The Issue of Centralizing Purchasing

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Table of Contents

Introduction
Literature Review
Methodology
Data gathering
References

Introduction

The subject matter is take a decision about centralizing or decentralizing purchases for a conglomerate company whose head quarters as well as a plant is situated in the same country. Each of the purchasing systems has its own advantages and disadvantages that are required to be analyzed and evaluated before reaching at a suitable decision for the conglomerate.

Aims and objectives

The aims and objective of the study is to evaluate the merits and drawbacks of centralized as well decentralized system of making purchases in the light of operative style of multi national company. The basic objective is selection of purchasing system for the company that promotes efficiency and quality in production as per the required standards keeping an efficient inventory turnover. Various literature reviews and practical experiences of industries and businesses are required to be studied and analyzed in depth in order to understand pros and cons of each of the systems.

Background Information

The company under consideration is a multinational company. Naturally the company has to handle its purchases of raw material and other products required for its different plants and stores situated in different countries in an efficient manner and as per a time bound program. Company’s new plant, being in same country, may prove helpful for decision in favor of centralized purchasing but its location in the opposite direction of head office may not prove to be of that advantageous location wise.

Structure of Report

As this is an interim report it represent more of collection of data and ideas that will be helpful in studying both centralized and decentralized systems of purchases, with the help of information gathered in literature review section of the report. An effort has been made to be very specific so far as literature references are concerned. The methodology adopted in the study is first to define and explain each of the systems with their advantages and disadvantages by providing practical business examples and references as far as possible. Merits and demerits of each of systems are presented together in the methodology section purely from the point of view of a multinational company in order to arrive at a suitable practical decision.

An effort has also been made to support each detriment of centralized and decentralized purchasing system with available data evidences. Data of practical experiences using different purchasing system is displayed in data gathering part of this interim report. Limitations of each of systems have been emphasized with explanations of damages that could happen to the company if those limitations of the system are not taken care of. The report carry no recommendations as the study of systems is mid way and thus conclusive analysis cannot yet been drawn.

Literature Review

Review of background theory and review of previous research

Purchasing may be centralized or decentralized. ‘Centralized as applied to purchasing has two connotations. The first concerns the concentration of buying authority for single plant within the purchasing department. The second, more common connotation of terms implies central purchasing control, usually at headquarters; even when there are several plants in different locations, run by divisional mangers.’(Victor H Pooler, page 22)¹

In this study the scenario is that of a multinational company. Accordingly the later connotation of centralized is applied in the study. A number of multinational companies like Seers, The General Motors and others are few examples that follow the centralized purchasing system of later type where the central purchasing control is at the head quarters. “Sears retained a centralized purchasing department (i.e. a functionally defined unit) from which all its retail stores obtained their goods. While geographically based divisions were independent from each other, they were nonetheless all dependent upon centralized purchasing.

The General Motors Automotive Divisions (Chevrolet, Pontiac, Buick, Oldsmobile, and Cadillac) were dependent to a considerable extent on the parts and accessories divisions, and there were important functional departments and interdivisional committees for purchasing, standardization of parts, technical engineering problems, and many other such matters.”(Richard P Rumelt and others, page 101)²

Under centralized purchases all buying activities are concentrated at one location and normally that is head office of the corporation. Under decentralized purchasing the activities of purchasing is delegated to branch level or plant level or even to heads of different departments. The theory of centralized purchasing has emerged out of the theory of public administration that encourages employees to exercise a sort of unilateral control over the administration.

The theory of centralized purchases envisage that “by concentrating all purchasing responsibility in one organization it is possible to achieve standardization to eliminate duplication of effort, and to lower prices as a result of volume buying. Such organizations permit the hiring of people professionally trained in the business of purchasing. The vendors and general public may thus look to one professional staff for information and for assurance that the state’s purchases are being handled properly and economically.” (SAM)³ Such unilateral control or centralization of activities eliminates the malfeasance, wastefulness, and also discourages the improper and uneconomical activities of staff.

As per Harry E Hough and James M Ashley (page 16)⁴, “Over the past 30 years company organizations have shifted from highly centralized to decentralized back to centralized stricture ad infinitum A change in the structure may have to do with the personality of the chief executive than with any proof what is best system. A dictatorial style of management logically favors the centralized system whereas those who prefer to delegate authority are inclined to prefer a decentralized system.’ Concentration of purchasing is basically a by product of Bouniatian theory of over capitalization that emphasizes that “this concentration of purchasing power enhances the accumulation of capital; for

the desire of increased consumption does not expand so quickly as income has risen, and
the spirit of enterprise is increased by increased profits received.

The larger supply of capital leads to a greater demand for the means of production, and raises their prices- now concentrating purchasing power in the hands of those who own or produce the means of production. This new concentration enhances once more the accumulation of capital.”(Wesley Clair Mitchell, page 9)⁵ In this economic sense centralized purchasing are one of the reasons for inflation and rising prices. There are a number of limitations of centralized purchasing system. But the most striking limitation that grew over the period “might be called ‘corporate obesity’-excessive overhead cost and even opulence in some cases. Companies would boost elaborate headquarter building in fashionable areas justifying them as symbol of success which would appear to potential shareholders. Oversized central offices also typically work with a slow response to divisional matters- despite the extra people; the system did not provide good service to remote customers.” (Marc Day and David Farmer, page 15)⁶

In other words centralized purchasing system gets corrupted with its application overtime and its limitations start appearing that loosen the effective grip the system gained making efficient and effective purchasing power for the company.

