Procurement as a process is a little more complicated than just buying office supplies – since many organizations have entire teams dedicated to their procurement and purchasing activities. So what exactly does it encompass?
We’re going to thoroughly explore this vital component of corporate strategy. From what the process entails, the many ways to approach and adopt it, to related business concepts, you’ll learn how to utilize and improve this process to better achieve your individual business objectives.
What Defines Procurement?
Regardless of size or industry, no business is entirely self-sufficient. Everyone relies on purchasing goods and services provided by third-party suppliers to maintain internal operations and or manufacture products to sell.
Procurement involves not only deciding on what to buy based on needs and budget, but also ensuring that the company is receiving enough value from the purchase. We all perform this work ourselves as individuals. Any purchase you make depends on the quality of the product, the amount of time it takes to be delivered to your doorstep, how much value you’ll get out of your purchase, and many other factors.
But the process involved for businesses, nonprofit organizations, and governmental bodies is even more complex. In addition to finding out what goods and services offer the best value for money, procurement involves:
- Determining needs based on inventory management and market demand
- Planning the budget and inventory far in advance
- Conducting market research to find the ideal third party vendor
- Negotiating contracts with suppliers and undergoing competitive bidding
- Handling vendor relationships
- Performing quality assurance on the received goods and services
- Ensuring that the supply for a raw material or an essential service is always in stock
- Maintaining a purchase order record and other ways to measure procurement performance
For direct procurement (which we’ll explore in more detail below), you can think of procurement as a systematic approach to acquiring goods and services within a supply chain. A procurement officer needs to handle all the activities involved with finding the right goods and services a business needs, all while staying aligned with the overall goals of the business.
This broad definition just scratches the surface for what the concept entails. Let’s expand upon it now.
How Procurement Fits Into an Overall Corporate Strategy
Don’t think that this process only matters to the financial department. Procurement actually has an overarching function linked with other aspects of running a business. The profit margin and bottom line are the first consideration of a buyer’s business during a B2B transaction.
Beyond the financial aspects, procurement strategy directly impacts the overall corporate strategy in a few ways.
- Corporate identity. What are the beliefs of your organization, and what does it stand for? The answers to these questions must align with your choice of goods and services. For example, if you pride yourself on environmental friendliness, the suppliers you choose better match that dedication.
- Position in the market. Who is your target audience, and what do they expect of you? Choose your vendor relationships in a way that matches with the needs and preferences of your client base.
- Human resources. Whomever you hire ultimately affects how the procurement process is approached. Are you hiring a properly experienced procurement professional, or should you entrust purchasing activities to someone else?
It makes sense that administrators often put a lot of time and effort into creating and staffing a procurement department since it basically defines the business model.
The Types of Procurement
This process is often subdivided into a few categories: direct, indirect, and service. How much each type is used depends on the company, but all of them play an essential role.
Some goods and services are required for the creation of your product lineup. A laptop manufacturer, for example, needs to order individual computer components like memory, batteries, and displays. This type of direct purchase is common in the manufacturing industry in general.
Because this category directly impacts your revenue and growth, the supplier relationship matters in the long-term, as not many companies change raw material sources often.
Other purchasing activities are intended primarily to serve the internal, daily operations of the business like purchasing cloud-based software solutions, office equipment, travel expenses and utilities. Acquiring goods in this sense “keeps the gears turning,” so to speak, and is most common in service-based industries.
The goods and services we’re talking about here are often consumable and temporary when compared to that of direct procurement, hence why the supplier relationship is often treated as short-term. However, forming trusting supplier relationships within indirect procurement are also important, and can serve buyers when shopping around for best prices and renewing contracts.
Companies never operate entirely as a homogenous group; you need ways to connect employees and processes together. You might pick up professional consulting services, software subscriptions, or contingent workforces to do so.
Services procurement, which “fills in the gaps” to generate a smooth workflow, often results in contract-based relationships with vendors.
Key Differences Between Procurement and Purchasing
One question that inevitably comes up is how to differentiate procurement vs. purchasing. The concepts are entwined but not the same, as procurement refers to more than just purchasing activities.
Procurement involves the subset of unique processes that take place when an organization is sourcing something. These include negotiations with various vendors or suppliers, the process of onboarding vendors to the organization, and the strategic selection of goods and services based on an organization’s budget, values and more.
Purchasing, simply put, relates to the process of how goods and services are ordered. Purchasing sits within the larger process of procurement. To help differentiate the two further, keep in mind that they differ in terms of:
The purpose of procurement is to fulfill a certain company need in a manner that is strategic. This goes beyond the simple process of ordering a service or good, and digs deeper into the process of exploring different options and identifying the most ideal one based on certain criteria the company defines (like cost, location of the provider, etc.).
