What Is Procurement? Complete Guide For Businesses
With markets undergoing tremendous change faster than ever, many businesses are increasingly reinventing their business models, processes, and products to keep up. For procurement teams, it has never been more important to innovate and redefine practices to provide value.
When procurement leaders were asked to rate the effectiveness of their procurement processes in reporting and promoting the savings generated for their organizations, less than half (48%) of the survey participants said they were very effective at doing so.
In other words, many procurement departments still have a ways to go before they can truly consider themselves effective or efficient.
What Is Procurement?
Procurement is a core business function that involves the acquisition of goods and services, typically for business processes like manufacturing and production. Essentially, procurement happens when one business buys from another business, often on a relatively large scale. It's also worth noting that procurement refers to the act of buying goods and services not the seller's activities.
Whatever the case, procurement will always involve two parties - a buyer and a seller. Procurement is often a vital supply chain management function in many organizations, especially those that depend on raw materials and supplies from other companies to make their final products. Because of this, procurement and all processes under it often require a significant portion of the company's time and resources.
In many companies, procurement teams are often given a specific budget (which can be fixed or throughout the year) when purchasing goods and services they need. To control and reduce procurement costs, managers will devise and implement procurement strategies to ensure profitability and ensure their practices align with company standards.
While different companies have different approaches to procurement, most teams and departments typically deal with the following activities-
- Supplier/vendor selection
- Payment negotiation
- Contract negotiation
- Final purchase
10 Stages of Procurement
To the casual observer, the procurement process can appear to be relatively simple. But a closer look will reveal that it involves multiple activities and steps that follow this workflow.
1. Identifying Requirements
The first step in buying goods and services is figuring out what's needed in the first place. This could turn out in one of two ways-
- Identifying the need to buy a new product or service
- Reordering a product or service when existing stock or output falls below a certain threshold
In many companies, this step may require consultations with key stakeholders before any purchase orders can be approved. This ensures that purchase decisions don't overlap or lead to issues down the line.
2. Identifying the Specific Details of Requirements
Once the procurement department confirms a need for a good or service, the next step is to determine the details of the purchase. This would generally involve looking at the technical specifications of a product, part, or component and determining the quantities of each.
If this is the first time the company is procuring an item, the procurement team will have to consult all technical people involved in the purchase. For services, the scope and length of time the service is needed are the two things that will need to be confirmed.
In any case, procurement teams must get feedback from key stakeholders across different departments to ensure that they obtain the right goods and services. This will prevent expensive mistakes and any need to return unnecessary items.
At this stage, the procurement team will conduct the necessary research to look for vendors that can provide the required item or service.
For new purchases, the team will go through what can be a lengthy process of identifying and vetting potential vendors to determine their quality, pricing, reliability, and compliance with legal requirements. One way to expedite things is to work with vendors the company has existing relationships with. For repeat orders, the team can simply choose from a list of existing vendors.
The procurement team will then request and compare quotes from different vendors before making a final purchase decision. A good rule of thumb is to narrow a selection of vendors down to three quotes and running them through the appropriate managers for approval. For companies that require a bidding or tendering process, any bids, tenders, or proposal requests must be published for transparency.
4. Negotiating and Finalizing Terms
When it comes to direct purchases, quotes from vendors will be compared based on factors such as price, speed, and features. Vendors will also be selected based on soft factors, such as promptness, responsiveness, and quality of service. The procurement team can negotiate the terms of the purchase with each vendor to get the best possible supply at the best value.
For procurements that require a bidding or tendering process, the selection process will be based on a set of terms and conditions disclosed to all bidders. The bidding process and the result should be made public for fairness and transparency.
5. Purchase Requisition
Many organizations require their procurement departments to generate a purchase requisition document, which serves as the official notice seeking permission from the appropriate authority to buy goods and services. Once approved, the document will generate a purchase order - another document that contains all the purchase's specifics, including all pertinent terms and conditions.
Procurement teams should also make it a point to compare the purchase order with the purchase requisition and the supplier quote to prevent any discrepancies from causing problems.
