Page 257 - Electronic Commerce

Chapter 5

company buys during a year is called its spend. In large companies, the spend can be
many billions of dollars. Managing the spend in those companies is an important function
and can be a key element in a company’s overall profitability. Major international
manufacturing companies have spends that exceed $50 billion and can process millions of
purchase orders each year. By using Internet technologies in their purchasing, logistics,
and support business processes, such companies can save billions of dollars each year.
The Institute for Supply Management (ISM) is the main organization for procurement
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professionals. ISM runs conferences, publishes a monthly journal (see the Web Link to
Inside Supply Management), and offers helpful information on its Web site. Many of the
articles in the journal discuss implementations of Internet technologies in purchasing and
logistics. Full-time students who want to learn more about supply management can join
ISM at no cost.

Direct vs. Indirect Materials Purchasing
Businesses make a distinction between direct and indirect materials. Direct materials are
those materials that become part of the finished product in a manufacturing process. Steel
manufacturers, for example, consider the iron ore that they buy to be a direct material.
The procurement process for direct materials is an important part of any manufacturing
business because the cost of direct materials is usually a very large part of the cost of the
finished product. Large manufacturing companies, such as auto manufacturers, engage in
two types of direct materials purchasing. In the first type, called replenishment
purchasing (or contract purchasing), the company negotiates long-term contracts for most
of the materials that it will need. For example, an auto manufacturer estimates how many
cars it will make during a year and contracts with two or three steel mills to supply most
of the steel it will need to build those cars. By negotiating the contracts in advance and
guaranteeing the purchase, the auto manufacturer obtains low prices and good delivery
terms. Of course, actual demand never matches expected demand perfectly. If demand is
higher than the auto company’s estimate, it must buy additional steel during the year.
These purchases are made in a loosely organized market that includes steel mills,
warehouses, speculators (who buy and sell contracts for future delivery of steel), and
companies that have excess steel that they purchased on contract (demand for their
products was lower than they had anticipated). This market is called a spot market, and
buying in this market, the second type of direct materials purchasing, is called spot
purchasing. Indirect materials are all other materials that the company purchases,
including factory supplies such as sandpaper, hand tools, and replacement parts for
manufacturing machinery.
Large companies usually assign responsibility for purchasing direct and indirect
materials to separate departments. Most companies include the purchase of
nonmanufacturing goods and services—such as office supplies, computer hardware and
software, and travel expenses—in the responsibilities of the indirect materials
Procurement Department. Many vendors that manufacture general industrial merchandise
and standard machine tools for a variety of industries have created Web sites through
which their customers can purchase materials. A number of customers buy these indirect
material products on a recurring basis, and many of them are commodities—that is,
standard items that buyers usually select using price as their main criterion. These

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