The purpose of purchasing is to arrange company spending and acquire the chosen good or service.
The process of procurement tends to place more emphasis on the value of a certain good or service, more so than its cost. Purchasing focuses more on price than value, which makes sense considering that purchasing centers around company expenditure.
Order of Operations
Remember when we mentioned that procurement involves the act of purchasing something? Indeed, purchasing fits within the larger scope of procurement. The scope of procurement activities extends from identifying a need all the way through to fulfilling it, with purchasing standing as the point toward the end of the procurement process when the need is fulfilled.
We’ll delve deeper into the exact steps of procurement, but for now, having a basic understanding of the different tasks involved in procurement can really help solidify the ways procurement differs from purchasing. The tasks involved in procurement differ to some degree across companies, and typically involve:
- Identifying the need for the good or service
- Submitting a purchase request
- Exploring the different available sourcing options
- Negotiating and closing contracts with selected suppliers
- Onboarding suppliers and collaborating on related documentation
- Creating a purchase order
- Receiving the good or service
- Conducting three-way matching
- Approving the invoice and executing payment
By contrast, purchasing focuses on fundamental tasks surrounding obtaining the good or service: ordering, receiving, and payment. That is, it focuses on transactional activities like purchase order handling, purchase requisitions, and payment processing.
Impact on Suppliers
It’s important to consider that suppliers or vendors are a key element to both procurement and purchasing processes. For each of the two processes, the supplier’s point-of-contact within the company may be different. The supplier’s relationship with each of these POCs will most likely also be different.
The person responsible for purchasing from the business’s side will be more focused on executing the transaction most efficiently, whereas the person or people involved in procurement will be interested in developing a friendly and mutually beneficial relationship with the supplier.
Differences with Other Related Workflows
Even some professionals make the mistake of using procurement interchangeably with related processes like sourcing and supply chain. Let’s clear up those terms next.
Procurement vs. Sourcing
Sourcing, like the purchasing process, is considered a subcategory of procurement. During this step, a business searches for potential suppliers for the goods and services it needs using data from market reports and industry experts. It will consider various factors of each vendor, including:
- Cost and quality
- Supplier certifications
- Financial risks
- Tax costs
- Potential logistical problems
It’s heavily recommended not to limit yourself to a single source. Not only is it more difficult to negotiate competitive rates this way, but you also put yourself at risk of potential disruptions if that supplier is undergoing difficulties.
Market awareness is key here, as a buyer will be able to take advantage of new opportunities and changes in the range of suppliers.
Procurement vs. Supply Chain
Another commonly confused term is supply chain management, of which direct procurement is actually a component. Procurement refers to the upstream work of obtaining goods and services for maintaining internal operations and manufacturing products. The supply chain covers both upstream and downstream workflows for the creation of a business’s product line.
To be more specific, the supply chain workflow picks up after procurement finishes. The steps that follow are:
- Manufacturing the business’s product output
- Transporting those finished units to wholesalers, warehouses, and distribution centers
- Distribution to retail
- Final sales to end consumers
Quality control and logistics matter significantly in the field of supply chain management. The goal of the process is to increase revenue while keeping supply rates and customer satisfaction up. As long as the output of your company reaches the hands of the consumer seamlessly, supply chain management is doing its work.
What Makes Up the Procurement Process?
First, we need to understand how it flows. What exactly happens in the boardroom of a procurement or finance department meeting?
What Is the Procurement Process Flow?
From a requisition to a purchase order to the approval of the invoice, procurement refers to a set of steps unique to every business that practices it. Nonetheless, you can find 3 constituents common to all applications of procurement.
- Procedure. The company should specify exactly what steps must be completed while reviewing, accepting, and receiving orders from suppliers. A disorganized or poorly implemented procedure results in inefficiencies and potential mistakes that can lead to delays and missed payments.
- Administration. Who are the stakeholders here, and what responsibility does each one have towards the success of the workflow? Are proper authorizations being made at each step? The larger the organization and the more important the purchase, the larger the number of people involved becomes.
- Documentation. Paperwork is simply a reality of procurement process flow, as storing information later for reference and auditing makes it hassle-free for both the buyer and the seller.
A process flow is essentially a flowchart detailing what the next step is regarding the purchase process. When everyone knows what the whole procedure looks like, procurement becomes transparent and fair for all. A chart also helps you identify potential areas of improvement or gaps in the process.
What Are the Steps Involved In Procurement?
