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Proper procurement is a pillar of business success.
A company needs to consistently obtain the right resources to continue operations and expand a brand.
Streamlining workflow and placing tighter controls on the supply chain leverages product development, strengthens relationships, and opens the door for more opportunities. This starts with taking a closer look at the procurement process and how it can be improved.
What is Procurement?
Procurement is the act of sourcing and obtaining goods and services for a business. The procurement process is most commonly associated with business because a company needs to purchase goods and solicit services to grow.
The term “procurement” usually refers to the final act of purchasing, but it can also include the overall procurement process, from new supplier onboarding to contract management and invoice approval.
Procurement vs. Purchasing
When it comes to procurement vs purchasing, the simple act of purchasing is more reactive to internal requests. While it focuses on short-term goals and business needs, procurement is based on strategic, long-term goals, like corporate strategy and gaining a competitive advantage.
The entire procurement cycle is critically important for organizations leading up to their final purchasing decision. A business can be on both sides of the procurement process, as buyers or sellers.
How Procurement Works
Procurement can require a substantial portion of a company’s resources to manage. Procurement processes are typically dictated by company standards that are centralized by controls from accounts payable. It includes the preparation and processing of a demand, as well as the receipt and approval of payment.
A procurement budget will provide managers with a specific value they can spend to procure goods and services for the business. This system is a key part of a company’s strategy because the ability to purchase specific materials and services can determine if operations are even profitable.
Comprehensively, the procurement process can include (but is not limited to):
- Purchase request and planning
- Standards
- Specifications determination
- Supplier research
- Selection
- Financing
- Price negotiation
- Inventory control
As such, the bigger the company, the more support is required from different areas of a company for successful procurement management.
Subsidiaries of Procurement
When it comes to the procurement process, there are four main subsidiaries:
- Direct
- Indirect
- Services
- Goods
All of these differ in aspects of definition, assignments, and process. By taking a deeper look at these systems and understanding what they’re comprised of, stakeholders will have an easier time taking the appropriate measures to ensure the need is fulfilled.
Direct vs. Indirect Procurement
Direct procurement (also called direct spend) refers to any expense related to the cost of production and goods sold. This includes all items required for the finished product or anything directly related to its creation, like raw materials, components, and parts. For a merchandising business, this also includes the cost at which merchandise is purchased from a wholesaler.
In a service-based company, direct costs will typically equate to the labor costs of whoever is performing the service. Procurement for items pertaining to the cost of goods sold, will directly affect a company’s gross profit.
The indirect procurement method involves the act of purchasing supplies or services that are required to keep daily operations moving and the business open. One way of classifying indirect procurement is that it never adds to the bottom line. It involves expenses like equipment repairs, office supplies, and costs for acquiring services.
Goods vs. Services Procurement
Goods and services procurement methods account for revenues and costs differently. Companies focused on goods (physical items) will need to deal with the procurement of those goods as inventory. Thus, these businesses tend to place a lot of importance on supply chain management. Goods procurement can also include non-physical items, like software subscriptions, and may reflect both direct and indirect procurement methods.
Service-based companies provide one or more services as their primary source of revenue. These businesses don’t necessarily rely heavily on the supply chain for inventory, although they may need to purchase goods for tech-based services.
Generally speaking, the cost of sales for most service-based companies is from the hourly cost of labor. Therefore, procurement as a direct expense is never a major factor. However, service-based companies often have higher indirect costs because they deal with their own procurement as an indirect expense through marketing.
Competitive Bidding
The competitive bidding process for goods-based companies is often more simplified than services-based. For a goods-based business, accepting multiple bidders involves proposals that detail shipping, delivery, and per-unit price.
Competitive bidding for services can be a little more complex. It requires a ton of factors including the individuals involved, technology services, client servicing, operational procedures, training, service fees, and more.
In each case, the solicitor of the bids chooses a list of suppliers based on costs and operational business aspects. They are then responsible for accounting for the expenses depending on the goods/services agreed to. Larger enterprises may choose to solicit proposals on an annual or scheduled basis to ensure they maintain the business relationships.
10 Steps in the Procurement Process
The beginning of the procure-to-pay accounting process starts with planning. Here are the ten most common stages of the procurement process:
- Recognize the company’s needs of goods and services
- Submit a purchase request
- Review the requisition package
- Solicit the best suppliers
- Review and evaluate the top suppliers’ performance
- Negotiate a contract
- Manage orders
- Conduct two and three-way P.O. matching
- Approve or dispute invoices
- Keep records
#1) Recognize the company’s needs of goods and services
The first stage is known as needs recognition. In this beginning phase, a business starts its research. Planning is initiated for how goods and/or services can be procured in a timely manner, at a fair cost.
#2) Submit a purchase request
The next step is a purchase requisition, which is basically a written means of permission to make the expense. It’s an internal document used by staff to raise a request for the goods and/or services required to complete a job. It contains all the details needed for approval, including but not limited to):
- Product
- Quantity
- Price
- Name of requester
- Department
A purchase request should include any essential data to fulfill the existing need and keep operations running smoothly. The purchase requisition should always have key information to procure goods, services, or works.
