The process through which any goods or services are purchased from a source external to the firm is called procurement. The purchased items should be acquired at the best possible cost and should be the closest match to the needs of company. The closest match implies the best possible quality, quantity, time, and location for the cost incurred.
In this article, we will look at, 1) what is procurement, 2) steps in the procurement process, 3) optimizing the procurement process, 4) procurement best practices, and 5) ensuring ethics in procurement.
WHAT IS PROCUREMENT
The process of procurement is usually detailed and thorough and ranges from the preparation work involved with the demand process, the assessment of options, approvals, invoicing, payments and record keeping.
There are always ethical concerns within the area of procurement. For this reasons both public and private organizations often try to create clear and defined processes to ensure that fair, open and impartial procurement can occur without the threat of any fraudulent activities.
Processes in Procurement
The procurement function is vital for the company’s ability to continue operations. For this reason, it is usually part of the company’s strategy. How necessary materials are purchased and at what cost can make the difference between a successful company and one that is not. Some of the processes that may be part of the overall procurement function include:
- Planning: The processes within planning may include purchase planning, determining standards, developing specifications, researching and selecting possible suppliers, performing value analyses, and determining available financing.
- Negotiating: During this stage, the procurement department will approach suppliers or ask for bids. A price negotiation may result from this, or a selection of the best option.
- Purchasing: At this point, the actual purchase will be made and the procurement function will ensure that the supplier continues to meet the terms of their contract.
- Post Purchase Activities: The function also controls inventory and any disposal or related activities
STEPS IN THE PROCUREMENT PROCESS
Though the procurement process varies from company to company and depends on the nature of the business, there is a general framework that can be applied to most modern businesses. This procurement cycle consists of 6 key steps.
Identify the Need
An internal process, the company formulates strategy for the next few years and translates this into technical direction and requirements. This helps set targets for what needs to be procured along with an established criteria for acceptable quality standards and pricing.
Identify the Supplier
Before suppliers can be identified, the company usually decides important things such as make or buy and whether multiple suppliers will be used or only one. Following this, work will be done on identifying who the potential suppliers are.
Communicate with Suppliers
With an idea of who the possible suppliers are that may fulfill requirements, they are approached through methods such as requests for proposals, requests for quotes, and requests for information. The communication channel can be direct or through mass advertising such as a newspaper or a trade publication. There may be a need for clarification of all services expected and provided, as well as the possibility of sample testing or trial runs.
Negotiation is a vital stage of the process, with discussions on price, availability, timelines and the possibilities for customization. Service level agreements and contracts are drawn up and signed.
Liaison With Suppliers
At this stage, the supplier and the product or service provided is assessed, usually as it is being used. At the time of completion, contract renewal, or reorder, the performance of supplier and the material is assessed and becomes a determinant of future relationships.
Working closely with the supplier, the procurement function ensures shipment, delivery and payment schedules are completed according to the terms of the contract.
Key steps of the Purchasing Process
OPTIMIZING PROCUREMENT PROCESS
Understanding the Current State of Procurement
Given its importance and sensitivity, the procurement process for any company needs to be streamlined, smooth and efficient. But to achieve this, there needs to be dedicated time, resources and a lot of hard work. Though it may appear simplistic, enhancing a procurement function is a complicated endeavor.
The first thing to assess is where to begin from. If the two key factors of time and necessary resources are assumed to be available, the point of initiation still needs to be determined. According to consulting firm PwC, there are some important questions that need to be answered before any activity to this end can begin. These include:
1. What is the maturity level of the procurement function?
- Informal Stage: The focus here is usually on transactions for purchase with budget and price being key metrics. Procurement may be a non-strategic element at this point and there are probably limited systems and process. The function performs as a buyer with no value addition to the organizational goals as a whole.
- Control Stage: At this point, some initial processes may be defined and suppliers limited to a few key ones. The role has shifted from that of a buyer to more of a negotiator.
- Integration Stage: By now, procurement may be handled by cross functional teams. Systems are in place to handle procurement activities and procurement is seen as a strategic function.
- Optimization: The teams have moved beyond cross-functional with links developed with service departments as well as R&D if relevant. Supplier management programs are in place to bring a focus on continuous improvement. Systems are fully automated. Supply markets are subject to research and testing.
2. What are key questions to ask about current processes?
Once the current stage of the function is determined, it may be pertinent to further understand the way things are at status quo. To achieve this, several pointed questions can be asked and answered. These questions, when asked regularly, also ensure that the procurement function continues to operate at an optimal level. These questions can include the following:
- Is the procurement function working effectively with business units to support overall company strategy?
- Is it possible to generate reports accurately or in timely manner regarding different categories or purchases?
- Is there a short term plan to reduce all possible operational expenditures?
- Is there a system to manage suppliers in a strategic manner and to measure the value that they add to the business?
- Are negotiations with suppliers effective?
- Are there specific and separate processes in place for the purchase of both generic commonly used items and specialized ones?
- Is procurement involved in strategic discussions regarding investments and design?
- Is there a risk management program to ensure the continuation of business?
It is clear that improving a procurement process is not an easy task and there are several complex steps involved in the activity even before it formally begins. But given its criticality to business operations, these steps need to be taken in order to reduce the risk of lost business, money and time.
According to the PwC report,
“Without a mature, strategic procurement function to influence, control and report on organizational spending, it is impossible for a business to fully leverage its total purchasing power and create the value and service levels required from third party suppliers.”
