DPSS

Extract from Practical Procurement

Extract from “Practical Procurement”

published by Cambridge Media

By Ray Carter and Steve Kirby

Capital Goods Acquisition

Introduction

This extract from “Practical Procurement” will examine the procurement of capital items, considering how this may differ from the procurement of stock items. It will also examine life cycle cost

issues, payback calculations, compatibility issues (the importance of ensuring that

capital items purchased are complementary to existing equipment), maintenance

and training issues and after-sales support.

Definition of ‘capital’ equipment

‘Items that are expected to produce benefit to the firm over a period longer than

the accounting period in which the expenditure was secure’.

The following capital equipment characteristics help to create further under-standing

of the nature of capital equipment, as well as how it differs from stock items.

� High cost/single item – capital items tend (although not always)

to be high cost and to be single, often unique, items.

� Depreciation – it is usual for a company’s accountants to

depreciate the item over its projected life span. This is done

to represent the reducing value of the item over time.

� Financed from capital – if the item is purchased outright, it will be

paid for out of the company’s capital fund. There are alternatives

to outright purchase that will be considered later

� Tax considerations – these differ from country to country but,

usually, there are tax advantages for a company purchasing

a piece of capital equipment.

� Loans and grants – there may be loans/grants available from

either central or local government for the purchase of capital

equipment. This may be particularly true if the equipment

is seen to contribute in some way towards the re-generation of an

area.

� Postponable – the decision to purchase may be capable of being

postponed until (e.g.) a more favourable time period.

� Consequential decisions (sales and labour) – there may be

other decisions consequential to the procurement of a piece of

capital equipment. An example would be the need to take on more

labour to operate a new piece of equipment.

� Adapted terms and conditions – the company’s normal

terms and conditions of purchase are not normally adequate

to cover capital procurement. It may, therefore, be necessary to

add/subtract some terms or even develop a complete set of new

terms for capital purchases. An example would be the

negotiation of a guarantee, which is normal for capital purchases

but not so for stock item procurement.

� Problems of specification – specifications are often much more

complex for capital equipment than for stock items. Often

performance specifications need to be used to try to incorporate

suppliers’ expertise to generate a ‘bespoke’ piece of equipment.

Examples of Capital Equipment

Source: C. K. Lysons ‘Purchasing and Supply Chain Management’ Prentice Hall.

� Buildings.

� Installation equipment – used directly to produce the goods and

services. Examples include plant and machinery. Different types of

plant and machinery will be used in different industries but specific

examples would include drilling rigs and platforms in the oil

production industry.

� Accessory equipment – used to facilitate the production of

goods/services. This is durable, major equipment used to

support the production of goods and/or services. Examples include

large turbines, compressors, heavy-duty cranes and

materials handling equipment. Installation and accessory

equipment often coincide, but there is an important distinction best

explained by means of an example. An aeroplane purchased by

an airline would be ‘installation equipment’ whereas the

same aeroplane purchased by an oil production company

to facilitate the movement of personnel would be ‘accessory

equipment’.

� Operating equipment – semi-durable minor equipment that is

moveable, used to support the production of goods and services.

Examples might include safety equipment and special footwear.

� Tools and instruments – semi-durable or durable portable minor

equipment associated with the production of goods and services.

Examples include computers (PCs), timing devices, tools such as

drilling bits.

� Furnishings and fittings – all items needed to fit buildings

for their organisational purpose. Examples include carpets,

furniture, shelves, counters and benches.

Committee approach

In many organisations a capital procurement committee is set up to consider all

capital purchases. The purpose of this is to involve all departments in the organisation

that may be concerned with the purchase of the equipment to consider such aspects

as:

� specifications.

� the need to bring in potential suppliers to discuss specifications

(performance specs).

� terms and conditions of contract.

� life cycle cost/investment appraisal issues.

The role of the procurement function in this process should be:

� to ensure that commercial issues are considered alongside

technical ones. In many companies, decisions as to capital

procurement are made almost exclusively on technical grounds.

While it is important to remember that, ultimately, the equipment

must be capable of performing the function for which it is being

purchased, commercial issues should be brought into play

as well. This prioritising of technical issues may cause the

procurement function to take a ‘back seat’ in such purchases.