The exact flow differs from business to business, as every company has its own requirements, needs, and preferences. Let’s take a look at a typical example of flow:
- The business identifies a need. Department heads, managers, and other stakeholders collaborate to find and justify what they need to buy. Inventory control plays a role so that enough stock for raw materials and services is always available to the business without paying for too much.
- The stakeholders write up a purchase requisition. If a supplier is already available, the request to buy is sent to the designated approval team responsible for ensuring that orders are in line with business objectives. Upon approval, the order becomes a purchase requisition.
- … or an RQF. If a supplier is not available yet, the procurement department sends out RFQs, or Requests for Quotations to find an ideal vendor. This step can be direct negotiation or an auction-based tendering process. Market analysts compare supplier quality and determine which ones would result in the best return on investment for the company.
- Requisitions are reviewed. In either case, an approval stage follows where end users and department heads decide whether or not the need is valid and funding is available. If approved, the order becomes a purchase requisition that details the exact technical specifications and other attributes of that order.
- The purchase is made. Once approvals are complete, contracts are negotiated, and the vendor is decided upon, the vendor delivers the goods and services. Upon receipt of the order, the business undergoes a 3-way match, where the purchase order, the vendor invoice, and the delivered goods are all cross-checked to ensure accuracy. Any discrepancies or issues with the delivery are brought up early on to prevent problems later.
- A record is made of the transaction. The procurement team’s task does not end at the final transaction. It’s also responsible for keeping tabs on all this financial activity in a central location. In case issues come up or auditing is needed later, looking back at records is the best way to develop solutions.
Among the sub-processes of procurement are demand planning and forecasting, the selection of suppliers, vendor negotiations, and KPI assessment.
Demand Planning and Forecasting
You don’t have to be an expert to know that market research matters. Keeping customers engaged with your brand means not only delivering on what they want but also doing so in a timely manner.
For a procurement department to plan its purchase orders and inventory stock properly, it must predict fluctuations in consumer demand and make adjustments accordingly. Otherwise, the organization risks being understocked and failing to meet demand or being overstocked and losing revenue to unsold units. The advantages here include:
- Proper handling of spikes in demand. Holidays, natural events, or even seasonality can cause spikes and dips in demand that the supply chain will struggle to meet if not for proper demand planning.
- Labor management. Having too many or too few staff members can be costly for the manufacturing process. Avoid delays in production by hiring temporary additional staff members when you need them.
- Cash flow management. In addition to preventing unsold inventory, demand forecasting tells financial teams when to arrange for credit to bridge dips in demand.
Using factors like historic customer activity, current events, and data analytics, a business can adjust the supply chain to match what the expected output should be.
Whether it’s local or international, the right choice of a vendor will give you the most cost-effective service for what you need. Businesses issue RFIs (Requests for Information) to gain knowledge of various vendors, including their financials and previous activities. Cross-referencing these documents with your needs is part of the selection process.
From there, you can start issuing RFQs to detail the nature of your order, such as its volume and expected timescale. Once a supplier is chosen and tendering evaluation has begun, it’s time to check on the terms of the contract. You might look at:
- Price comparisons with other vendors
- The ability to fulfill the order accurately
- Quality of the product or service
- Credit checks
- Supplier audits
A procurement contract follows that will specify terms and conditions to minimize risk for both parties. You will use this document for maintaining supplier relationships, resolving any issues, and measuring your key performance indicators (KPIs) later.
Having a positive relationship with your suppliers will put you on good terms with the industry, improve future procurement activities, and might allow you to manufacture products faster and bring them to market before the competition.
Often described as an “art,” negotiation requires both personal skills and financial awareness to pull off effectively. When done right, it allows both your business and the supplier to come to terms that benefit both parties. In terms of procurement, that means the best price at the best quality at a reasonable timeframe.
Negotiating in business can rarely be done in a day. Expect to talk for multiple days before you reach agreeable conditions. Tested negotiation strategies include:
- Researching your vendor or supplier. What motivates the supplier to do well in its field? Understanding what the deal looks like from its perspective helps you find where you can appeal to its interests.
- Having a base price rather than a range. It may be tempting to offer a price range to your vendor up-front, but usually that strategy results in the highest price in that range being agreed upon. Be direct about your minimum price beforehand.
- Be flexible. You will inevitably have to compromise in some situations, so don’t go in with too many concrete requirements.
- But know what you can’t accept. Remember your non-negotiable factors as well so that you don’t end up with an unfavorable agreement. Establishing fundamental requirements is still necessary in most cases.
- Know when to give up. A skilled negotiator will know early on whenever agreeable terms cannot be met. Always have solid alternatives in place, which will give you something to fall back on and potentially be a point in your favor during the meeting.
