanding on the act

 

 TOPIC 9 

ETHICS AND INTEGRITY IN PURCHASING.

Topic 4 : Ethical Issues in Purchasing

Ethical Definition: 

Ethics(also known as moral philosophy) is a branch of philosophy which seeks to address questions about morality; that is, about concepts such as good and bad, right and wrong, justice, and virtue. Ethics can also be defined as rules or standards governing the conduct of a person or the members of a profession e.g. procurement function.

Integrity Definition: 

Integrity is the quality of being honest and having strong moral principles or moral uprightness. It is regarded as the honesty and truthfulness or accuracy of ones actions.

Importance of ethical buying to an organization: 

  1. High profitability
  2. Value for money
  3. Public confidence
  4. Cultivating ethical culture
  5. Saving costs
  6. Cultivate better Buyer supplier relationship
  7. Conformance  to KISM , PUBLIC officer code of ethics codes and PPADA 2015

CAUSES OF UNETHICAL PRACTISES

  1. Culture
  2. Motivation
  3. Complexity of systems
  4. Collusion
  5. Role models

Principles of Professional Ethics

Individuals acting in a professional capacity take on an additional burden of ethical responsibility. For example, professional associations have codes of ethics that prescribe required behaviour within the context of a professional practice such as procurement, medicine, law, accounting, or engineering.

 

 

These written codes provide rules of conduct and standards of behaviour based on the principles of Professional Ethics which include:

1.      Impartiality; objectivity
2.      Openness; full disclosure
3.      Confidentiality
4.      Due diligence / duty of care
5.      Fidelity to professional responsibilities
 

 

 

6.      Avoiding potential or apparent conflict of interest

7.      Business gifts

8.      Hospitality

9.      Fair competition

 

 

Ethical standards:

The Code of Ethics and standard of Professional Conduct are the ethical cornerstone of many companies across the globe. They are essential to company’s mission to lead the global investment profession and critical to maintaining the public’s trust in the financial markets.

The procurement ethical standards are:

  1. all business must be conducted in the best interests of the State, avoiding any situation which may impinge, or might be deemed to impinge, on impartiality;
  2. public money must be spent efficiently and effectively and in accordance with Government policies;
  3. Agencies must purchase without favour or prejudice and maximise value in all transactions;
  4. agencies must maintain confidentiality in all dealings; and
  5. Government buyers involved in procurement must decline gifts, gratuities, or any other benefits which may influence, or might be deemed to influence, equity or impartiality.
  1. Dealing with suppliers ethically
  2. Develop open, transparent and direct long-term stable relationships with suppliers rather than relying on ‘arms length’ contracting and licensing agreements.
  3. Avoid the attraction of searching for the cheapest labour and goods at the expense of social and environmental responsibility.
  4. Avoid frequently changing suppliers- this undermines their commitment to long term progress on labour standards.
  5. Develop a reasonable and agreed time frame for suppliers to meet standards as specified in the company’s ethical purchasing strategy or code.
  6. Avoid ‘cutting and running’ from high risk suppliers-engage suppliers to improve conditions on an incremental basis.

 

D Code of Ethics and Conduct as per the Kenya Institute of Supplies Management  (KISM)

Content sourced from Kenya Institute of Supplies Management

DEFINITIONS

Ethics:
Guidelines or rules of conduct that govern our lives, work, behavior and communication in both public and private undertaking

Conduct:
The way we carry ourselves, behave in the public eye, do things, respond to situations, give instructions, obey rules and think of or perceive the needs of the other human beings

Code:
A body of rules of conduct which people with common interest, aspirations, objectives, goals, duties, activities and responsibilities have to adhere to all the time so long as they continue to remain in the profession, group or trade

The need for a code of ethics and conduct
A code of conduct is necessary for the following reasons:

  1. Our society, employers, peers and workmates are genuinely concerned about our individual and organizational ethical behavior
  2. Our work performance and standards can only be of manifestly acceptable quality and appreciable level if good rules of ethical conduct are not only obeyed but also seen in practice
  3. Discipline can only be instilled in our behavior through a codified procedure. The surest way of disciplining errant members of a group is through a code of rules and conduct
  4. A group of profession can only stand the test of time, defend itself and spread its influence if its members are ethically upright and steadfast in doing the right things, at the right time, in the right place, in the right way and at the right level of performance
  5. The overall need for a code of conduct is that it will bring respect to, enhance recognition for, uphold discipline and harmony within the profession

Principles of ethical behavior
In carrying out their duties and responsibilities appertaining to work and the profession, members of KISM shall:

  1. Be loyal to the employing organization (i.e. the employer)
  2. Do justice to those with whom they deal with and interact
  3. Be faithful to their profession
  4. Abstain from temptations and acts that are harmful to themselves and members of the society or community
  5. Do the right thing at the right time, in the right place, in the right way and at the right level of performance

 

  1. ROLES OF EACC IN KENYA.

Vision

A Corruption free Kenyan Society that upholds integrity and rule of law.

Mission

To promote integrity and combat corruption through law enforcement, prevention and education.

