How Procurement Works in a Modern Business
Procurement is a critical part of supply chain management. Regardless of the size of your company, applying discipline to the process by which you acquire goods and services directly improves your bottom line.
Good procurement practices also allow you to monitor the quality of the materials you buy and apply your company strategy and principles in what is often the biggest expenditure on your books.
Here we’ll look at procurement from the perspective of a typical small to medium enterprise (SME). Businesses of this size often have the most flexibility in how they approach procurement. They have a lot to gain from studying procurement best practice, and have the freedom to create a procurement system that suits their particular needs.
In this guide
What is procurement?
Procurement is the process of purchasing goods and or services for use in a business – or an organisation such as a government department. Procurement encompasses the actual purchasing process – from issuing a purchasing order request through to invoice payment – but also includes the surrounding planning, strategy and procedures that allow for control and optimisation of buying behaviour.
When we use the term procurement we’re looking at the exchange of goods or services from the perspective of the buyer. From the perspective of the vendor the same activity is a sale.
Direct versus indirect procurement
Direct procurement is the process of buying raw materials, components and parts used in the production of finished goods. Or, for a merchandising company such as a wholesaler or retailer direct procurement is purchasing finished goods for on-sale.
So for a brewer, direct procurement involves purchasing hops, yeast, grain, cans and bottles; while for a liquor store direct procurement is buying the finished cans and bottles of beer.
Indirect procurement is the process of buying materials indirectly used in either of the above scenarios – for example the electricity used by a manufacturer, or uniforms purchased by a grocery chain.
Direct and indirect procurement are often handled by different departments in a firm, with a procurement manager typically mainly responsible for the direct procurement budget.
Why procurement is so important in supply chain management
Regardless of the size of your business there are benefits to having a sound procurement process – and risks to doing it wrong. Reasons why procurement is important include:
Along with labour costs, the purchasing of raw materials, components and stock is likely to be one of the largest expenses in your company. Good procurement practice will see you seek out the lowest price for equivalent goods and services, and review those purchasing decisions regularly to ensure your direct materials costs remain low.
While buying in bulk will reduce the price of goods, good procurement practice must balance the cost of goods purchased with proper inventory management.
For instance a bakery chain could buy fresh eggs in bulk at half price. However they would lose money if too many eggs spoil or break before they can be used – and if holding more stock lifts their warehousing costs too.
Another consideration that must be balanced against the unit price paid is the quality of goods purchased. A good procurement system can enforce quality control measures during the purchase process.
For example procurement within the construction industry can create discipline around proper certification of steel strength. Or an organic juice bottler might require orchardists to file a relevant organic certification number before winning a contract.
Optimising supplier contract terms and conditions
An unglamourous but important part of procurement is setting the right terms and conditions for your needs. More than just explaining your payment terms, your supplier contracts should set out specifications for the goods to be supplied, warranty periods for any defective goods received, confidentiality and intellectual property details, termination clauses and more. Carefully drafted contracts set out what you expect – and what happens if things go wrong.
Planning and strategy
A well-functioning procurement system works hand-in-hand with forward planning. For example a new product launch can only proceed if the right components are secured ahead of time. And a price point for the new product can only be set by sales and marketing once the cost of materials is known.
Similarly, a cost-effective product business must avoid production halts and stock outs, both of which require the support of smooth and responsive procurement.
Policy typically plays a big role in government procurement, where anything from trade policy to anti-money-laundering legislation affects how public money is spent. Robust procurement processes are also an important check against cronyism, where contracts are awarded even when they’re not in the best interests of the buyer.
Meanwhile in business procurement, company policies around purchasing are increasingly informed by issues such as stakeholder pressure around corporate social responsibility (CSR). So while a chocolate maker might be able to source vegetable oil most cheaply from palm oil plantations, a CSR procurement policy might dictate that it be purchased from more sustainable sources.
Procurement management and procurement managers
While larger organisations will have a procurement department with several staff, many small firms will run their procurement out of accounts payable, with responsibility for purchasing bundled into one or two other positions.
However as a business matures the need for a dedicated procurement manager typically grows. Here are some of the key responsibilities, skills and attributes required of modern procurement managers.
