Procurement has been a vital, transactional part of conducting business for almost as long as commerce has existed. Although the days of scribes tracking purchases on papyrus scrolls are long past, the process of carefully selecting and purchasing the goods and services needed for day-to-day business operations remains as important as ever. By enabling the company to reliably get the supplies it needs at the lowest cost, procurement can directly impact the bottom line.
What Is Procurement?
Procurement encompasses a range of activities involved in obtaining goods or services. What is the purpose of procurement? In general, procurement teams work to obtain competitively priced supplies that deliver the most value. However, not all companies define procurement in the same way. Many companies consider that procurement encompasses all the stages, from gathering business requirements and sourcing suppliers to tracking the receipt of goods and updating payment terms, while others define procurement as a narrower range of activities, such as issuing purchase orders and making payments.
- Procurement is a vital business function. When managed efficiently and done well, it can help increase your business’s profitability.
- It includes a range of activities involved in obtaining goods and services, including sourcing, negotiating terms, making purchases, tracking when supplies are received and maintaining records.
- It’s important to continuously monitor and assess the procurement process to improve any weak spots or inefficiencies.
- Technology can reduce procurement cost and administrative overhead by automating and tracking procurement processes.
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 procurement process. So, what exactly is procurement?
Procurement involves every activity involved in obtaining the goods and services a company needs to support its daily operations, including sourcing, negotiating terms, purchasing items, receiving and inspecting goods as necessary and keeping records of all the steps in the process.
Video: What Is Procurement Software?
Why Is Procurement Important in Business?
Procurement is an important step in understanding supply chains, because it helps a company find reliable suppliers that can provide competitively priced goods and services that match the company’s needs. That’s the case whether the company is seeking raw materials for manufacturing, a marketing services provider or new office supplies.
For example, if a company needs a new supplier to provide an ongoing service for an indefinite period of time — such as an email security solution — the procurement process helps the company choose the supplier that best meets all of the business’s requirements at a reasonable price. It enables the business to avoid wasting time, money and valuable resources dealing with an inadequate supplier.
Minimizing cost is one important aspect of improving your procurement processes. But it’s also vital to identify suppliers that provide the quality of goods and services that the company needs 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 indirect procurement, depending on how the company will use the items being procured. It can also be categorized as goods or services procurement depending on the items that are being procured.
- Direct procurement refers to obtaining anything that’s required to produce an end-product. For a manufacturing company, this includes raw materials and components. For a retailer, it includes any items purchased from a wholesaler for resale to customers.
- Indirect procurement typically involves purchases of items that are essential for day-to-day operations but don’t directly contribute to the company’s bottom line. This can include anything from office supplies and furniture to advertising campaigns, 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 procurement generally relies on good supply chain management practices. It may include both direct and indirect procurement.
- Services procurement focuses on procuring people-based services. Depending on the company, this may include hiring individual contractors, contingent labor, law firms or on-site security services. It may include both direct and indirect procurement.
How Procurement Works
The procurement process generally involves a number 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, negotiates terms 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 supporting specific internal business groups. For some items, the team may need to gather input from several different business groups in order to determine the company’s overall requirements.
It’s important to remember that procurement doesn’t consist of a series of isolated acts — it’s an ongoing process. For example, businesses generally aim to establish relationships with key suppliers to help obtain the best service and lowest possible costs, which ultimately translate into higher profit margins. Companies may also need to conduct regular quality assurance checks and performance analysis to make sure suppliers consistently meet expectations.
9 Steps in the Procurement Process
Procurement processes vary greatly depending on each company’s structure and needs, but generally include the following nine core steps:
1. Identify which goods and services the company needs. First, a business must identify its requirements for a specific item or a service. This may be a new item that the company hasn’t previously purchased, a restock of existing goods or a subscription renewal. This step typically involves delving into the nitty-gritty details of what the business needs, such as the precise technical specifications, materials, part numbers or service characteristics. At this stage, it’s a good idea to consult all business departments affected by the purchasing decision to ensure the procured items accurately reflect the needs of each department.
2. Submit purchase request. When an employee or business group needs to procure a significant quantity of new supplies or services, they make a formal purchase request (also known as a purchase requisition). A purchase request notifies the company that a need exists, usually via department managers, purchasing staff or the financial team, as well as specifications such as price, time frame needed, quantity and other important things for the purchasing team to keep in mind. The department overseeing the purchase can then approve or deny the purchase request. If approved, the procurement team can proceed with selecting a vendor and making the purchase.