#3) Review the requisition package
The official process of procurement only starts after the purchase requisition is approved and a cross-check for budget availability is completed. In these beginning stages, managers and department heads review the requisition package. They check if there is a genuine need for the requested goods and/or services, and verify whether the funding is available.
Approval of the requisition request will turn it into a purchase order (P.O.). Rejected requests are sent back to the requisitioner with the reason for rejection.
#4) Solicit the best suppliers
After the P.O. is generated, the procurement team will develop a procurement plan and a corresponding solicitation process. The scope of this plan ultimately depends on the complexity of the requirement.
Once the budget is approved for an expense, the procurement team forwards a request for quotation (RFQ) to vendors with the intention to receive and compare bids to shortlist the best suppliers.
#5) Review and evaluate the top suppliers’ performance
In the evaluation stage, the solicitation process is closed. At this point, the procurement team will review and evaluate supplier performance, referrals, and quotes to determine the best price and fit.
#6) Negotiate a contract
Contract negotiation begins after the vendor is selected and the purchase order is forwarded to them. A legally binding contract will be activated as soon as the vendor acknowledges and accepts the purchase order.
#7) Manage orders
At this stage, the vendor will deliver the goods/services within the specified timeframe. After receipt, the buyer will examine the order and notify the vendor of any issues with the received items/service.
#8) Conduct two and three-way P.O. matching
The supplier’s invoice must be validated prior to sending for approval. This is done through P.O. matching. The traditional sense would have AP staff searching for receipts, P.O.’s, and other paperwork, and attaching that to the invoice. This is so all data is in one spot for the approver to give their signature.
In automated P.O. matching, companies like Tipalti streamline the process of collecting paperwork. In a three-way match, the purchase order, invoice, and receipt are compared to ensure there aren’t any discrepancies.
Once matching is complete, the invoice is sent for approval.
#9) Approve or dispute invoices
At this stage, the appropriate approvers will review all paperwork and sign off on payment. The invoice is then forwarded to payment processing.
#10) Keep records
Once all payment is sent, a company accounts for the transaction. A record is made for bookkeeping and auditing purposes and all appropriate documents are stored in a centralized location.
Optimizing the Procurement Process
Effective procurement starts with streamlining workflow. Optimization offers better controls over every stage of the procurement lifecycle.
Here are a few tips to help you get started:
- Define a clear procurement strategy
- Enable quick adoption with in-depth staff training
- Determine costs and plan according to budget
- Invest in smart procurement software like Tipalti
- Create an open channel of communication with suppliers
- Integrate procurement processes with APIs
- Establish policies and process compliance
Spend Analysis
The finance team should have controls in place for analyzing procurement spend to decrease costs, increase efficiency, and improve supplier relationships. Examining this procurement activity is typically known as “spend analysis.”
Spend analysis (and the resulting analytics) is one of the key tools used to proactively identify savings opportunities, optimize buying power, and manage risks. This deduction allows a business to identify areas of cost reduction and process improvement which results in a lower overall cost to procure goods/services.
The following are some common sources of procurement spend analysis data:
- Purchase orders
- ERP (enterprise resource planning) tools
- Data shared by suppliers
- General ledger info
- Credit ratings
- Transaction data
- Risk reviews
- Other internal systems
- External sources
What are the Key Benefits of Working with Suppliers?
Long terms success is incumbent upon solid supplier relationships—which don’t happen overnight (or without nurturing). Implementing and executing a supplier development program is vital for long-term success. It allows for stronger collaboration and greater visibility into supplier risks. This results in faster recovery times from disruptive events and greater controls on avoidance strategies.
Continual and open dialogue with suppliers helps to address supply chain issues quickly and react accordingly. A well-designed and executed supplier development program reduces costs and leads to stronger relationships. This has huge business advantages like:
- Increased supplier responsiveness and engagement
- Full transparency between all parties
- Higher rate of customer satisfaction
- Streamlined sourcing activities and lead times
- Improved collaboration
- Better quality, reliability, and manufacturability for new designs
- Increased awareness of supplier diversity
Supplier development also leads to more responsiveness and increased visibility of the full supply base to procurement. This type of relationship management can be carried out through purchasing or the quality control department, depending on organizational structure. As long as there is some sort of program in place, you’re on the right track to diverse and committed suppliers.
FAQ
How does e-procurement work?
What is e-procurement? E-procurement is the process of buying something online. Sometimes called “supplier exchange” it’s the business-to-business (B2B), business-to-consumer (B2C), or business-to-government (B2G) purchase and sale of supplies, services, and work through the internet, as well as data and networking systems, such as electronic data interchange (EDI).
When implemented correctly, e-procurement facilitates communication with suppliers by creating a direct link through bids, purchase orders, e-mails, and more.
E-procurement helps to automate manual processes to free up time and avoid human errors. It simplifies a procurement system through advanced technologies, compliant steps, and a touchless digital process.