Core Values

  • Integrity
  • Professionalism
  • Fidelity to the Law
  • Courage
  • Teamwork
  • Innovation

Mandate

To combat and prevent corruption and economic crime in Kenya through law enforcement, preventive measures, public education and promotion of standards and practices of integrity, ethics and anti-corruption.

About the Commission

The EACC is a public body established under Section 3 (1) of the Ethics and Anti-Corruption Commission Act, 2011.

As per Section 4 of the Act: The Commission shall consist of a chairperson and two other members appointed according to the provisions of the Constitution and this Act.

Section 16 (1) of the Act states that: The Commission shall, through an open, competitive and transparent process, and with the approval of the National Assembly, appoint a suitably qualified person to be the Secretary of the Commission.

 

Statutory Functions

13 (1) The Commission shall have all powers generally necessary for the execution of its functions under the Constitution, this Act, and any other written law.

(2) Without prejudice to the generality of subsection (1), the Commission shall have the power to –

  1. Educate and create awareness on any matter within the Commission’s mandate;
  2. Undertake preventive measures against unethical and corrupt practices;
  3. Conduct investigations on its own initiative or on a complaint made any person, and,
  4. Conduct mediation, conciliation and negotiation.

 

What you could do to help fight corruption?

Report all forms of corruption to the Ethics and Anti-Corruption Commission (EACC) or other Law Enforcement Agencies.

You could report corruption to us:

    • In person at our offices
    • By writing to us a letter or an email
    • By telephone or fax
    • By use of drop-in corruption reporting boxes
    • By use of any other method convenient to you.
    • Anonymously

All information given to the Commission will be treated with utmost confidentiality

  1. PUBLIC OFFICERS CODE OF ETHICS (P.O.C.E)

A public officer shall-

  1. Carry out his duties in a way that maintains public confidence in the integrity of his office;
  2. Treat the public and fellow public officers with courtesy and respect;
  3. To the extent appropriate to his office, seek to improve the standards of performance and level of professionalism in his organisation;
  4. If a member of a professional body, observe the ethical and professional requirements of that body; Publication of specific Codes.
  5. Observe official working hours and not be absent without proper authorization or reasonable cause;
  6. Maintain an appropriate standard of dress and personal hygiene; and
  7. Discharge any professional responsibilities in a professional

Methods of Eradicating Unethical practices

  1. Capacity building
  2. Punitive measures including investigating and arrests
  3. Lifestyle audit
  4. Wealth declaration
  5. Frequent vetting of both procurement and accounting officers
  6. Market research on prevailing prices, specifications
  7. Strictly following PPADA 2015
  8. Due diligence on prospecting bidders
  9. Strict internal and external audits.
  • Recognize that managing ethics is a process: Ethics is a matter of values and associated behaviours. Values are discerned through the process of ongoing reflection. Therefore, ethics programs may seem more process-oriented than most management practices. Managers tend to be sceptical of process-oriented activities, and instead prefer processes focused on deliverables with measurements. However, experienced managers realize that the deliverables of standard management practices (planning, organizing, motivating, controlling) are only tangible representations of very process-oriented practices. For example, the process of strategic planning is much more important than the plan produced the process. The same is true for ethics management. Ethics programs do produce deliverables, e.g., codes, policies and procedures, budget items, meeting minutes, authorization forms, newsletters, etc. However, the most important aspect from an ethics management program is the process of reflection and dialogue that produces these deliverables.
  • The bottom line of an ethics program is accomplishing preferred behaviours in the workplace.
    As with any management practice, the most important outcome is behaviours preferred the organization. The best of ethical values and intentions are relatively meaningless unless they generate fair and just behaviours in the workplace. That’s why practices that generate lists of ethical values, or codes of ethics, must also generate policies, procedures and training that translate those values to appropriate behaviours.
  • The best way to handle ethical dilemmas is to avoid their occurrence in the first place.
    That’s why practices such as developing codes of ethics and codes of conduct are so important. Their development sensitizes employees to ethical considerations and minimizes the chances of unethical behaviour occurring in the first place.
  • Make ethics decisions in groups, and make decisions public, as appropriate.
    This usually produce s better quality decisions including diverse interests and perspectives, and increases the credibility of the decision process and outcome reducing suspicion of unfair bias.
  • Integrate ethics management with other management practices.
    When developing the values statement during strategic planning, include ethical values preferred in the workplace. When developing personnel policies, reflect on what ethical values you’d like to be most prominent in the organization’s culture and then design policies to produce these behaviours.
  • Use cross-functional teams when developing and implementing the ethics management program.
    It’s vital that the organization’s employees feel a sense of participation and ownership in the program if they are to adhere to its ethical values. Therefore, include employees in developing and operating the program.

 

 TOPIC 9 

ETHICS AND INTEGRITY IN PURCHASING.

Meaning of integrity

 

Importance of ethics

KISM Code of Ethics

Role of EACC in public procurement

Public officers code of ethics

Causes of unethical practices

Measures of eradicating

Do’s and don’t the officers

 

A voluntary, deliberate, and legally binding agreement between two or more competent parties. Contracts are usually written but may be spoken or implied, and generally have to do with employment, sale or lease, or tenancy.

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