Procurement & Profitability (2024)

Procurement has been a vital, transactional part of conducting business for almost as long ascommerce has existed. Although the days of scribes tracking purchases on papyrus scrolls arelong past, the process of carefully selecting and purchasing the goods and services neededfor day-to-day business operations remains as important as ever. By enabling the company toreliably get the supplies it needs at the lowest cost, procurement can directly impact thebottom line.

What Is Procurement?

Procurement encompasses a range of activities involved in obtaining goods or services. Whatis the purpose of procurement? In general, procurement teams work to obtain competitivelypriced supplies that deliver the most value. However, not all companies define procurementin the same way. Many companies consider that procurement encompasses all the stages, fromgathering business requirements and sourcing suppliers to tracking the receipt of goods andupdating payment terms, while others define procurement as a narrower range of activities,such as issuing purchase orders and making payments.

Key Takeaways

• Procurement is a vital business function. When managed efficiently and done well, it canhelp increase your business’s profitability.
• It includes a range of activities involved in obtaining goods and services, includingsourcing, negotiating terms, making purchases, tracking when supplies are received andmaintaining records.
• It’s important to continuously monitor and assess the procurement process toimprove anyweak spots or inefficiencies.
• Technology can reduce procurement cost and administrative overhead by automating andtracking procurement processes.

Procurement Explained

Traditionally, some businesses have used the term procurement synonymously with purchasing.But now, purchasing is often seen as just one stage in a larger, more strategic procurementprocess. So, what exactly is procurement?

Procurement involves every activity involved in obtaining the goods and services a companyneeds to support its daily operations, including sourcing, negotiating terms, purchasingitems, receiving and inspecting goods as necessary and keeping records of all the steps inthe process.

Video: What Is Procurement Software?

Why Is Procurement Important in Business?

Procurement is an important step in understanding supply chains, because it helps acompany find reliable suppliers that can provide competitively priced goods and servicesthat match the company’s needs. That’s the case whether the company is seekingraw materialsfor manufacturing, a marketing services provider or new office supplies.

For example, if a company needs a new supplier to provide an ongoing service for anindefinite period of time — such as an email security solution — the procurementprocesshelps the company choose the supplier that best meets all of the business’srequirements ata reasonable price. It enables the business to avoid wasting time, money and valuableresources dealing with an inadequate supplier.

Minimizing cost is one important aspect of improving your procurement processes. Butit’salsovital to identify suppliers that provide the quality of goods and services that the companyneeds and have the capacity to deliver reliably and a track record of doing so.

Types of Procurement

Procurement can be categorized in several ways. It can be classified as direct or indirectprocurement, depending on how the company will use the items being procured. It can also becategorized as goods or services procurement depending on the items that are being procured.

• Direct procurement refers to obtaining anything that’s requiredtoproduce an end-product. For a manufacturing company, this includes raw materials andcomponents. For a retailer, it includes any items purchased from a wholesaler for resaleto customers.
• Indirect procurement typically involves purchases of items that areessential for day-to-day operations but don’t directly contribute to thecompany’sbottom line. This can include anything from office supplies and furniture to advertisingcampaigns, consulting services and equipment maintenance.
• Goods procurement largely refers to the procurement of physical items,but it can also include items like software subscriptions. Effective goods procurementgenerally relies on good supply chain management practices. It may include both directand indirect procurement.
• Services procurement focuses on procuring people-based services.Depending on the company, this may include hiring individual contractors, contingentlabor, law firms or on-site security services. It may include both direct and indirectprocurement.

How Procurement Works

The procurement process generally involves anumber of steps. The business identifies particular goods and/or services that it needs,sources the suppliers that will help the company reach its business objectives, negotiatesterms and costs and then purchases and receives the relevant items.

A small company may have just one person handling procurement of all goods and services.Larger companies may have a team of people specialized in dealing with different suppliers or supportingspecific internal business groups. For some items, the team may need to gather input fromseveral different business groups in order to determine the company’s overallrequirements.

