Moving toward Value-Based Purchasing

Manufacturing firms continue to face an increasingly complex environment. Raw material shortages, price volatility, new technologies, globalization of business activities, currency shifts, supply/demand fluctuations, and other such factors are combining to create a dynamic, challenging operating environment. As these firms seek to improve productivity and quality, more emphasis is being placed on increasing the "value" of an organization's product or service. The term "value" has many meanings. For example, it may refer to relative worth, the difference between price and cost, the price itself, or the amount that a buyer is willing to pay for a particular product or service of given quality. Several of these definitions reflect the fact that the value of an item may change, given the particular situation, buyer, or time period. Each individual and function plays a role in increasing the value of the firm's products and services. However, one function that may have more impact than others is the purchasing function. Purchasing is generally viewed as an important contributor to the organization. In a recent survey of CEOs, 66 percent of the executives felt that the purchasing function is very important, in fact more important than, or equal to, that of all other departments except marketing and finance.|1^ Yet, typically, the purchasing contribution is recognized only in terms of its ability to directly reduce material costs. Value-chain management pursues the viewpoint that the purchasing function, interacting with both the firm's internal and external environment, has tremendous potential to provide value. These interactions may, or may not, directly reduce the cost of purchased materials; however, they may very well increase overall firm or system performance. For example, through functional interaction, information is exchanged and product value is enhanced. Similarly, through the development of supplier partnerships or the use of electronic data interchange, value is generally increased. These examples indicate how, in addition to reduced material costs, purchasing can increase the value of the firm's products through improved relationships. Yet, for purchasing to actively improve these relationships, both the motivation and ability to do so must be present. This article discusses the concept of value chain management and the role of the purchasing function in increasing the value of the firm's products and services. In particular, it (1) describes the concept of managing within the value chain; (2) identifies the factors that affect value-based purchasing; (3) through the presentation of empirical data, presents an indication of the readiness of the organizational environment for implementation of value-based purchasing; and (4) provides suggestions to enable purchasing and materials managers to effectively manage within the value chain and create a competitive advantage. VALUE CHAIN MANAGEMENT LINKS PROVIDERS TO CUSTOMERS In today's business environment, a firm can no longer afford to perform activities or incur costs that do not increase the value of the product or service being produced. One approach used to focus on value and identify those nonvalue-adding processes is application of the value chain concept.|2^ The value chain presents the organization, and the entire economy, as a series of links in a chain. The chain consists of three primary links: upstream--with the firm's suppliers, internal--among the firm's functions, and downstream--with the firm's customers. Another link, the distribution or channel link, can be included if appropriate. The value chain can also be considered in a micro sense because each of the "macro" links possesses a number of internal links. For example, within the firm, the functions of purchasing, marketing, manufacturing, and accounting are linked through the value chain. Similarly, manufacturing work centers are also linked. Effectively managing within the value chain requires a system that not only links all portions of the value chain but also encourages and enables each link of the chain to focus on increasing the value of the firm's products and services. …