� to negotiate the contract with the chosen supplier. Even if technical

issues have been uppermost in terms of source selection, the

buyer should be charged with the contract negotiation. This, after

all, is a procurement skill.

Food for thought

Consider a recent capital purchase in your organization. What was

the role of the procurement function?

Alternative methods of acquisition

As indicated above, outright purchase of capital equipment is not the only means

of its acquisition, there exist also the possibilities of leasing and contract hire. The

actual decision depends on such issues as:

� whether these alternatives exist in the company’s environment -

not all countries have such sophisticated lease/hire alternatives as

others.

� what the company actually wants the equipment for.

� how long the company needs the equipment for.

� whether capital is available.

The following table should help to summarise the relative advantages and

disadvantages of the three means of capital acquisition.

Buying used equipment

One alternative method of acquiring many types of capital equipment is to buy used

items. Used equipment may be purchased from dealers’ auctions or direct from

previous owners. Thriving ‘used’ markets exist in many countries for the following

types of equipment:

� Vehicles.

� Materials handling equipment.

� Storage equipment (racking, etc.).

� Office equipment such as photocopiers/computers.

Advantages of buying used equipment

� The cost is usually lower than that of new equipment (often

substantially so).

� Used equipment may be more readily available, although this does

depend on the nature of the specific equipment and the state of

the ‘used’ market in the particular country.

� Used equipment may have a long life and be protected by

guarantees. This is especially true if the equipment has been rebuilt

or re-conditioned.

Buying Leasing Contract Hire

Advantages Capital asset

Low cost

Ownership

Resale

Depreciation

Releases capital

Tax + VAT

Balloon

schemes

Profit/asset ratio

Buyback

Full service

Flexible

Seasonal

New technology

Match

demand/supply

Disadvantages Capital tied up

Running costs

Profit/asset

ratio

Disposal

Costly

No asset

Contract terms

inflexible

Costly

No asset

Contract

� Investment appraisal and life-cycle costing techniques can be

used to ascertain the economic viability of a ‘used’ purchase.

Often, it may be more economically viable over the long-term to

buy ‘used’ and it can, sometimes, be economically viable to buy

‘used’ but not to buy ‘new’.

� A used machine may be more compatible with existing ones in the

organisation, thus reducing the cost of carrying spares. This

comment depends on the nature of the equipment to be

purchased and on that of the existing equipment in

the organisation.

� It may be possible to inspect the equipment in use under actual

operating conditions. This is a very useful possibility but

does depend, again, on the type of equipment.

Avoiding pitfalls in the procurement of ‘used’ equipment

The most obvious pitfall here, indeed the one that would put many buyers off buying

‘used’, is the possibility that, due to its previous use, the equipment may not be

reliable or may not have a long life-span.

In the UK, laws such as the Sale of Goods Act and Trades Descriptions Act (see

chapter 14) afford some protection to the buyer of used equipment and many other

countries will have similar legislation. However, it is always best when considering

the procurement of used equipment to adopt the principle of caveat emptor (let

the buyer beware) and take as many precautions as possible over the quality and

reliability of used equipment under consideration.

Such precautions might include the following.

� Ask the vendor whether a history of the equipment is available and

study it in conjunction with technical personnel if it is.

� Is there any indication of the age of the equipment? Examples

might be a serial number that could be checked against

manufacturer’s records or a certificate of manufacture/ registration.

� Try to ascertain how well the equipment has been maintained

during its previous working life. The assistance of technical staff to

inspect the equipment from this standpoint may be required,

and the buyer could ask the vendor if any records of maintenance

exist. If so, these may be studied. This is essentially the equivalent

of the service history that should be available for a used car.

� Ascertain whether spares are available and, if they are, for

how long this situation will continue. Used equipment is more likely

than new equipment to require spares and, for this reason,

this point is very important.

� Compare the cost of the used equipment with that of the new.

Does it represent good value?

� Is the vendor well-established and enjoying a good reputation?

The buyer should avoid at all costs buying equipment from

a ‘fly-by-night’ operator.

� Consider the general and special terms and conditions, if any, that

might apply to the purchase. Do any of them cause particular

problems?

� Is the vendor attempting to supersede any statutory protection

available to the buyer with a guarantee? If so, this should set off

‘alarm bells’ for the buyer.

� Ascertain whether the vendor will allow any trials or test/approval

period for the equipment. This can be the best way of ensuring<

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