It’s important to remember that procurement doesn’t consist of a series ofisolated acts —it’s an ongoing process. For example, businesses generally aim to establishrelationshipswith key suppliers to help obtain the best service and lowest possible costs, whichultimately translate into higher profit margins. Companies may also need to conduct regularquality assurance checks and performance analysis to make sure suppliers consistently meetexpectations.

9 Steps in the Procurement Process

Procurement processes vary greatly depending on each company’s structure and needs, butgenerally include the following nine core steps:

1. Identify which goods and services the company needs.

   First, a businessmust identify its requirements for a specific item or a service. This may be a newitem thatthe company hasn’t previously purchased, a restock of existing goods or asubscriptionrenewal. This step typically involves delving into the nitty-gritty details of whatthebusiness needs, such as the precise technical specifications, materials, partnumbers orservice characteristics. At this stage, it’s a good idea to consult allbusinessdepartmentsaffected by the purchasing decision to ensure the procured items accurately reflecttheneeds of each department.

2. Submit purchase request.

   When an employee or business group needs toprocure a significant quantity of new supplies or services, they make a formalpurchaserequest (also known as a purchaserequisition).A purchase request notifies the company that a need exists, usually via departmentmanagers,purchasing staff or the financial team, as well as specifications such as price,time frameneeded, quantity and other important things for the purchasing team to keep in mind.Thedepartment overseeing the purchase can then approve or deny the purchase request. Ifapproved, the procurement team can proceed with selecting a vendor and making thepurchase.

3. Assess and select vendors.

   With a clear list of requirements and anapproved purchase request, now is the time to find the best vendor and submit arequest forquote (RFQ) – this is what the purchasing team sends to potential suppliers inordertoreceive a quote – it is important to be as detailed as possible so you cancompareapples toapples. Vendor assessment should focus not only on cost but also on reputation,speed,quality and reliability. Many companies consider ethics and social responsibility aswell,since procurement is often intertwined with corporate identity. A retailer thatpridesitself on sustainability would stand to benefit from partnering with environmentallyresponsible suppliers, for instance.

4. Negotiate price and terms.

   A common best practice is to get at leastthree quotes from suppliers before making a decision. Examine each quote carefullyandnegotiate where possible. If you need to walk away from a deal, be sure that youhaveconcrete alternative options. Once you’ve agreed on final terms, be sure toget theminwriting.

5. Create a purchase order.

   Fill out a purchase order (PO) and send it tothe supplier. The PO should be sufficiently detailed to identify the exact servicesor goodsneeded and to enable the supplier to fill the order.

6. Receive and inspect the delivered goods.

   Carefully examine deliveries forany errors or damage. Make sure everything is delivered as specified in the PO andthat thequality meets or exceeds expectations.

7. Conduct three-way matching.

   Accounts payable should conduct three-waymatching by comparing the purchase order, order receipt or packing list and invoice.Thegoal is to ensure the goods or services received match the purchase order and topreventpayment for unauthorized or inaccurate invoices. Highlight any discrepancies betweenthethree documents and resolve issues before arranging payment.

8. Approve the invoice and arrange payment.

   If the three-way match isaccurate, approve and pay the invoice. Businesses should strive to have a consistentinvoicepayment process through accounts payablethat checks that payments matchthe invoice amount and due date. A standardized process can help make sure invoicesarealways paid on time, which can prevent late fees and build good relationships withsuppliers.

9. Keep Records.

   It’s important to maintain records for the entireprocurement process, from purchase requests to price negotiations, invoices,receipts andeverything in between. These records may be useful for multiple reasons. They helpthecompany reorder goods at the right price in the future, as well as assist withauditingprocesses and calculating taxes. Clear, accurate records can also help resolve anypotentialdisputes.

Stages of Procurement

The nine major steps of the procurement process can also be thought of in three distinctstages: the sourcing stage, the purchasing stage and the receiving stage.