3. Assess and select vendors. With a clear list of requirements and an approved purchase request, now is the time to find the best vendor and submit a request for quote (RFQ) – this is what the purchasing team sends to potential suppliers in order to receive a quote – it is important to be as detailed as possible so you can compare apples to apples. Vendor assessment should focus not only on cost but also on reputation, speed, quality and reliability. Many companies consider ethics and social responsibility as well, since procurement is often intertwined with corporate identity. A retailer that prides itself on sustainability would stand to benefit from partnering with environmentally responsible suppliers, for instance.
4. Negotiate price and terms. A common best practice is to get at least three quotes from suppliers before making a decision. Examine each quote carefully and negotiate where possible. If you need to walk away from a deal, be sure that you have concrete alternative options. Once you’ve agreed on final terms, be sure to get them in writing.
5. Create a purchase order. Fill out a purchase order (PO) and send it to the supplier. The PO should be sufficiently detailed to identify the exact services or goods needed and to enable the supplier to fill the order.
6. Receive and inspect the delivered goods. Carefully examine deliveries for any errors or damage. Make sure everything is delivered as specified in the PO and that the quality meets or exceeds expectations.
7. Conduct three-way matching. Accounts payable should conduct three-way matching by comparing the purchase order, order receipt or packing list and invoice. The goal is to ensure the goods or services received match the purchase order and to prevent payment for unauthorized or inaccurate invoices. Highlight any discrepancies between the three documents and resolve issues before arranging payment.
8. Approve the invoice and arrange payment. If the three-way match is accurate, approve and pay the invoice. Businesses should strive to have a consistent invoice payment process through accounts payable that checks that payments match the invoice amount and due date. A standardized process can help make sure invoices are always paid on time, which can prevent late fees and build good relationships with suppliers.
9. Recordkeeping. It’s important to maintain records for the entire procurement process, from purchase requests to price negotiations, invoices, receipts and everything in between. These records may be useful for multiple reasons. They help the company reorder goods at the right price in the future, as well as assist with auditing processes and calculating taxes. Clear, accurate records can also help resolve any potential disputes.
Stages of Procurement
The nine major steps of the procurement process can also be thought of in three distinct stages: the sourcing stage, the purchasing stage and the receiving stage.
- Sourcing stage: This covers the initial steps in which the business identifies its needs, creates a purchase request and assesses vendors. Even after the initial sourcing steps are complete, it’s a good practice to build a strong relationships with suppliers. They can establish grounds for suppliers to learn from partners, improve products and processes and develop trust.
- Purchasing stage: This stage includes negotiating terms, creating orders and receiving and inspecting goods and services.
- Payment stage: Accounts payable conducts three-way matching to ensure order and invoice accuracy. The invoice can then be approved and the payment is arranged. Records of all invoices, orders and payments should be kept and carefully maintained.
Procurement Life Cycle
Organizations commonly think of steps in the procurement process as a life cycle. This perspective provides a reminder that all the tasks and stages in the procurement process overlap and rely on each other and that the process is continuous. A carefully thought-out procurement life cycle also recognizes the integration between the process and the business as a whole, including the need to align with existing company rules and procedures covering areas such as budgeting. The process is not always linear, 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, process and paperwork.
- People: People generally are responsible for initiating or authorizing every step of the procurement process. In addition to procurement specialists, the people involved include other stakeholders, such as accounts payable and the business groups that request the goods and services. The number of people involved often depends on the value of the goods and services; more stakeholders may be involved in specifying and approving high-value purchases.
- Process: An effective procurement process can help a company succeed by keeping costs down and ensuring supplies arrive when the business needs them. A well-designed and methodical process helps to promote accuracy and timeliness because every person involved knows exactly what they need to accomplish and how long they have to complete the tasks. In contrast, a disorganized procurement process results in inefficiencies and potentially costly errors. Overpayments, for example, can impact the bottom line, while late payments negatively affect relationships with suppliers.
- Paperwork: It’s important to maintain records for every stage of the procurement process and ensure they are easily accessible. These records act as a store of organizational knowledge about payment terms and supplier performance, helping the business maintain an efficient procurement process — even if the procurement staff changes over time. In the case of an audit or a dispute, a business must be easily able to 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, you might be wondering: What’s the difference between purchasing and procurement? The answer is that purchasing is essentially transactional, focusing on managing specific orders to meet company needs. Procurement is a much broader and more complex set of processes, including establishing and maintaining supplier relationships. Another way to think about the difference between purchasing and procurement is that procurement takes a proactive approach that starts with analyzing the company’s needs, whereas purchasing is a reactive approach — simply focusing on obtaining what the company has already decided it needs.
