Types of Purchasing Policy adopted by Industrial Enterprises
Purchasing policy means purchasing sufficient quantity of materials for all the anticipated needs but neither overstocking nor carrying stocks at low levels. Generally, the following purchasing policies are adopted in an industrial enterprise according to specific requirements and prevalent market conditions;
1. Conservative buying policy
Under this policy, purchases are made strictly on the basis of current needs of Industrial concerns. Small lot purchases are made through small and frequent orders, of course, the buyer has to sacrifice quantity discount. But he incurs minimum risk of loss, when he adopts this policy of hand-to-mouth purchases.
A conservative buying policy is obviously suitable and always preferable when there are plenty of materials available in the market or when prices are falling i.e., in a buyer’s market. When the stock position in the near future is expected to be quite satisfactory, the manufacturer can follow this hand-to-mouth policy of buying with advantage.
Such a buying policy can avoid the risk of loss either through an adverse change in the price or through lowering of quality and buyer can have fresh stocks from time to time. The placing of small and frequent orders involves locking up of lesser capital at a time and the cost of warehousing and insurance will also be lower. Lastly, the selling plans will be elastic or flexible.
The conservative or hand-to-mouth buying policy on the basis of current needs is naturally unsuitable in a rising market or when the outlook of future supplies is dark and uncertain and even when the present supplies are inadequate to satisfy the normal demand.
If the buyer follows this policy under such conditions, he will have to enter the market frequently and each time fresh purchases will have to be made at higher prices and costs. Of course, limited financial resources may prevent him from buying in bulk, but he can borrow from the money market, if necessary, to protect himself to some extent at least against price rise which is almost certain.
Hand-to-mouth policy of purchasing involves recurrent orders, receipts, payments, repeat checking, inspection etc., at the buyer’s office. These will increase office expenses and cost of purchasing. On account of the absence of economies of bulk purchases, small scale buying operations will lead to higher purchase cost per unit. This will reduce the profit margin of buyers. Hand-to-mouth buying creates a constant danger of getting out-of-stock.
2. Concentrated buying policy
The number of sources on which a manufacturer may depend for has supplies may be very few or limited. It is called concentrated buying policy. Such policy offers the following benefits:
1. Patronage given to a limited number of suppliers will enable the buyer to secure the status of a privileged customer even in a rising market and to get better services, special treatment, prompt delivery, reasonable prices etc.
2. Reduction in the cost of contractual function — efforts in searching sources of suppliers and maintaining contacts with them — is possible.
3. Large orders on a few suppliers yields the benefit of lower prices and quantity discounts.
4. Bulk purchases reduce cost of handling and transport per unit of purchases.
In general, there should be at least two or three alternative sources of supplies for all important items. This will reduce the danger of extreme concentration. All eggs should not be put in one basket. It is very risky to depend on one source only. If it fails, the business will be paralyzed. The choice of materials will be limited if one relies on one source only.
3. Diversified Buying policy
Under this policy, instead of depending on one source of supply, purchases are made from a large number of sources. This policy is also known as scattered buying policy. This policy offers the following benefits:
1. Buying plan is flexible.
2. Possible to extract better terms of sales and lower prices when there is healthy competition among many suppliers.
3. Diversification helps reduction of risk arising out of extreme concentration. All sources cannot fail simultaneously to supply materials to the firm.
4. Diversification makes selection easy and gives a wider choice to the buyer. Extreme scattering may create a few disadvantages e.g., sacrifice of quantity discounts, incidence of higher transport and handling costs, absence of special privileges and lack of better services, etc.
4. Reciprocal buying policy
It is a good policy to place an order with the seller who is the customer of the firm. For example, a sugar factory agrees to buy sugarcane from a farmers’ cooperative society, provided the society also agrees to buy sugar from the sugar factory.
Reciprocity is industry’s version of “you scratch my back and I will scratch yours“. Reciprocal buying, “If you buy from me, I buy from you” provides a return consideration wherever possible and it helps to build connections and goodwill. A careful buyer can get better quality at a reasonable price. It may increase sales and simplify purchasing.
However, such a policy may reduce the choice of suppliers. He may have to buy at higher prices and under unfavorable terms. In short, reciprocal buying should be limited and not widespread. The gains from such a policy should be more than the losses. The main limitation of this policy is that it puts a premium on inefficiency of both buyers and suppliers.