Gaps in the literature

It is seen that scholars have differed extensively providing gaps in their opinions about the importance and limitations of centralization and decentralization of purchasing. Such differences are the result of time and business era during which the scholars were studying and analyzing the issue of centralized or decentralization of purchases. These gaps in literature are examined hereafter.

None of the system of purchasing is complete in itself; particularly in case of larger organizations centralization has also promoted functional units of centralized purchases at different functional and geographical level. Naturally the advantages of decentralization have been gained as some element of decentralization is involved into functional centralization. Accordingly centralized purchasing or decentralized purchasing both are extreme ideas that may work in smaller size organizations. In larger organization centralization of purchasing need some element of decentralization to make competitive and effective decision making about purchases. Similarly decentralized purchasing need some centralized check to endorse a dose of efficiency into decentralized purchasing units or functions.

At the same time there are theories emphasizing that ‘centralized purchasing does not benefit significantly from economies of scale and specialization that constitute its underlying rationale.’(William D Savedoff, page 88)⁷ There is gap in practice and theory as well. William D Savedoff also states that ‘ The one factor most commonly claimed is that both price surveying and central purchasing are inefficient when local prices vary significantly and when transportation and storage cost are significant.’(Page 98, 99)⁸.

The theory of central purchases contradicts itself as it does not take into account the circumstantial features into account. Taking into consideration such gaps between the extreme theories of centralized and decentralized purchasing systems, the hybrid system of purchasing that is manipulative as per circumstances and conditions is more practical and useful. In hybrid purchasing system ‘the most common form is that decide to buy some commodities centrally and other locally.’(Marc Day and David Farmer, page 20)⁹

Another feature that has also created the gap among theories of centralized and decentralized purchasing is the emergence of information technology. ‘Information technology reduces transaction delays and costs when firm searches for best suppliers’ (Seven – Eric Sjostrand, page 114)¹⁰ The changes in information technology particularly with the use of internet the decision making has become instant and that eliminates the limitations of decentralized purchasing system to a great extent. Literature always advocated centralized or decentralized system but never advocated forcefully a hybrid system and thus a gap existed in scholars’ opinions.

Definition of research question

In the light of above researched information about centralized and decentralized purchasing systems the research question under study is defined taking into consideration the enlarged geographical structure and existence of plants of the company. Both centralized and decentralized systems of purchasing have lost their verve to a great extent with advent of information technological advancement. Even otherwise creation of a hybrid system of purchasing eliminates to a great extent the limitation of both systems. Under such circumstances the research question is whether to centralize purchasing with elements of decentralization (that is a hybrid purchasing system) for the conglomerate organization or not.

Methodology

The methodology adopted is to individually analyze the advantages and disadvantages of each of purchasing systems keeping in view the requirements of multinational company under consideration. The analysis of each system follows:

Overview of possible approaches

Let us first examine the methodology of centralized purchasing system. As stated earlier there are two connotations under centralized purchasing. The first involves the concentration of purchasing authority within the purchasing department working for a single plant; and the second involves the establishment of a central purchasing control at the headquarters of the company. Whatever may be the form there are certain specific advantages and disadvantages of centralized system of making purchases. The benefit of economies of scale is well known advantage of centralized purchases. Then there is advantage of control. “A centralized function provides greater control over costs or salaries than letting the bunch of smaller units make their own decisions.”(Tom Gorman, page 100)¹¹

Then ‘prompt payments reassure vendors and may reduce bids.’(Lent Dayton Upson, page 156)¹² Also it is ‘easier to bring in new people into the larger department and train them properly before they are put on the important buying job.’(Victor H Pooler, page 23)¹³

Decentralization of purchases involves a structure where ‘purchasing offices and decision making are not coordinated, supplier strategies are not linked, volume are not leveraged, and there are local incentive schemes.’(Dave Nelson and others, page 56)¹⁴ In fact the essential virtues of decentralized virtues are that ‘it is supremely sensitive to the values of consumers of final products, and that it provides a spontaneous motivation to utilize purchased goods and services efficiently to satisfy consumer value.’(Robert A Solo, page 338)¹⁵

The ‘decentralized purchasing department can react in emergencies than the centralized group.’(Victor H Pooler, page 23)¹⁶ It is natural that under decentralized purchasing system the ‘local purchasing is more responsive to needs of particular operation.’(Derek L Waller, page 495)¹⁷

Both systems have their own merits all right but they are also plagued with demerits as well. Like centralized purchasing increasing the purchasing costs as at least minimum established quantity is required to be kept in the stocks and that increases extra establishment and transportation efforts. ‘It is commonly argued that centralized purchasing creates more bureaucracy at the central agency; that even though in principle it can operate efficiently, in practice it is generally inefficient.’ (William D Savedoff, page 88)¹⁸

The quality of material required in the plants cannot be better judged by those sitting in central office. That is why it is said that under centralized purchasing ‘the actual user has relatively little say in decision process.’(Bhaskar Chkaravorti, page 77)¹⁹ In case of decentralization of purchases, local management may compromise with quality of purchases in their enthusiasm of reducing the costs to show increasing profits. In other words there is always a danger that local staff may unknowingly play with the reputation of the organization. That is why some degree of local control becomes necessary in order to avoid local interferences in the basic policies of the company. That is to say some sort of hybrid system of purchases is always preferable.

