Procurement

The ultimate goal of a business is to reduce the cost of production and increase profitability. Many aspects of the supply chain can help companies achieve this goal, including streamlining processes, identifying better suppliers, and reducing the cost of raw materials. The process of finding suppliers and acquiring raw materials for business is called procurement. In this explanation, you will learn about procurement and the role it plays in business.

Procurement meaning

Procurement allows the business to acquire goods and services in case of scarcity and reduce the cost of production. It is a prerequisite for seamless business operations.

Procurement and purchasing are often used interchangeably. However, while purchasing is limited to acquiring goods and services, procurement refers to the entire process, from identifying potential suppliers to negotiating contracts and obtaining raw materials.

For businesses, procurement is of great importance. When done effectively, it can give the company a competitive advantage by saving money, resources, and time. Procurement also optimises business operations. As a result, many companies involve the head of procurement in senior management.

Procurement: Managing stock

Managing stock is crucial for businesses. It can be in the form of office supplies or raw materials. These stocks help businesses with their daily operations. The nature of stocks and the amount spent on managing them is different for every business. Ideally, two approaches are used to manage stock effectively.

Procurement: Just-in-time

As the name suggests, in this approach the stock arrives just in time to be utilised by the business for manufacturing or operational activities. If a business wants to minimize the holding costs of stock, this approach should be used. JIT offers lower stock-holding and opportunity costs, and less material damage.

Procurement: Just-in-case

In this approach, businesses keep more stock in case the need arises. Therefore, stock is available at all times. Businesses using this approach tend to buy supplies in bulk. However, this approach increases the stock-holding costs and makes procurement less efficient.

Procurement process

In the procurement process, there must be comprehensive planning and precise execution to get the desired results. Here are the seven steps to procurement:

1. Identifying needs: the first step is to identify the need for obtaining goods or services. Every department in the company should be examined to determine which departments are over-spending and for which departments the company needs to procure. Once the area and the need are identified, a budget should be assigned for procurement.
2. List potential suppliers: the company should shortlist potential suppliers after conducting research. It is important to find the right supplier who can ensure fast and cost-effective delivery of goods or services. If the company fails to find the right supplier, this could have a major impact on its operations. From the shortlisted suppliers, select the one that best fulfils the criteria.
3. Negotiate: after choosing the right supplier, the company has to negotiate terms with them. A mutual agreement should be reached on the price, scale, and timeline of the project. A contract is only signed after all the terms are agreed upon.
4. Release purchase order: after the contract is signed, a purchase order is released. This document has information regarding the goods or services, quantities, and costs. At this stage, the working partnership between a business and a supplier begins.
5. Payment: when the supplier receives a purchase order, he sends an invoice to the company, which contains the price, the mode of payment, and the details of the order. Payment is then made to the supplier at the time agreed in the contract.
6. Delivery and audit: the supplier delivers the goods or services to the company. The company should record the date on which it receives the delivery. Then it can see if the supplier has delivered at the agreed time or not. It's also important to audit the order to make sure every required product is delivered.
7. Maintain records: last but not least, the business should keep a record of everything in the procurement process, including records of invoices and payments. This will allow the company to track the transactions and analyse how much it has spent on procurement.

Types of procurement

Before completing the procurement process, businesses must pick the type of procurement method they want. The four main types of procurement are:

1. Direct procurement,

2. Indirect procurement,

3. Goods procurement, and

4. Services procurement.

The types of procurement a business chooses will depend on the types of products they sell and its operations.

Types of Procurement Methods

Based on the goal of procuring goods and services, procurement can be split into:

• Direct procurement: the procurement of materials to produce an end-product is called direct procurement. Items such as raw materials and machinery are acquired through direct procurement. In this type of procurement, procurement officers and suppliers are key stakeholders.
• Indirect procurement: the procurement that is done to manage daily business operations but does not contribute directly to the end-product is called indirect production. Equipment maintenance and office supplies are examples of indirect procurement.

Based on the type of products procurement is intended for, procurement can be divided into:

• Goods procurement: The procurement of physical items is called goods procurement. It includes both direct and indirect types of procurement.
• Services procurement: Service procurement refers to the procurement of people-based services. Individual contractors and on-site security personnel are examples of services procurement, which can be done via either direct or indirect procurement.

Fig. 1 - Types of procurement

Procurement cycle

The procurement cycle consists of various stages that require proper planning and execution. Each stage plays an important role in driving procurement strategy for the company. Here are the six stages of the procurement cycle:

Procurement planning

In this stage, the problem is identified and an initial review is conducted to confirm the details of the problem. For instance, what kind of product is needed and which solution would be appropriate for solving the problem. Is the required product commercially available or is it custom-made? All questions related to problem identification and solution-finding are part of the planning stage.

Procurement: Requirement definition

Once the planning is done, the next stage is requirement definition. All the requirements of problem-solving are listed in a document called a statement of work. It is a crucial step because these requirements demonstrate how well the prospective suppliers understand the problem. Only by fully understanding the problem will they be able to give better solutions.

Procurement: Sourcing

During this stage, the business will contact the supplier and communicate all the details of procurement, including terms and conditions, delivery schedules, and product/service requirements. Suppliers will inspect, examine, and respond to a company’s offer with a proposal.

Procurement: Evaluation and selection

After evaluating proposals sent by suppliers, the company will select the best among them. The selection is based on how well the solution is defined in the proposal.

Procurement: Contract awarding

The contract is awarded to the chosen supplier. Further negotiations will be carried out in case the company needs more information about certain aspects of the proposal.

Procurement: Contract management

Once the supplier is given the contract, it is important to manage it to resolve any potential contractual issues. The aim is to make sure that the supplier is fulfilling all the requirements of the contract. From on-time deliveries to the cost of deliverables, everything is managed in this stage.

Fig. 2 - The procurement cycle

Factors affecting the choice of suppliers

Value and quality – the procurement process must be value-driven, i.e., companies must look for products that offer value for money. A company should not select a cheaper option as it could compromise quality.

Open competition – there should be open competition among potential suppliers. This allows the company to select the supplier from a good pool of potential suppliers.

Transparency – the entire procurement process must be transparent. The decision of selecting a supplier must be fair. This factor improves the process and brings optimal results.

Reliability – the business should always aim to choose reliable suppliers, as an unreliable supplier can potentially harm daily operations.

Price – while selecting the supplier, price is also an important consideration. A supplier who provides supplies at a reasonable price is ideal for the business.

Effects of procurement and the value of supply chain management

The effects of procurement and the value of the supply chain are huge for the business. They help in optimising business operations by reducing the cost of production and ensuring the smooth running of business activities.

Effects of procurement on business

Procurement has a major impact on business: it helps in increasing efficiency and reducing unit costs in a business. For instance, having a credible supplier means there is less chance of raw materials being faulty; instead, quality supplies are used.

Procurement: Value of supply chain management

Effective supply chain management adds value to the business. The key activities include working with the supplier to ensure the supply chain is working efficiently and cost-effectively, procuring supplies that give more value at a reasonable price, and reducing the cost of production.

For businesses, the role of procurement is vital as it could increase profitability and reduce the cost of production. Therefore, it is essential to implement the procurement strategy effectively.