Note. From ProPhotoStock, 2014. CC BY 3.0.
- Define procurement and its purpose.
- Understand key procurement objectives.
- Explain procurement roles and activities.
- Analyze the key procurement procedures and processes.
- Evaluate the key steps carried out in managing the procurement process.
What do you know about the procurement process?
Procurement in the Supply Chain World
The purpose of this book is to equip the learner with knowledge about the key aspects of procurement and supply management. The chapters are intended to provide an overview and definitions of supply management and procurement. Additionally, key policies, procedures, processes, and requirements for effective and efficient implementation are presented. The effective implementation of procurement activities is a critical function in the overall supply chain process. This chapter further describes the identification of requirements, identification, and qualification of suppliers, supplier bidding and negotiation, approval for purchases, and supplier performance monitoring and performance measurement.
Purchasing and Procurement
The terms procurement and purchasing are often used interchangeably; however, they have important similarities and differences between them. This certification track employs the following definitions for each term:
- Procurement: Procurement is the management of all processes involved in obtaining the goods and services necessary for manufacturing products and providing services to customers. Procurement focuses on sourcing activities, negotiation with suppliers, and the strategic selection of goods and services that enable an organization to maximize value from a select group of key supplier partners.
- Purchasing: Purchasing is a function within the procurement process that is largely transactional and associated with how goods and services are ordered. Purchasing involves receiving and processing purchase requisitions (requirements) and converting them to purchase orders (POs) (awards to suppliers).
A Procurement Example
Procurement professionals interact with a wide array of internal and external organizations; they work with suppliers, other functions in the supply chain, and other functions within the company, such as marketing and engineering. An example of a cereal manufacturing and supply chain process and the key role procurement plays to purchase grain and other raw materials, along with packaging and labelling products needed to make breakfast cereal, the finished product in this example.
In addition, to the raw materials, the company also purchases paperboard from a paper manufacturer and labels from a label manufacturer. In turn, the paper manufacturer purchases trees to make the paper, and the label manufacturer purchases semi-finished stock to make the labels. After making the cereal and packaging it, the cereal manufacturer sends the cereal to the distributor, which then ships the product to the grocery store at which the end customers purchase their cereal. Throughout this sample supply chain, the purchasing of goods and services takes place between various entities.
The example shows how materials and products move from one entity to another while information (e.g., specification, quantities, and desired receiving date) also flows between the various entities. This information flow is important because it is needed to ensure the right products are delivered at the right place, at the right time, and at the right price.
The Importance of Procurement
The procurement function plays a critical role in supporting the ongoing functioning of a firm by ensuring a continuous flow of materials, products, and services to support the firm’s operations while continually seeking opportunities to reduce costs, minimize supply risk, and maintain expected quality levels. The importance of the procurement department can be seen by the key inputs it provides firms, including:
- The raw materials and intermediate goods and services needed in the production
of goods and services.
- Finished goods and services required for resale or for operational purposes.
- Capital goods and consumables are needed for the business.
These inputs are critical to a business. The procurement department plays a key role in obtaining these inputs at appropriate levels of cost, quality, and on-time delivery to ensure the continuity of inputs from suppliers. As noted previously, the procurement function plays a vital role in the supply chain; the following list describes several major benefits of effectively managing procurement.
- Cost reduction: Procurement represents an excellent opportunity for saving money because organizations can spend up to 50% or more of their revenues on raw materials, work in process, finished goods, spare parts, services, and other goods needed to keep operations going.
Significant savings can be achieved by applying effective procurement techniques.
- Quality improvement: Procurement directly impacts the quality of the
overall products sold by companies, because it is responsible for purchasing
raw materials and other unfinished or finished goods. The quality of raw and other
materials used in producing goods almost always affects the quality of the end products.
- Product enhancement: Procurement can also improve products and process designs by helping introduce new technologies into companies’ product and service offerings. For example, procurement can
work with internal and external engineering personnel and suppliers to
improve product reliability and performance while also reducing costs.
The 5 Procurement Functions
The main objective of the procurement function is purchasing materials and services at the lowest total cost possible while ensuring the required quality levels and meeting the needs of internal and external customers. Much of this effort entails identifying and negotiating with suppliers to reduce the costs of purchased products and services; however, procurement departments must also consider other items that add to the total cost of procurement, including transportation costs, payment terms, return policies, and warranties.
The five key objectives for a procurement department are: supporting operational requirements, working with other functional groups, partnering with suppliers, supporting organizational goals and objectives, and developing sourcing strategies.
1) Supporting Operational Requirements
Procurement supports the day-to-day operational requirements of a firm by acquiring raw materials, components, subassemblies, finished goods, maintenance, repair items, and services. Procurement aids supply chain elements like transportation and distribution centres (DCs) by ensuring that the end customers receive the replacement parts or finished products they need. Additionally, procurement supports the departments involved in developing new plants or products, installing and commissioning new machinery, and providing replacement parts by ensuring that parts, replacement parts, and machinery are available as needed in the required quantities, at the required quality, and at an appropriate cost.