Procurement managers – the scope of the role
A procurement manager is responsible for all purchasing and procurement activities, and oversees a firm’s ‘spend under management’ – a term for the funds that a business uses to acquire goods and services.
A procurement manager can be tasked with:
- Ensuring security of supply for the company
- Optimising the use of funds under management
- Predicting, managing and mitigating risk in the supply chain
- Building relationships with potential suppliers and partners
- Maintaining a company’s approved supplier list
- Managing any tender processes within the company, and preparing documents such as Requests For Proposals (RFPs) and Requests For Quotation (RFQ)
- Evaluating multiple offers from suppliers and selecting a winner
- Negotiating and preparing contract documentation
- Supplier quality management – evaluating the performance of existing suppliers and enforcing compliance
- Setting policies and guidelines for procurement within the company
- Hiring and training procurement staff
- Ensuring any technology platforms used for procurement are sufficient for the company’s needs
- Monitoring procurement KPIs and lifting performance
- Reporting to key stakeholders
Traits of a good procurement manager
Naturally these responsibilities will vary with the size and complexity of the firm. However given the potential complexity of the role, procurement managers need a versatile set of skills. Good procurement managers:
- Are fiscally responsible and detail oriented
- Possess solid negotiation skills
- Communicate well with diverse stakeholders, both internal and external
- Have a service mindset towards their own company
- Can think strategically
What’s the difference between purchasing and procurement?
What is the difference between procurement and purchasing? Essentially procurement is strategic, while purchasing is practical.
Procurement encompasses all of the functions of purchasing, but also wraps around the broader policy and strategy. Procurement also involves pre-purchasing activities such as research, negotiation and planning – and can include functions such as supplier quality management, risk management and reporting.
Purchasing meanwhile focuses on the purchasing process, including raising purchase orders, receipting goods and services and authorising payment.
The procure to pay cycle
A term often used in the context of using software to aid procurement is ‘procure to pay’ – or the procure to pay (P2P) cycle.
Essentially this is the full lifecycle of procurement broken down into steps, and recreated as functions within a technology package.
The exact details of the procure to pay cycle vary according to which software vendor you speak to. However one of the most complete lists of P2P stages is provided by software platform G2.com, which lists the P2P stages as:
- Identification of requirement
- Authorisation of purchase request
- Approval of purchase request
- Identification of suppliers
- Inquiries/receipt of the quotation
- Selection of the vendor
- Purchase order acknowledgement
- Advance shipment notice
- Goods receipt
- Invoice recording
- Three-way match
- Payment to supplier
Procurement software versus purchasing software
For businesses looking to streamline their procurement with a software solution the distinction between procurement and purchasing is important, as the two terms are used for two different types of technology.
Also known as E procurement, procurement software is generally used by large and complex organisations. E procurement aims to streamline and improve the full procure to pay cycle.
Well-known procurement software solutions include cloud-based apps like Procurify, as well as ERP solutions like Access Financials.
Purchasing software, on the other hand, handles only a subset of the P2P cycle. Generally the term purchasing software is used for any solution that lets a business raise a purchase order, receipt goods and process payments.
Unleashed, for example, falls into this category: as part of its core inventory management functions it allows for streamlined purchase order creation, receipting of goods (and reconciliation with live stock-on-hand info), as well as financial reconciliation via its integration with payments and accounting platforms like Xero and QuickBooks. Another term used for these business functions is purchase order management.
Choosing between procurement software and purchasing software
There are considerable benefits to automating your procurement – whether you intend to digitise the full procure to pay cycle, or simply smooth out your purchase order management. Compliance, oversight and efficiency can all be dramatically improved, lifting your company’s overall supply chain management in the process.
However the choice between a full procurement system versus a simpler purchasing solution will depend on the particulars of your own organisation.
For larger firms the extra cost of a full procurement solution is easily justified by the ability for diverse departments to request materials – and have their needs met quickly by a global procurement department. Procurement software makes a centralised strategy around materials management possible, and helps ensure capital is used efficiently in what is for many firms the main area of expenditure.
For many growing SMEs however, the flexibility cloud-based purchasing software offers is preferred – as is its affordability. With many SaaS products now able to integrate with leading accounting, inventory, CRM and eCommerce apps, this approach to purchasing and procurement is an ideal solution to digitising this important part of supply chain management.
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