The concept and forms of

Value addition in
procurement

J.NGERA,MCIPS
Introduction: What is added value?
• Value is the worth of a product or service. i.e. What the
customer is willing to pay compared to the cost to produce.
• A firm creates value by performing activities better, differently
or more efficiently than its competitors. A customer on the
other hand purchases value by comparing firm’s products and
services with those of its competitors.

• Added value refers to the addition of greater value or worth to

a product or service as a result of all processes that support its
production and delivery to the customer i.e. marketing, design,
production, customer service, distribution, maintenance etc.
Organization value
• Ultimate value is measured by the amount customer is willing
to pay for its products and services over and above the cost to
the firm of carrying out all its value creating activities. A firm
is profitable if the realized value to customers exceeds the
cost of value creation.
• Value = Total revenue – total costs
• Organization therefore adds value by:
• Inducing customers to pay more through quality processes
• Reducing cost or increasing the efficiency of processes
• The main focus for procurement is value addition through
cutting costs and or securing operational efficiency
The value chain

• Sequence of business
activities by which
value is added to the
products or services
produced by an
organization.
Primary value activities
• Inbound logistics: Receiving, storing, disseminating inputs, material handling,
warehousing, inventory control

• Operations: Transformation i.e assembly, testing, packing, maintenance etc.

• Outbound logistics: storing, distribution, delivery, warehousing, product handling,

transport planning, order processing etc

• Marketing and sales: marketing research, new product development,

advertisement, sales force management, channels management, pricing etc.

• Service: activities to enhance or maintain value e.g. Installation, repair, training,

parts supply and maintenance.
Secondary value activities
• Firm infrastructure: systems and assets for planning, finance,
quality control and management, organization structure
• Human resources: Recruiting, deploying, retaining and
developing people in the organization
• Technology development: equipment, systems and methods of
work: product design, production processes and resource
utilization.
• Procurement: all activities undertaken to acquire inputs for
primary activities.
The value system

• The wider value chain extended through supply chain is

known as a value system or value network
Concept of waste
• Value network are sequences of activities that successively
add value to organizational resources as they flow towards
customer. However not all activities add value; some activities
just add cost without adding value to eyes of the customer.
• Activities that add cost without adding value are known as
wastes. They contribute nothing to the flow of value and
therefore they should be minimized or eliminated throughout
the supply chain.
Contribution of purchasing to value
addition
1. Reducing costs
2. Improving quality
3. Reduce inventory quantities
4. Efficient and effective logistics strategies
5. Strategic collaborations
Cost reduction strategies

• Cost strategies involve knowing what the costs really

are and looking at how to reduce them. This is
achieved through cost analysis, whole life costing and
then positioning to look at eliminating waste,
negotiating on price etc.
Contribution of procurement to cost reduction
• Restructuring to minimize labour and overhead costs and maximize efficiency
• Centralizing or decentralizing purchasing
• Developing supplier relationship for cost and price advantages
• Applying ICT and automation technologies to streamline processes
• Working with key supply chain partners to develop lean supply and production
• Collaborating with supply chain partners on cost reduction programs
• Reducing transaction and administrative costs
• Managing cash flow
• Sourcing from low cost countries
• Outsourcing of non core activities
• Improving specifications
• Using value analysis and value engineering to eliminate waste
• Selecting and managing suppliers
• Risk management
Improving quality
• Improved quality adds economic value by allowing the
organization to charge premium prices. SC has a crucial role in
maintaining and assuring quality.
• Quality must be built into the product. It is the buyer’s
responsibility to ensure that suppliers possess the ability, the
motivation and adequate information to produce materials and
components of the specified quality in a cost effective manner.
• Buyers must take control of quality through:
• Strategic level: Supplier relationship management, early supplier
involvement, supplier selection and development policies, continuous
improvement and quality management.
• Operational level: Materials specification, service level agreement,
contracting, supplier evaluation, quality control, benchmarking,
contracting management etc.
Contribution of procurement in quality
improvement and ensuring value for money
• The use of value analysis in order to eliminate non essential features.
• Consolidation of demand through variety reduction, aggregation of orders, use of
buying consortium, etc
• Centralized negotiation of contracts and prices
• Proactive sourcing: avoiding complacency
• Tiering of suppliers
• Encouraging standardization
• Adopting whole life costing methodologies
• Eliminating or reducing inventory
• Using e-procurement
• Global purchasing
Reduction of inventory
• Value addition in relation to quantities is achieved through reduction in
inventory while still ensuring that there is sufficient stocks to meet
required service levels and maintain operations
• Accurate demand forecasting and transparency across the supply chain to avoid bullwhip
effect

• Use of appropriate stock replenishment systems for independent demand items

• Use of appropriate pull inventory management techniques for dependent demand items

• Application of JIT and lean principles

• Standardization and variety reduction

• Consignment stocking
Logistical considerations
• Added value is achieved through development of effective and efficient transport
and logistics strategies to secure timely, efficient and risk managed supply
• Rationalization and restructuring of logistics and warehouse locations

• Outsourcing of logistics to third party providers with better competences and

resources
• Selecting the most efficient, effective and risk managed mode of transport for a
given procurement
• Planning transport loads and routes to minimize cost, environmental impact and
minimize wasted vehicle space
• Ensuring that transport risks are effectively managed
Strategic collaborations
• Supplier can assist the buyer in achieving cost savings by
collaborating to jointly reduce cost along the supply chain.
• One of the technique is target costing. In this technique, the entire
supply chain agree on the selling price to consumers and then work
backwards along the supply chain to determine the costs that must
be achieved in order to provide a suitable profit.
• Others are:
• Open book costing – Supplier share costs
• Cost transparency- Both buyer and supplier share costs
• Early supplier involvement (ESI)
• Outsourcing
• Negotiating for extended payment or warranty terms
Early supplier involvement (ESI)
• A practice that brings together one or more selected suppliers with a buyer’s product
design team early in the product development process. The objective is to utilize the
supplier’s expertise and experience in developing a product specification. ESI enables a
supplier to make proactive suggestions relating to improving product and service
design.

• Supplier can contribute to product development process through:

• Constructive criticism of designs i.e. suggesting alternative materials, technologies,

manufacturing methods etc.
• Technical information about performance and tolerance of materials or
components
Advantage and disadvantage of ESI
 3. Outsourcing
• Close, trusting relationships and information sharing enable the organization
to outsource some of its internal activities to specialist external providers.
Outsourcing enables the organization to:

• Focus its managerial, staff and other resources on its core and distinct
competences

• Leverage the specialist expertise, technologies, resources and economies of

scale of suppliers with potential to add value at less cost than the
organization could achieve itself for non core activities.
Payment and warranty terms
• Buyers can add value by negotiating for extended payment or
warranty terms in the supply contract. Extended payment means
that the money will perhaps earn more interest in buyer’s bank than
it would have been if it was in supplier’s account. The buyer can also
be able to sell the goods and repay the seller without using his
capital.

• However willful delay of payment may have a damaging effect on

supplier relations.