2) Working with Other Functional Groups
Procurement plays a vital role in ensuring continuity of supply, reducing costs, sourcing from qualified suppliers, and ensuring that the quality of goods and services is maintained. However, procurement cannot accomplish these tasks without a close working relationship with several other functions within a firm, including top management, operations, engineering, marketing, quality assurance, and finance. Procurement works with top management to ensure that the procurement strategy is aligned with the overall organizational strategy and objectives. Procurement has a working relationship with the following functions within a firm shown in the list below.
- Make vs Buy
- Insight into Capacity, Materials, Service Needs
- Requirements in Quality, Cost, Cycle Times
- Insight into Specifications and Requirements
- Support in Value Analysis Exercises
- Insight into Evolving Technologies
- Sales & Marketing
- Insight into New Product Development
- Support in Total Cost Analysis
- Sales Forecasting
- Quality Assurance
- Suppliers perform as expected
- Quality training
- Corrective action planning
- Supplier quality planning
- Material re-work costs
- The total cost of an item
- Making or buying products
- Capital acquisition decisions
3) Partnering with Suppliers
Partnerships and effective supplier management have become increasingly important to improve firms’ Supply Chain Management (SCM) competitiveness. For instance, forming partnerships, or strategic alliances, with suppliers allows them to focus on providing quality products and services. This comes about while working closely with key suppliers to develop long-term partnerships based on trust. Additionally, close buyer-supplier relationships offer numerous technical, financial, and strategic advantages, such as opportunities to work together to re-engineer products to lower costs while maintaining functionality. Many companies have adopted a strategy of using a smaller number of suppliers for key products and services rather than working with many suppliers. This strategy is adopted to allow companies to focus their efforts on improving performance and reducing costs with fewer, better suppliers.
Typically, a partnership with suppliers is required to ensure an adequate supply of quality materials overtime at an optimal total acquired cost. A strategic alliance is defined as a purposive relationship between two or more independent firms that involves exchanging, sharing, or co-developing resources and capabilities to achieve mutually relevant benefits (Kale & Singh, 2009). However, once formed, these strategic alliances must be developed through effective relationship management. For example, a company may provide warehouse layout and design services to multiple companies and may work together with a firm that provides the actual storage and handling equipment that support new warehouse designs.
Global competition has grown, and companies have developed supply chains that rely heavily on external suppliers. One well-known example is Apple, which outsources product and component manufacturing. This emphasis on concentrating on core competencies has seen a dramatic rise in outsourcing to, and reliance on, external suppliers to provide not only materials and products but also services (e.g., IT support and design services). As more emphasis is placed on the use of external suppliers, including global suppliers, procurement departments’ roles must also involve close support and management of these suppliers. The procurement function has a vital responsibility to meet the needs of both internal and external customers by choosing products and services with specific criteria. Products and services must come from the best sources of supply and be made to the correct specifications, have the desired levels of quality at a reasonable cost, and be made and delivered in the correct quantities. Products and services must be delivered at the right time and to the satisfaction of internal and external customers.
4) Supporting Organizational Goals and Objectives
In order for a company to grow and remain profitable, procurement can help increase revenues and reduce costs and expenses. Using effective procurement strategies, organizations can position themselves to be competitive on both the quality and pricing of their products and services. By helping to reduce the costs of materials and services, procurement thus improves corporate profit margins and return on assets. Additionally, procurement plays an essential role in ensuring the quality of the goods and services needed by an organization. Organizational goals and objectives can be described under four main categories: survival, growth, finances, and environment. However, procurement goals and objectives are typically expressed using other terms like quality and function, delivery, quantity, price, terms and conditions, and services. A critical first step in developing organizations’ strategies is to develop strategic goals, in which procurement plays a major role. The next step is to translate these goals into specific procurement objectives. According to Monczka, Trent, and Handfield (2005), procurement functions must ultimately support the strategic goals and objectives of the entire organization, including ensuring overall profitability and adequate return on investment for organizations’ shareholders.
5) Developing Sourcing Strategies
Many firms face the challenge of remaining competitive in the face of highly competitive world markets. A firm’s ability to effectively develop and execute strategic plans is a major factor in generating future earnings and can even be critical to the firm’s survival. Organizations must take in more than what they spend on operating costs over the long term if they want to grow and remain profitable. Increasing revenues, decreasing costs, or a mixture of both can accomplish this key goal. Procurement plays an important role in helping accomplish both objectives.