There are far more aspects to strong negotiations than we can cover here, but some techniques and pitfalls to watch out for are:
- Preparing in advance. Finalize an agenda for the meeting and do your research on the vendor beforehand to answer any questions quickly. The more prepared you are, the faster the process can be for both parties.
- Choosing the right people to join you. What team members in your company are best at building a rapport with the vendor? Strong communication skills obviously matter when it comes to negotiation.
- Have an ending summary. At the conclusion of the meeting, summarize all the agreed-upon points in writing to prevent misunderstandings.
- Avoid aggression. Remember that negotiations aim to build positive relations for both participants. It may be tempting to take the aggressive route, but keeping emotions mitigated and avoiding arguments are always ideal.
Negotiation is a complex field that requires strong personal skills, prior research of the vendor, and the right strategies and tactics to pull off effectively.
It’s much easier to understand the progress and performance of your business when you have KPIs to measure against. If any of these metrics dip below acceptable levels, procurement teams will know exactly when adjustments should be made. The following are the essentials.
- Purchase order cycle time, cost of each PO, and lead time.
- Supplier availability, quality, and compliance level.
- Return on investment, including savings and cost avoidance.
Procurement key performance indicators come in many forms. Additional ways to measure success include:
- Inventory. Warehousing management is a common bottleneck for procurement efficiency. KPIs to measure here include stock and fulfillment accuracy, back order rate, and inventory turnover.
- Employees. How effective is your staff training? What percentage of your employees are performing well or underperforming? Questions like these matter since staff productivity has immense implications for procurement.
- Timeframe. Speed can be just as important as cost when it comes to inventory procurement. Pay attention to lead time, purchase order cycle time, and other factors.
- Return on investment. There are always ways to optimize your investment, whether it’s determining cost per order or finding competing suppliers to purchase from.
Measuring success through KPIs not only helps you track progress but also convinces upper management of the importance of procurement.
Who Works on Procurement?
Though procurement is an important and complex task, not all organizations have a dedicated team. Smaller organizations usually put the finance team in control of the procurement function, while larger companies with more complex purchasing requirements may employ a dedicated procurement team to work alongside finance and AP.
A qualified team can streamline the business’s spending through:
- Risk management
- Cost savings
- Understanding of compliance
- Contract management
At the same time, procurement must also involve collaboration among other departments as well. It’s vital to maintain direct lines of communication with the sales, operations, marketing, distribution, manufacturing, and finance departments.
At the helm of most dedicated teams are the chief procurement officers (CPOs) who typically also serve on the board of executives. These professionals align procurement and supply chain efforts with the goals of the company.
Designing a Procurement Strategy For Your Business
Even if your business already has procurement processes and related systems in-place, it’s never too late to set up a strong procurement strategy to take advantage of the benefits. Want to strengthen sales, inventory, and procurement management in your organization but not sure where to start? Let’s look at the wider procurement process and what can be done to craft an effective and compliant system.
There are a few key elements to designing a solid procurement strategy:
- Understanding how procurement happens within your business today
- Ensuring that you cover the main pillars of procurement
- Adopting the right procurement models
- Understanding how technology can help make procurement the best process in your company
How Does Procurement Look Today?
Developing a strong procurement strategy must begin with an understanding of how procurement happens within your company today. This requires a deep look at how goods and services are currently being procured, and where the related pain-points lie.
When you explore your current procurement operation, consider these questions:
- What elements of the procurement process are unclear or confusing to employees?
- At what stages of the procurement process is the flow bottlenecked?
- What systems are involved in the different stages of procurement? Do these systems communicate?
- Who uses and has access to each of these systems?
- Is procurement-related information saved in a centralized location, or locally within employees’ individual folders?
- How is procurement-related information that is stored in email or in files like Excel managed?
- Who are the different team members involved in procurement?
- What forms of communication are used with suppliers?
- What systems are used for vendor onboarding?
- What systems and forms of communication are used for vendor relationship management?
- Where is vendor data saved? Who has access to this data?
- Where is purchasing data saved? Who has access to this data?
- At what stage in the procurement flow is the budget consulted? Are budgets always up-to-date?
- Where is budget information saved? Who has access to this data?
Start with what you have and work from there to build improvements and make the entire system seamless from end to end.
The Pillars of Procurement
Procurement in general serves its role on both a national and local business scale. It promotes healthy and active economies while ensuring the best-performing vendors get the business they deserve. There are five pillars procurement relies on for this purpose. What you should look out for are:
- Ethics. Unethical practices and lack of transparency will damage the quality and value of the products and services being delivered.