• Sourcing stage: This covers the initial steps in which the businessidentifies its needs, creates a purchase request and assesses vendors. Even after theinitial sourcing steps are complete, it’s a good practice to build a strongrelationships with suppliers. They can establish grounds for suppliers to learn frompartners, improve products and processes and develop trust.
• Purchasing stage: This stage includes negotiating terms, creatingorders and receiving and inspecting goods and services.
• Payment stage: Accounts payable conducts three-way matching to ensureorder and invoice accuracy. The invoice can then be approved and the payment isarranged. Records of all invoices, orders and payments should be kept and carefullymaintained.

Procurement Life Cycle

Organizations commonly think of steps in the procurementprocess as a life cycle. This perspective provides a reminder that all the tasks andstages in the procurement process overlap and rely on each other and that the process iscontinuous. A carefully thought-out procurement life cycle also recognizes the integrationbetween the process and the business as a whole, including the need to align with existingcompany rules and procedures covering areas such as budgeting. The process is not alwayslinear, and sometimes adjustments need to be made to account for a dynamic digital supply chain with shifting suppliers,availabilities and costs.

Three Components of Procurement

Three key components work together to make the procurement process happen: people, processand paperwork.

• People: People generally are responsible for initiating or authorizingevery step of the procurement process. In addition to procurement specialists, thepeople involved include other stakeholders, such as accounts payable and the businessgroups that request the goods and services. The number of people involved often dependson the value of the goods and services; more stakeholders may be involved in specifyingand approving high-value purchases.
• Process: An effective procurement process can help a company succeed bykeeping costs down and ensuring supplies arrive when the business needs them. Awell-designed and methodical process helps to promote accuracy and timeliness becauseevery person involved knows exactly what they need to accomplish and how long they haveto complete the tasks. In contrast, a disorganized procurement process results ininefficiencies and potentially costly errors. Overpayments, for example, can impact thebottom line, while late payments negatively affect relationships with suppliers.
• Paperwork: It’s important to maintain records for every stage oftheprocurement process and ensure they are easily accessible. These records act as a storeof organizational knowledge about payment terms and supplier performance, helping thebusiness maintain an efficient procurement process — even if the procurement staffchanges over time. In the case of an audit or a dispute, a business must be easily ableto follow the paper or electronic trail through each stage of the procurement process.

Procurement, Purchasing and Supply Chain: What’s the Difference?

The terms procurement, purchasing, sourcing and supply chain are often used interchangeably.However, there are important distinctions between them.

• Procurement vs. purchasing: If procurement involves purchasing, youmight be wondering: What’s the difference between purchasing and procurement? Theansweris that purchasing is essentially transactional, focusing on managing specific orders tomeet company needs. Procurement is a much broader and more complex set of processes,including establishing and maintaining supplier relationships. Another way to thinkabout the difference between purchasing and procurement is that procurement takes aproactive approach that starts with analyzing the company’s needs, whereaspurchasing isa reactive approach — simply focusing on obtaining what the company has alreadydecidedit needs.
• Procurement vs. sourcing: Sourcing, like purchasing, is only partof the overall procurement process. Sourcing is an early stage of the procurementcycle. It encompasses activities such as identifying and assessing potential suppliersof goods or services, negotiating terms and selecting the vendors that best meet thecompany’s needs.
• Procurement vs. supply chain:Procurement covers one aspect of supply chain management. Procurement includessourcing, obtaining and paying for goods and services. Supply chain management alsocovers the logistics involved in obtaining goods, such as shipping and warehousemanagement, as well as transforming the procured goods into products and distributingthem to customers.

7 Common Principles of Procurement

In public-sector organizations, the procurement process is generally similar to the processin private-sector organizations — but with a few important differences. Because thepeopleinvolved handle public funds, they generally must follow rigorous principles during theprocurement process.

These principles can be regarded as an ethical code of conduct thatholds public servants accountable for their purchases. Some of the principles may also bebeneficial to private-sector organizations.

The principles vary somewhat depending on the organization. Here are seven of the most commonprocurement principles:

1. Value for money:

   The organization must manage funds efficiently andeconomically when procuring goods and services. This may include conductingcost-benefitanalyses and risk assessments. It’s worth noting that low cost does notnecessarilyequate to greater value; characteristics such as quality and durability also factorintodetermining whether the purchase represents value for money.