What are some common issues in the procurement process?
A major challenge in the procurement process is supply risk. This is an umbrella term for a multitude of concerns that encompass buying what you need for running a business.
Potential fraud, market shifts, quality, delivery problems, and cost all constitute the most common types of risk. Additionally, compliance issues like policy adherence and corruption create a more volatile environment for efficient procurement functions.
Here are some of the top issues procurement departments face right now:
• Poor supply chain transparency
• Inaccurate data
• Compliance to contract
• Better risk management
• Control and visibility of spending
The solution starts with an active procurement risk management program. This will help to anticipate risks and safeguard businesses from any issues that arise during procurement.
Every purchase brings a set of critical factors like product quality, customer satisfaction, vendor reliability, company reputation, and more.
What’s the purpose of a procurement audit?
Auditing your procurement process is important to ensure compliance, drive accuracy, and improve efficiency. It entails periodically reviewing procurement processes, contracts, and vendor history to make sure contract terms are being met.
The primary objective of a procurement audit is to determine if the current level of delegated authority is efficient and to formally evaluate the performance of a supplier. It can also be used to create documents that further streamline procurement practices and focus efforts within an organization.
How Do You Negotiate with Suppliers?
The best practices for procurement negotiations depends on who you ask. When it comes to developing superior deals, here are a few tips:
Active Listening
Do not use your supplier’s time to rehearse arguments. Practice active listening during your counterpart’s speaking time to better formulate counterarguments.
Think Creatively
If a supplier is stubborn on price, consider “outside-of-the-box” opportunities to lower expenses. For example, a business can negotiate to reduce the amount of a down payment when buying in bulk. A company can also look for faster shipping without additional expenses, improvements to the warranty, and longer payment terms. You can also ask for early payment discounts when submitting invoices.
Agree on Negotiation
All parties must agree on the negotiation process. This includes things like the frequency of contact, team composition, and the choice of meeting venues. All of it plays a role in the effectiveness and quality of discussions.
All details should be clarified in advance to ensure everyone is on the same page. The negotiation process is anything but straightforward and often requires adjustments on both sides.
Build Trust
Always take the time to get to know your main contact. Having a mutual interest or shared goals are good ways to reach a deal. Even if discussions take place over email, setting up a call creates the best possible conditions for the negotiation. There’s a shared pleasure in getting the deal done.
Convey Repeat Business
When a supplier suspects you are serious about their product/service, and will give them repeat business, it leverages the negotiation process. If you have a trackrecord of past purchases, let them know how much business they can expect from you. If you’re just starting out, providing a sales projection plan is a good move.
Ask the Right Questions
Asking questions that are open-ended is a great way to move procurement negotiations in the right direction. Don’t hesitate to ask about specific needs, terms, limitations, or future expectations.
Talk to Multiple Suppliers
To encourage competitive pricing, talk to at least three suppliers and let them know you are gathering quotes and will go with whoever has the best price. Don’t forget to always take quality into consideration.
Instead of a single proposal per them, consider multiple offers. If you’re negotiating delivery, mention three different methods using variables of frequency, delivery points, and time slots. The idea is to never find yourself in a “take it or leave it” situation, but to work to find the best possible solution for both parties.
Offer Bigger Deposits for More Discounts
Every business is concerned about their accounts receivable. A good way to secure bigger discounts is to offer larger deposits on supplier orders. If the vendor knows they will receive 50 to 60 percent up front, it increases the buying power and makes pricing more negotiable.
Don’t Say Yes to the First Offer
The number one rule of negotiation is to never accept a party’s first offer. Instead, issue a counter-offer or ask they get back to you with a better price. This can be justified with the amount of business you’re offering to give them or the length of the partnership.
Transfer Business to One Supplier
More business means deeper discounts. If you’ve been giving business to multiple vendors, consider consolidation for cost savings. Before you take the plunge, however, call the supplier and ensure there’s a discount available.
Be Affable
It doesn’t matter how much business you give suppliers, if you’re the “problem customer.” If it’s too much work to do business with you, negotiations will be tough. Always maintain good supplier relationships which includes open communication, on-time payments, and mutual collaboration.
Define the “Best Alternative”
Have a fallback solution for when negotiations aren’t successful. This includes two things: #1) define the limit beyond which the deal is no longer an advantage and #2) identify an alternative solution so your back isn’t up against a wall. This allows you to approach negotiations with maximum peace of mind and ensures you’re closing a deal advantageous to your business.
Additional Tips
- Take it one step at a time and don’t rush
- Be aware of anchoring bias
- Present multiple offers simultaneously
Summary
For a business, fiscal responsibility starts here. Procurement is a vital business function directly related to the success of a company. Modern procurement relies on technology to gain a competitive advantage.
Look for automation tools that strengthen the process, minimize the chances of error, and fulfill all of your procurement needs. When managed efficiently, a streamlined procurement process flow can increase a company’s profitability, drive growth, and secure a positive source of revenue.