6. Sending the Purchase Order to the Supplier
Procurement teams can send purchase orders to suppliers through fax, email, or through procurement software. Ultimately, however, the delivery method should be defined in the terms agreed upon by both parties.
7. Timeline Creation
This involves setting a timeline for the delivery of the purchased goods and services from a supplier. The timeline should also factor in any contingencies that may delay the delivery.
Buyers are responsible for inspecting any supplied goods and services and ensuring that they match the specifications outlined in the purchase order. If everything checks out, the buyer approves the delivery.
However, if the quality or condition of the supply deviates from the terms accepted by both parties, the supplier will have to retake the delivery until the problem is fixed.
The procurement team forwards all documents relating to the order to the company's finance department. From here, the details of the original purchase order will be compared with the shipping document and payment request invoiced.
Any discrepancies will have to be resolved before payment is approved. If there are no problems, the payment is made through the channels defined in the contract's terms and conditions.
10. Record Keeping
Both the buyer and seller are expected to maintain accurate records of all purchases and sales for auditing and tax purposes. For procurement teams, accurate record-keeping plays a vital role in these processes-
- Reviewing supplier performance
- Monitoring transactions to settle disputes
- Comparing old quotes and contracts with new proposals and quotes
Excellent record-keeping also makes it easier and faster to re-order the same goods and services.
3 Components of a Procurement Plan
When creating a procurement plan, companies and their procurement teams need to account for three critical components.
The number of people involved in procurement will largely depend on the company's size and the procurement orders it generates.
For instance, small and medium-sized enterprises (SMEs) may have a few personnel dedicated to procurement. Sometimes it might even be done on an ad hoc basis.
Larger companies, on the other hand, may have dedicated teams during each stage of the procurement process. This is especially true for critical or high-value procurements, where the level of detail and approval requires the participation of the C-suite executives.
Even the most informal procurements involve some kind of repeatable or routine process. To be efficient, however, procurement teams need to design organized and well-thought-out processes that logically flow from point A to point B.
This reduces discrepancies and the chances of issues delaying orders and deliveries. Procurement processes should also be transparent to prevent corruption and comply with legal regulations.
Keeping documents as well as records of transactions and messages through each step of the procurement process allows both the buyer and seller to hold each other accountable. For procurement teams, records are vital to tracking supplier performance and procurement costs.
Key Principles of Procurement
Procurement departments and teams can ensure the effectiveness of their processes by embedding these principles into their practices.
- Value - While the procurement process should focus on getting as much value from the suppliers as possible, this doesn't necessarily mean basing decisions on price alone. Factors such as customer support and quality of product and service are also critical value factors.
- Fair Competition - An open and transparent vendor selection process creates a level playing field for all suppliers. The more transparent the procurement process is, the less likely the company is to exposes itself to legal issues. It also makes it more likely for the company to find suppliers that can provide the best value for money.
- Ethical Practices - Unethical practices taint the company's reputation and skew the vendor selection process, compromising the quality of procured goods and services.
- Accountability - Accurate record-keeping allows both buyers and vendors to hold each other accountable.
- Equity - Creating a fair system and treating existing and potential suppliers uniformly will ensure that everyone gets an equal opportunity to thrive.
Types of Procurement Models
While every company will have a unique approach to procurement, most procurement teams will employ methods under one of the following models.
- Local Model
The logic behind this approach is that procurement staff and managers are in the best position to understand the department's needs, making it more efficient to delegate decisions to them rather than go through the slow and meandering process of seeking approval from high-level executives. However, the local model also presents the risk of maverick spending that does not align with business goals.
- Centralized Model
Teams and departments, on the other hand, are in charge of negotiations. The downside to this model is that the layers of bureaucracy required to approve purchases can make procurement processes slow and less agile.
- Hybrid Model
Like any other vital business function, procurement requires careful preparation and a proper strategy. And while its activities tend to center on an organization's procurement team or department, it is ultimately a function that involves everyone in the company.
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- What Is Procurement? Complete Guide For Businesses