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04/15/2012

Capital Goods Purchasing: Five Levers for Top Performance

In times of lean budgets and looming credit crunches, capital goods purchasing will require more than just price comparisons. The following trade paper describes which levers bring about successful purchasing.

 

Capital goods purchasing considerably influences the economic result of companies. Thus, the procurement costs for capital goods amount on average to about 10% of the total procurement volume. In addition, capital goods purchasing usually also results in follow-up costs – for example for energy, maintenance, repair and consumables in the amount of about 5 to 10% of the total procurement volume. Investment decisions will furthermore affect a company's productivity and technological capabilities for a long time. Nonetheless, the degree of professionalism of capital goods purchasing has not yet reached the required level in many companies.

Challenge of capital goods purchasing

Capital goods purchasing is facing numerous challenges. For example, qualified decisions must frequently be made since machines or plants newly to be procured must generally be integrated into an existing environment. This circumstance should be taken into account at every stage of the procurement process. Another challenge concerns the monetary performance measurement in capital goods purchasing. Since capital goods are frequently procured on an irregular basis and consequently no comparison with historical prices is possible, it is difficult to measure the monetary procurement performance. This challenge is to be met with suitable methods and organizational framework conditions of savings measurement.

Tied-up capital. The long period of utilization of capital goods together with mostly high financial stakes will result in a lot of capital being tied up. This presents a particular challenge especially in the current situation of a looming credit crunch. Accordingly, the award decision is highly important, reasons to be given – in safe compliance – from an economic viewpoint and by suitable analyses. Since the technical life of capital goods in many cases will exceed their economically feasible life, it is recommended to regularly calculate the optimum replacement time. Moreover, capital goods are frequently connected with corresponding services, such as maintenance. This must be taken into account already for the purchase decision.

Aside from the described challenges, capital goods purchasing harbors great potential. The following five levers can be used for it:

Lever 1: Ensuring actually required technical specifications

Budget determinations in capital goods purchasing are frequently based on empirical values or also in parts on selectively obtained offers. Technical specifications underlying budget determinations are often established, however, by technical people without involvement of the purchasing department. Without critical scrutiny, over-specifications will be the result. Furthermore, dependencies on specific suppliers will result already at an early stage of the procurement process, and purchasing is no longer able to use its negotiation skills. Yet, especially here are great savings potentials. By means of the functioning interaction of purchasing and engineering and by ensuring neutrality in the determination of specifications, the actually required funds can be very much reduced in many instances.

Lever 2: Realization of savings potentials through the professional utilization of purchasing instruments


The procurement process of capital goods is extremely complex. During the stage up to the final contract award, additional potential can be realized by using classical purchasing instruments — such as supplier selection, tender invitations, negotiations. Care must be taken that the existing documents are complete to be able to compare the different offers in their commercial and technical aspects. Moreover, the technical staff and the purchasing department need to sit down at one table as early as possible to jointly determine the specifications.

Lever 3: Strict project management to prevent supplements and time delays

One frequent phenomenon in capital goods purchasing concerns subsequent cost increases and time delays – both in the public sector and in private sector enterprises. Especially for production plants, time delays are frequently connected with very high costs. At this stage, purchasing can contribute to the success of the project by preventing supplements, by providing expert support, as well as by a functioning project and time management.

Lever 4: Calculation of the total cost of ownership

In most cases, follow-up costs exceed procurement costs in capital goods purchasing. Frequently, the purchase price of capital goods is merely between 30 and 50 percent of total life cycle costs. It is therefore highly important to take into account – already in every purchasing decision – any follow-up costs such as energy, personnel, maintenance and repair and assess them within the scope of the net present value approach. Since the technical life of capital goods in many cases will exceed their economically feasible life, it is moreover recommended to regularly calculate the optimum replacement time.

Lever 5: Establishing a continuous compliance management

Compliance security is particularly relevant because of the large number of personal interfaces and the high degree of internationalization of capital goods purchasing. Thus, the parties involved are facing numerous ethical and legal rules of conduct. This concerns not only internal corporate partners but also external partners. For example, if a supplier disregards statutory requirements or social and ecological standards, risks might also result for the purchasing enterprise. In conformity with audits, companies are urged to document planning and budgeting processes as well as award decisions in capital goods purchasing. A special compliance audit can help to indicate weak points.

Hence: Early integration of the purchasing department


For many companies, capital goods purchasing is extremely important because of both short- and long-term costs, as well as its effect on competitiveness. The purchasing department is facing major challenges – given the special characteristics of capital goods as well as their procurement process. Early and thorough involvement of the purchasing department is indispensable to be able to nonetheless fully utilize the financial potentials in capital goods purchasing.

Jens Hornstein, Partner, Kerkhoff Consulting GmbH
Prof. Dr. Erik Hofmann, Professor, University of St. Gallen