2. Fairness:

   Procurement should not provide preferential treatment toindividuals or suppliers. All bids should be assessed objectively, based on how wellthey meet the organization’s needs.

3. Competition:

   Organizations should seek competitive bids from multiplesuppliers, unless there are specific reasons not to do so, such as a sole-sourceprovider where the good or service is only available from a single vendor.

4. Efficiency:

   Procurement processes must be carried out efficiently tohelp maximize value and avoid delays.

5. Transparency:

   Organizations should make relevant procurementinformation available to everyone, including the public as well as suppliers.Information should be kept confidential only when there are legal or other validreasonsto do so.

6. Integrity:

   Those who practice public procurement should always striveto be perceived as trustworthy, reliable, honest and responsible. Funds must be usedfortheir intended purpose and in the public interest.

7. Accountability:

   People involved in the procurement process areaccountable for their actions and decisions. They are required to report procurementactivities accurately, including any errors.

How Procurement & Finance Can Work Together

In many companies, procurement and finance teams operate as separate departments.Historically, they have sometimes been at odds for one major reason: Procurement spendsmoney, while finance focuses on profitability, which sometimes means finding ways to spendless.

However, a strategic partnership between the two groups can benefit the business as a whole,partly because each group can provide unique insights into the business’s operations.Forexample, a well-run procurement team may have a deep understanding of how carefully sourcedgoods and services can help business groups maximize profitability. This helps the financegroup get a better overall picture of company spending and how it affects the bottom line.

Integrated supply chain managementsoftware that can connect information from across the business, including finance,is an important tool to bridge the traditional divide and help teams work together toadvance business objectives. Supply chain management software can also help you trackprogress toward goals by providing the information you need for key performance indicators(KPIs) in a simple-to-understand format for your procurement team.

Procurement KPIs

By monitoring procurement KPIs, businesses can boost the efficiency of their procurementprocess, track progress toward business objectives and identify areas for improvement. Hereare some commonly measured procurement KPIs:

Purchase order cycle time: Monitor the average number of hours or days ittakes to process requisitions and send purchase orders to suppliers.

Purchase order cycle time= # of hours or days it takes to process requisitions and send purchase ordersto suppliers / # of purchase orders sent to suppliers

Supplier lead time: The average number of days it takes for suppliers tosend items after they receive a purchase order.

Supplier lead time = # ofdays it takes for item(s) to arrive after supplier receives purchase order / total # ofpurchase orders sent to supplier

Number of suppliers: Having more suppliers gives the company more optionsbut also increases administrative work. Many procurement groups monitor the number ofvendors in their supplier networks and periodically remove little-used suppliers to increaseefficiency.

Supplier defect rate: An important measure of supplier quality, this isusually measured as the number of defective parts divided by the total number of partssupplied.

Supplier defect rate = #of defective parts from vendor / total # of parts from same vendor

Supplier availability: This measures each supplier’s ability torespond tolast-minute or emergency demands.

Supplier availability = #of times supplier fulfilled business orders / # of orders sent to supplier

Fulfillment accuracy: This measures the percentage of orders that suppliersfill accurately and match the purchase order exactly.

Fulfillment accuracy = #of accurate orders from supplier / total # of orders from same supplier

Total ROI of procurement process: This measures the value a business’sprocurement strategy delivers to the organization. It’s the ratio of the annualsavingsgenerated by the procurement group to the total annual amount spent on procurement.

How Technology Can Help Manage Procurement

As with almost any other area of the business, technology can increase the productivity ofprocurement groups, while reducing process costs by as much as 30%(opens in a new tab). You can alsosimplify steps such as soliciting bids, creating orders and paying for supplies using ERPsolutions with procurement software. It can also enable teams tobetter analyze savings and track supplier performance.

Procurement can play a key role in a business’s profitability and overall success. Itincludes a broad range of related activities, each of which requires attention to detail toensure the business gets the most value. Supply chain management software solutions can helpaccelerate, simplify, analyze and reduce the cost of the entire procurement process.