Capital Goods Purchasing

Investments are again at the very top of the to-do list — five levers for full utilization of potentials

Capital goods purchasing considerably influences the economic result of companies. According to the Statistische Bundesamt [German Federal Office of Statistics], German companies annually buy capital goods for nearly EUR 550 billion. An upward trend. On average, every German company uses 5 to 10 percent of its total procurement volume for long-term capital goods.
After the slump in growth during the financial and economic crisis, especially Germany's economy experienced an unexpectedly positive development last year. After a period of cost reductions, investments are again at the very top of the to-do list of German companies. The European Commission expects 19 percent of Germany's gross domestic product to flow into long-term economic investments this year.
Entrepreneurs and CEOs now have to examine the forms of their investments. Because such decisions frequently have far-reaching consequences: The long period of utilization of capital goods together with mostly high financial stakes will result in a lot of capital being tied up.

For many companies, capital goods purchasing is extremely important because of both short- and long-term costs, as well as its effect on competitiveness. Nonetheless, the degree of professionalism of capital goods purchasing has not yet reached the required level in many companies. 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. The following five levers can be used to fully exhaust this potential.

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.

Jens Hornstein, Rainer den Ouden, Prof. Dr. Erik Hofmann