Measuring Purchasing Performance - Optimized Supply Chain Impact
A purchase price reduction can allow companies to win business
Measuring purchasing performance is important, as the purchasing department plays an ever increasingly important role in the supply chain in an economic downturn.
A reduction in the cost of raw material and services can allow companies to competitively market the price of their finished goods in order to win business. An obvious performance measure of the success of any purchasing department is the amount of money saved by the company.
However, there are a number of performance measurements that businesses can use when they measure purchasing performance. These include:
- Purchasing Efficiency
- Purchasing Effectiveness
- Purchasing Functionality
- Performance Measurements
Administrative costs are the basis for measuring purchasing efficiency. This performance measurement does not relate to the amount of purchased items that the department has procured.
The measurement relates to how well the purchasing department is performing in the activities they are expected to perform against the budget that is in place for the department.
If the purchasing costs are within the budget then the efficiency of the purchasing department will exceed expectations. If the department is using funds over and above the budget then the purchasing function is not efficient.
The price that the purchasing department paid for an item is not necessarily a good measurement of purchasing performance.
The price of an item may fluctuate due to market conditions, its availability, and other demand pressures. Therefore, the purchasing department may not be able to control the price. A popular method of assessing purchasing effectiveness is to review the inventory turnover ratios. The ratio measures the number of times, on average that the inventory is used, or turned, during the period.
The ratio used to measure the liquidity of the inventory. However, this is not always a great measure of purchasing effectiveness as seasonal requirements for having items in stock can make this measurement inaccurate.
Purchasing performance can be measured against the functional requirements of the purchasing function.
The primary function of the department is to provide the correct item at the required time at the lowest possible cost. The performance measurement can take into account these elements, but it does not take into account factors that may relate to the supplier stability, material quality issues, and supplier discounts.
The performance of the purchasing function can be measured using a variety of measurements.
A company can decide which of these measurements of effectiveness are relevant to the performance of their purchasing department. The measurements can include:
- Cost Savings. If the purchasing department procures an item at a lower price than they did previously, then it is a cost saving. This can occur when a new supplier is found, a less costly substitute item is used, a new contract has been signed with the vendor, a cheaper transportation method has been found, or the purchasing department has negotiated a lower price with the existing supplier.
- Increased Quality. When an item has improved quality either by using a different supplier or by negotiating with the existing supplier, the improvement will be reflected in a reduction of waste or production resources.
- Purchasing Improvements. Efficiencies in the method used in the purchasing department will increase effectiveness. These can include the introduction of EDI, e-procurement systems, vendor managed inventory and pay on receipt processes.
- Transportation Improvements. When a purchasing department negotiates with a carrier or number of carriers to reduce the cost of transporting items from the vendor to the production facilities, the unit cost of the item will be reduced. This cost saving can be used as a measurement of effectiveness.
A number of studies have been carried out on purchasing performance and the results have noted that there is no one method that will cover every purchasing department.
However, there are a number of key measures that are found to be common in evaluating performance. Namely, cost saving, vendor quality, delivery metrics, price effectiveness, and inventory flow.
Although these key measures are common, the weight placed on these measures is by no means uniform and will vary between industries and businesses. In addition, the importance of these measures to the overall effectiveness of a purchasing department will change over time and therefore need to be assessed and modified on a periodic basis.
Updated by Gary Marion, Logistics and Supply Chain Expert.