- Equity. A fair and uniform procurement system ensures that all entities and industries have a chance to succeed.
- Competition. A vendor selection initiative free of bias enables a fair market where getting the best value for your money is possible.
- Accountability. Everyone involved deserves to be held accountable for a part of the process. We emphasize the importance of record keeping for this reason.
- Value. Don’t just go for the cheapest price. Compromising too much on quality reduces the value of your product or service you’re selling to clients.
Remember: you’re working not only for the profit margins and bottom line of the company but also a better market for all the players involved.
Starting with a Template Model
The fine details of procurement are the responsibility of your own business, as exactly how the system works varies from company to company. Firms can be small or large, be centralized or global, and run on different models accordingly.
- The local model. Decision-making is done at the departmental level in this model, with the idea that local departments have a better understanding of their local circumstances and can make decisions without bureaucratic resistance. At the same time, these teams miss out on the larger perspective and might not be held as accountable as a team on the centralized model.
- The centralized model. By contrast, this model has one department with complete control over procurement in a firm regardless of how many regional locations it might have. A centralized approach allows the overall budget to impact purchasing decisions everywhere and has a chance of ordering in bulk, opening the door for discounts. At the same time, the specific needs of local departments might go under the radar as a result.
There are strengths and weaknesses to both approaches, so it’s not uncommon to see a hybrid model, also known as “center-led procurement.”
How Technology Helps
For many businesses, especially larger ones, procurement is no small headache. The processes are often lengthier than desired and sometimes result in the company spending more than it has budget for.
This stems from a few common scenarios:
- The company’s Finance and Procurement teams are using separate systems that do not communicate. This results in relevant information being accessible only to certain relevant parties, which often slows down procurement processes and creates a misalignment between budgets and spending.
- Communication about procurement processes between company employees happens in various ways (email, in person, Slack, etc.) that are difficult or impossible to track and manage efficiently.
- Employees are unclear about the specific documentation they need to request from suppliers. This results in suppliers needing to endure a lengthier and more complicated process for collaborating with the business.
- Budgets are visible only to a select few, and budgets are updated only after purchases are made. This results in organizations easily slipping into the cycle of spending over-budget.
- There is no unified database with vendor information. Employees have no easy way to understand who the company’s preferred suppliers are. This results in multiple suppliers being used for the same service, and gets in the way of businesses consistently using suppliers who offer superior service at the best prices.
So what’s the solution? Procurement software, also known as eProcurement, deploys electronic sensors and data analytics to predict patterns and forecast future procurement decisions. Procurement software has also extended its capabilities beyond data entry and bookkeeping. We’re seeing artificial intelligence, machine learning, and even blockchains enter the fray.
- AI can be used in the supply chain for demand planning and forecasting. Analyzing a large amount of data is fast, scalable, and easy.
- Machine learning can generate accurate predictions from that data to help plan out logistics, spending, and forecasting.
- Blockchains are a relatively new addition for recording transactions in a digital ledger and boosting traceability in the process.
We’re seeing all the steps involved in procurement like RFQ processing, workflow approvals, and supplier contract management become more streamlined thanks to automated software. Businesses are finding out that monitoring the supply chain, improving communication, and generating audits are easier through procurement software. Some bonus features to add to the mix are:
- Integrations with current enterprise software like accounting applications and enterprise resource planners.
- Mobile notifications for alerts whenever stock reaches reordering points
- Automatic distribution of purchase orders, confirmations, and other documents.
- User-friendly interfaces and dashboards for effortless administration and control.
- Cloud-based offerings are making these programs more accessible to even smaller companies.
Suppliers especially see the advantage in bidding software. Reviewing requests for proposals and quotations and competitively bidding on each is a much more efficient way to handle communication.
Procurement software, an extension of Industry 4.0, is the new way of digitizing supply chain work to boost productivity beyond the manufacturing line. Automation and “smart” technologies have been at the forefront of reducing repetitive tasks so that professionals can focus on more important aspects of the business.
Where Your Future in Procurement Lies
Now that you have an understanding of what the practice of procurement encompasses, its many types, how it fits into the overall workflow of an organization, and ways to design and improve a procurement system, you are already better prepared for a smoother purchasing process than most.
By focusing on boosting performance, streamlining approvals, and controlling corporate spending, you will find that your product output quality goes up, customer satisfaction rises, and costs stay within budget.
With the growing trend in digitization, there are even more ways to streamline procurement. Not only can you develop new techniques to gain access to all the goods and services required to run your business, but you can also do so in a more precise and cost effective manner. Software ends up being an excellent solution for automating manual processes, reducing time spent and saving on costs.