Explanation of chosen approach

Taking into consideration the pros and cons of both centralized and decentralized systems of purchasing the hybrid system of purchasing is the chosen system or approach. Hybrid system has few advantages over both centralized and decentralized systems ‘including costs and time savings by eliminating duplicate bidding by each property for the same product. Moreover the system allows the regional purchasing office to fully utilize its contracted suppliers, national contacts, regional contacts, and other programs. (Joel D Wisner and Leong Tan, page 38)²⁰

Data collection method

Different sources like internet, scholar written articles, and books have been used to find the experiences of multinationals in the fields of system of purchases.

Data gathering

Centralized Purchasing in food industry in Ireland

“Foreign multinationals enterprises always made up an important part of the local market for food ingredients. From early 1940s until early 1970s foreign multinationals such as Rowntree Macintosh were major local customers, buying chocolate crumb from indigenous processors. The early 1970s saw the development of strong infant food manufacturing sector dominate by subsidiaries of larger multinationals enterprises such as Abbott, Wyeth and Cow and Gate (later acquired by Nutricia). Under centralized purchasing foreign multinationals have also invested in the Irish beverage industry.”(Bruce Trail and Eamonn Pitts, page 79)²¹

Procure to Pay is centralized purchasing policy in oil industry

“Caltex, a multinational petroleum company, needed to get its procurement systems under control. Its unique procure to pay (p2p) was designed to drastically streamline the procurement process.”(Michael Newland, Nov. 5, 2001)²²

Centralized/ decentralized purchasing structure based on overall company strategy

Centralize for greater cost control and corporate leverage
Decentralize for nimbler procurement responsiveness
Centralize procurement of common products
Decentralize procurement of specialized products
Align purchasing structure with corporate structure and strategy
Vary the centralized approach depending on the class of goods and services procured.
Adopt a procurement organization appropriate for the company’s size.’ (Source: Price Waterhouse Coopers)²³

Summary of data gathered

Multinationals cannot afford a single centralized or decentralized system of procurements. The system to be adopted by the company should be changes as per requirements to attain efficiency and cost effective procurement approach. Hybrid system based on suggestions of Price Waterhouse Coopers summarizes the gathered data.

References

Victor H Pooler, Purchasing and Supply Management, Springer, 1997, page 22.
Richard P Rumelt and others, Fundamental Issues in Strategy, Harvard Business Press, 1995, page 101.
SAM, State Administrative Manual, 9/85. Web.
Harry E Hough and James M Ashley, Handbook of Buying and Purchasing Management, CCH Tax and Accounting, 1992, page 16.
Wesley Clair Mitchell, Business cycle, Rediff Books, page 9.
Marc Day and David Farmer, Gower handbook of Purchasing Management, Gower Publishing Ltd., 2002, page 15.
William D Savedoff, Organization Matters, Inter- American Development Bank, 1998, page 88.
Ibid, page 98, 99.
Marc Day and David Farmer, Gower handbook of Purchasing Management, Gower Publishing Ltd., 2002, page 15.
Seven – Eric Sjostrand, Institutional Change, M E Sharpe, 1993, page 114.
Tom Gorman, The Complete Idiot’s Guide to MBA Basics, Alpha Books, 2003, page 100.
Lent Dayton Upson, Practice of Municipal Administration, Ayer Publishing, 1974, page 156.
Victor H Pooler, Purchasing and Supply Management, Springer, 1997, page23.
Dave Nelson and others, The Incredible Payback, AMACOM Div American Management Association, 2005, page 56.
Robert A Solo, Economic Organizations and Social Systems, University of Michigan Press, 2000, page 338.
Victor H Pooler, Purchasing and Supply Management, Springer, 1997, page23.
Derek L Waller, Operations Management, EMEA, 2003, page 495.
William D Savedoff, Organization Matters, Inter- American Development Bank, 1998, page 88.
Bhaskar Chkaravorti, The slow pace of fast change, Harvard Business Press, 2003, page 77.
Joel D Wisner and Leong Tan, Principal of Supply Chain Management, Cengage Learning, 2008, page 38.
Bruce Trail and Eamonn Pitts, Competitiveness in the Food Industry, Springer, 1998, page 79.
Michael Newland, Multinational Oil Company roll out unique procure to pay system, Tech Republic. 2001. Web.
Price Waterhouse Coopers, Global Best Practices. Web.

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