Once the current place in the procurement lifecycle is assessed, the current processes evaluated and the decision made to begin optimizing, the company can begin the actual work of streamlining the procurement function. The following basic process can be used to this end:
- Process Mapping: The first logical step in this activity is to map current processes. During this, the process is visually drawn out from beginning to end in the form of flow charts. The drawing begins with several boxes showing the flow of activities with decision points being highlighted. The process begins with request for proposals and ends with the consumption of the purchased items
- Identify Improvement Areas: Once the process is laid out visually, it becomes easier to identify any redundant stages as well as possibilities for automation. The point of this exercise is to help the process run faster with better quality and less possible choke points or delays. This improvement should also help respond to customer needs faster and manage suppliers better.
- Decide on Automation: Once it is clearly decided where improvements and automation can be included in the process, the company can make the decision to buy or create procurement software. A procurement system helps ensure that the processes are run as they should be regardless of the people involved within.
- Evaluate Strategy: Different companies have different types of operations and way of work. This can help decide whether the procurement function will be stand alone and centralized, or divided among different functional areas.
PROCUREMENT BEST PRACTICES
Increasingly, the global economic situation has been putting pressure on companies to cut costs yet continue to produce great results. This has meant the need to go through business transformation rather than merely business improvement. Adopting industry best practices has become necessary to success where the right methods, processes and philosophies can turn the organization around.
Though there are different methods used by companies considered best in class, there are some key practices that are often common to most of them. Though not a foolproof formula for success, these practices do give a systematic approach to check the effectiveness of a procurement function and the efforts to improve it.
- Create a Supply Chain Council: This council is made up of the head of the procurement area as well as other business unit heads and relevant company leaders. The purpose of the council should be to provide direction and ensure that the company’s strategy is supported by the procurement strategy. The presence of this council will strengthen the role of the procurement function through the commitment of senior management. The council can help remove any obstacles within the company for the function as well as encourage cross functional communication and access to information about upcoming projects and new strategies.
- Align and Staff the Procurement Function: There are many possible structures that can work for a procurement function. For some companies a centralized department is the best way forward. While for others, a more decentralized approach with procurement professionals present in each department works. Still others may choose a combination of these two possibilities with perhaps strategy at a centralized level with execution at a departmental level. The right structure needs to be followed up with the right people as well. The people running the procurement process need to have excellent supply chain management skills and knowledge. But in order to move up and join management teams, there also needs to be an accompanying focus on strong communication and relationship building skills, strategic thinking and a value focused approach.
- Select the Right Technology: Not all procurement software will automatically improve efficiency. Rather, there needs to be an assessment of current processes first to understand where improvement is needed, and then a selection of the software that meets that requirement. The right system will allow data to be taken in and meaningful information to be retrieved.
- Ally with Key Suppliers: Instead of just working on a contract to contract basis, best in class companies with form strong relationships with suppliers. Through effective two way communication, both supplier and the company will work together to strengthen the relationship. This method allows for a place where problems can be resolved, work can be done on continuous improvement and value creation and helps ensure that performance objectives are met.
- Create Collaborative Strategic Sourcing: One step beyond strategic procurement, a collaborative approach involves internal customers in the process of making decisions. With feedback channels created, there is meaningful conversation about procurement objectives and strategies which leads to lower costs, efficient processes and better responsiveness to customer needs.
- Look Beyond the Purchase Price: A focus on total cost ownership allows a move from just an eye on the purchase price to the complete cost of owning and using an acquired material or service. Rather than making a supplier decision based on the price quoted in a bid, it is a better idea to consider costs such as operating, storing, maintenance, training requirements, environmental impacts, transportation and the costs of disposal.
- Manage Contracts within the Supply Chain: Effective contract management can ensure that contract stipulations and timelines are met and followed. A central repository of all contracts should be created and maintained, which can help mitigate risk, reduce costs and ensure compliance to agreed terms. It can also help create a history of spend and relationship with particular suppliers.
- Establish Control Levels and Minimize Risk: Policies and procedures for procurement need to have structure and a sequence. They also need to be reviewed and updated regularly to remain relevant and effective. There is a stronger chance of the processes being followed if they are realistic and easy to understand. The right balance of complexity and control needs to be created when looking at these policies and processes. There should be no bottlenecks and there should be a smooth running process with the right controls to deter theft, fraud, and other issues.
Risk mitigation is an important aspect of procurement that needs to be a part of the policies and controls. The important aspects here are to identify all risks, determine the probability of a risk occurring, assess the cost impact of the risk on the procurement activity and prioritize for prevention and monitoring.
ENSURING ETHICS IN PROCUREMENT
The procurement function is often affected by ethical violation and scandals. To reduce the risk of these events, a company can take some steps to strengthen the ethical side of its procurement function and prevent ethical lapses.
- Create an Ethics Policy: The presence or written policies highlighting what is acceptable and ethical by the top management are necessary to help counter any possible ethical issues that arise.
- Conduct Ethics Trainings: It is not a good idea to assume that the ethics policies are clearly understood by all employees automatically. Rather it is a good idea to hold information and training sessions to ensure that everyone is on the same page about acceptable behavior and actions
- Appoint an Ethical Regulator: Appointing a person from the organization that employees can communicate in confidence about any potential ethical concerns. The presence of this person can be a balancing force between stronger senior employees and other employees.
- Management Review of Processes: The procurement processes should be subject to review by management to ensure that no violations occur
- Audits: Regular audits should be performed on procurement processes and activities to ensure ethical compliance. The possibility of audits, conducted thoroughly and regularly can act as a deterrent to any potential ethical problem.