What is the right purchasing method for a Food and Beverage business?
The answer is, it depends. When I help my clients about purchasing methods, I consider many elements before advising on which one to choose. But before looking at the various elements and how to choose the best for your Food and Beverage business, let’s take a step back to
Different purchasing methods for different businesses
What is a food purchasing system?
A system of purchasing is made of all the activities to:
- Forecasts future requirements
- Identify raw materials, finished goods and packaging required in terms of quality
- Estimate quantities to be purchased by comparing current inventory and remaining shelf life, demand forecast and lead time
- Place the order and, in most small companies, arrange the goods-in logistics too.
A system is more than just a list of tasks. It’s a method that describes how to proceed. It helps prioritising and defines guidelines to help users take a decision under conditions of uncertainty: e.g. Forecasts suggests we might need 20 litres of olive oil by next week and we only have 15 in stock; the minimum order to the supplier is 100lt. Should I buy now or skip this week order? With a method, users can be guided towards the decision that best meets the company's policies.
Why are purchase specifications important to food and beverage businesses?
Establishing food purchase specifications (AKA choose a purchasing method) for your business is important because It helps identifying the quality and quantities of raw material and packaging required to prepare the finished products. It also helps control costs, minimize waste and ensure that supplies are delivered on time to meet the demand. Purchase specifications vary according to business type, size and market segment, - a confectionary business will have different specifications compared to a bakery – Yet, for the vast majority of Food and Beverage businesses we can identify the following purchase specifications:
- Bill of Material – It describes the quality and quantities of all the ingredients and packaging required to manufacture (or assemble) one selling unit of finished product
- Main supplier and alternative (if applicable) - This identify the vendor from which the supplies are purchased. In some companies there can be more than one for the same item
- Supplier lead time – The time, usually in days, that a supplier needs to fulfil the order
- Transport lead time – This is how long it takes to get the goods in your premise once the supplier has made them available, some companies include the inbound lead time within the supplier’s LT, I would recommend to measure these separately
- Remaining shelf life on receipt – How many days of remaining shelf life will your supplies have when received? This is a critical element of your purchasing method, not enough shelf life on receipt means exposure to wastage
What are the methods of purchasing?
There are five essential methods; any of them (or more!) on can be the right purchasing method for you:
- Bulk buying
- Just in time
- Blanket Purchasing
- Speculative purchasing
- Reciprocate purchasing
Let's dive in
The most economical for of purchasing. Mostly used by Food and beverage wholesalers and resellers. It involves buying large quantities of inventory therefore, paying a lower price
Advantages of bulk buying
The most obvious advantage of bulk purchasing is price. when you buy large quantities of inventory you will get a low price per unit. A low unit costs means better gross margin profit. Bulk purchasing will guarantee lower inbound transport costs too, by shipping larger quantities of inventory, carriers lower the transport costs per individual selling units. This means lower landed costs therefore lower COGS
Disadvantages of bulk buying
It is often underestimated but, if you carry more inventory you are exposed to higher operational costs. Planning and ordering based on forecasting can be complex, therefore requires more admin time. Storing large quantities of inventory means higher storage costs, inventory management activities like stock rotation and quality control. All these activities require admin time, IT tools and assets like warehouses, forklifts and personnel. In addition to the above, bulk purchasing increases the risk of spoilage due to excessive buying.
Just in time
Arguably the most efficient purchasing method. With just in time purchasing you buy supplies to fulfil existing orders. This method means you can minimise holding inventory to a safety stock quantity or even zero inventory.
Advantages of JIT purchasing
With Just in time purchasing companies can minimize the storage space to store goods, this can free up funds that can be used for other strategic tasks. Wastage can be significantly reduced as inventory is purchased to fulfil existing demand rather than based on forecasts. Ordering stock when needed can also benefit the cash flow; a lower amount of cash locked into inventory means more cash available. Also, by purchasing stock to fulfil existing demand, companies can run on negative working capital if payment terms allow this. i.e. collecting payments –pro-forma invoice- when the order is received then ordering the materials needed and paying for it at the end of month.
Limitations of JIT
Obvious limitations of Just in time purchasing are: the high risk of losing control of time. Any delay affecting the receipt of the supplies will delay the fulfilment of the order, this might result in customer service issues, a business running on Just in time purchasing might not be able to respond fast to increased demand. If run properly, just in time is the most efficient way to manage purchasing and inventory, but it must be run by expert personnel and, even better, by using a strong inventory management and demand forecasting software.
Blanket orders allows to "pre-order" inventory for an entire year (or season), agree on price and conditions upfront, then requesting shipments of fractions of the order, to be delivered when needed. Until the total quantity has been fully delivered, terms and conditions will remain the same.
When should you use Blanket purchasing?
Often used to purchase staples or commodities. When buying supplies subject to availability constrains i.e. due to weather conditions, think of cereals, certain cheeses, wine or crops whose yield may vary from one year to another. Blanket purchasing is similar to a Future (in finance terms) and are in fact used mostly to buy crops before the yield, sometimes one or two years in advance.
Rarely used in the Food and beverage industry, this purchasing method involves buying supplies when the price is low, regardless of the demand. Store them in the company’s premises and resell them when the market is more favourable.
When is speculative purchasing used in Food and bev?
Limited editions of wines and spirits, exclusive ingredients like truffles can be purchased with a speculative method. Buy regardless of the demand, get a good price, figure out how to resell later. Be careful though, wastage exposure, inflation, market conditions may vary. Speculation is a risky activity.
Almost never used from Food and Beverage companies, reciprocate purchasing is when two parties agree to sell each other certain products. One of my clients had an agreement with an ingredients company for a reciprocate purchasing method. The client would buy spices from the supplier, use the spices to manufacture a sauce and re-sell the sauce back to them.
Which is the right purchasing method to use in your food and beverage business?
Each business is different and the right purchasing method depends on your company's business strategy. Here’s a few thoughts
If cash is an issue you must go lean. Just in time purchasing is the best option if you have limited cash
If you want to play the price game and profitability is an issue, you need to keep your direct costs down. If you have the assets and the cash, the best way of lowering direct costs is to bulk buy. This will result in lower landed costs (purchasing price + transport, receipt, handling and manufacturing costs. [more here]) the higher the volumes, the lower the cost the higher the profitability by the single line (if wastages are kept under control) This is how large Food and Bev corporation manage to keep prices so low
Supplier’s lead time
If your supplies have limited shelf life you should really aim for a just in time approach. Limit the excess inventory to keep wastage under control.
If your supplies are staples like wheat, rice, tinned vegetables, sugar, oils or fresh vegetables you should choose a mix of blanket purchasing and just in time: the blanket orders will make sure you pay a fair price and that you are not exposed to shortages due to low yields while a just in time method will help cope with unexpected high demand.
If you sell exclusive and hard to find products, speculative paired with just in time might be an option. Rare wines and spirits, caviar and truffles, beautifully crafted confectionaries. As long as you can calculate the risks and are prepared to lose, speculative purchasing is an option.
There is no one solution fits all when it comes to purchasing, your preferred method must be based on the business type, market segment, and commercial strategy. Also, a method is not a blueprint for success but guidelines. They will evolve and change as your business evolves and grows. The key is monitor, measure and change if necessary. If you need support with choosing and implementing the right purchasing methon in your food business, let's jump on a call