- Procurement vs. sourcing: Sourcing, like purchasing, is only part of the overall procurement process. Sourcing is an early stage of the procurement cycle. It encompasses activities such as identifying and assessing potential suppliers of goods or services, negotiating terms and selecting the vendors that best meet the company’s needs.
- Procurement vs. supply chain: Procurement covers one aspect of supply chain management. Procurement includes sourcing, obtaining and paying for goods and services. Supply chain management also covers the logistics involved in obtaining goods, such as shipping and warehouse management, as well as transforming the procured goods into products and distributing them to customers.
7 Common Principles of Procurement
In public-sector organizations, the procurement process is generally similar to the process in private-sector organizations — but with a few important differences. Because the people involved handle public funds, they generally must follow rigorous principles during the procurement process.
These principles can be regarded as an ethical code of conduct that holds public servants accountable for their purchases. Some of the principles may also be beneficial to private-sector organizations.
The principles vary somewhat depending on the organization. Here are seven of the most common procurement principles:
Value for money:
The organization must manage funds efficiently and economically when procuring goods and services. This may include conducting cost-benefit analyses and risk assessments. It’s worth noting that low cost does not necessarily equate to greater value; characteristics such as quality and durability also factor into determining whether the purchase represents value for money.
Procurement should not provide preferential treatment to individuals or suppliers. All bids should be assessed objectively, based on how well they meet the organization’s needs.
Organizations should seek competitive bids from multiple suppliers, unless there are specific reasons not to do so, such as a sole-source provider where the good or service is only available from a single vendor.
Procurement processes must be carried out efficiently to help maximize value and avoid delays.
Organizations should make relevant procurement information available to everyone, including the public as well as suppliers. Information should be kept confidential only when there are legal or other valid reasons to do so.
Those who practice public procurement should always strive to be perceived as trustworthy, reliable, honest and responsible. Funds must be used for their intended purpose and in the public interest.
People involved in the procurement process are accountable for their actions and decisions. They are required to report procurement activities 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 spends money, while finance focuses on profitability, which sometimes means finding ways to spend less.
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. For example, a well-run procurement team may have a deep understanding of how carefully sourced goods and services can help business groups maximize profitability. This helps the finance group get a better overall picture of company spending and how it affects the bottom line.
Integrated supply chain management software that can connect information from across the business, including finance, is an important tool to bridge the traditional divide and help teams work together to advance business objectives. Supply chain management software can also help you track progress toward goals by providing the information you need for key performance indicators (KPIs) in a simple-to-understand format for your procurement team.
By monitoring procurement KPIs, businesses can boost the efficiency of their procurement process, track progress toward business objectives and identify areas for improvement. Here are some commonly measured procurement KPIs:
Purchase order cycle time: Monitor the average number of hours or days it takes 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 orders to suppliers / # of purchase orders sent to suppliers
Supplier lead time: The average number of days it takes for suppliers to send items after they receive a purchase order.
Supplier lead time = # of days it takes for item(s) to arrive after supplier receives purchase order / total # of purchase orders sent to supplier
Number of suppliers: Having more suppliers gives the company more options but also increases administrative work. Many procurement groups monitor the number of vendors in their supplier networks and periodically remove little-used suppliers to increase efficiency.
Supplier defect rate: An important measure of supplier quality, this is usually measured as the number of defective parts divided by the total number of parts supplied.
Supplier defect rate = # of defective parts from vendor / total # of parts from same vendor
Supplier availability: This measures each supplier’s ability to respond to last-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 suppliers fill 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’s procurement strategy delivers to the organization. It’s the ratio of the annual savings generated 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 of procurement groups, while reducing process costs by as much as 30%(opens in a new tab). You can also simplify steps such as soliciting bids, creating orders and paying for supplies using ERP solutions with procurement software. It can also enable teams to better analyze savings and track supplier performance.
Procurement can play a key role in a business’s profitability and overall success. It includes a broad range of related activities, each of which requires attention to detail to ensure the business gets the most value. Supply chain management software solutions can help accelerate, simplify, analyze and reduce the cost of the entire procurement process.