Through effective procurement strategies, organizations can be competitive in the quality and prices of their products and services. For example, reducing the costs of materials and services is an area in which procurement plays a vital role and thus helps to improve corporate profit margins. In many cases, procured goods and services provide a major area of opportunity for reducing costs and improving return on assets. Procurement departments must develop sourcing strategies to support the overall organizational strategy; they aim to ensure the survival and competitiveness of the whole organization. A sourcing strategy is the expression of the goals and objectives for selecting the best sources of supply and optimizing the procurement spend for an organization, which are tied to the overall corporate strategy. For example, a commodity sourcing strategy might develop a specific approach for a category or group of raw materials that maximize quality and minimize cost.
Procurement Roles and Activities
The procurement function seeks to obtain the highest quality of goods and services at the lowest possible costs at the right time and place. To achieve this goal, various roles and activities are performed at different levels of management within the procurement function. Procurement provides an ongoing analysis of price and cost trends. The cost of purchased goods often represents the most significant component of companies’ costs, so procurement functions must analyze the cost of sourcing products and services to ensure they are obtained at the lowest possible cost. Procurement roles and activities consist of the following functions:
- Procurement assists internal departments in defining and documenting material specifications to communicate to suppliers.
- Procurement estimates the future supply needs of organizations, which are then communicated to suppliers.
- Procurement ensures that sourced goods and services meet minimum quality standards in order to meet buyers’ expectations at an acceptable cost.
- Procurement regularly reports on material lead times and supplier performance.
- Procurement draws up contracts and negotiates mutually acceptable terms with suppliers. Procurement conducts market research to identify new suppliers to meet customers’ needs. Procurement expedites and authorized premiums for the delivery of shipments, where necessary, to ensure that production needs are met and deliver appropriate customer order fulfillment.
- Procurement finds and develops best-in-class suppliers. The success of procurement depends on its ability to align supply-based decisions with organizations’ strategic priorities and to identify or develop suppliers, analyze their capabilities, select the most appropriate options, and work with those suppliers to deliver continuous improvement.
- Procurement ensures the uninterrupted flow of materials, supplies, and services required to operate organizations. This prevents stock-outs or late deliveries of materials, components, and services (which can be extremely costly in terms of lost production), reduced revenue or profit, and a decline in customer goodwill.
Types of Buying Organizations
Organizations procure goods and services for different purposes. According to Fill and Fill (2005), here are the primary forms of organization that procure goods and services:
- Commercial organizations: Commercial organizations consist of industrial distributors, original equipment manufacturers (OEMs), users, and retailers. They procure goods as raw materials, components, and finished products for resale. Additionally, the miscellaneous materials and services needed to support running an organization need to be procured. Support items may range from office supplies and real estate to
lawn services and health insurance policies.
- Governments: Governments are the biggest procurement customers. They often use procurement to meet small business (e.g., women-owned, veteran-owned, Native American-owned, etc.) objectives, spending many billions annually as a result. Governments’ procurement budget is spent on a wide range of activities, from public hospitals and schools to the organization of the departments themselves.
- Institutions: These include private universities, hospitals, and schools. Institutions buy, for example, textbooks, classroom furniture, medical equipment, audiovisual equipment, and computers.
- Public organizations: Public organizations include railways and nuclear power plants that make purchases for operational and production purposes.
Types of Products and Services Purchased
Procurement personnel are responsible for purchasing many different products and services, depending on the nature of their industry and the nature of their organization. These are examples of different goods and services procurement is responsible for procuring:
- Raw materials: These include products that have not been processed or have undergone only a small degree of processing. They are the basic materials in the production process and become part of final manufactured products. Examples include mined minerals, coal, and cotton.
- Semi-finished goods: They are also known as manufactured products because they have been partially assembled; however, they need further assembly and processing before they can be sold. These products are visible in final products and include elements such as steel and rolled wire.
- Capital equipment: Capital items are usually the most expensive purchases; they include large pieces of equipment used in production processes, such as power generating equipment and buildings.
- Original Equipment Manufacture (OEMs’) component parts: OEMs are products that are purchased for resale or assembled into final products with no further processing. An example of an OEM is the alternator in a motor engine.
- Maintenance, repair, operating materials: Maintenance, repair, and operating materials (MROs) are not directly required for the production process but are important for the continued operation of organizations, such as office and cleaning supplies and other consumables.
- Finished goods: Finished goods require no further processing. They are bought for resale or for use within organizations, such as stock bought for resale by retail organizations.
- Accessory equipment: Accessory equipment includes products used to facilitate production, such as personal computers, hand tools, desktop printers, and toolboxes.
- Services: According to Dwyer and Tanner (2009), services include transportation, advertising, banking, and labour services.
- Major subcontracted items: These include high-cost items used in finished products, such as automobile engines and aircraft engines.
Procurement Process Overview
The procurement process contains steps ranging from working to understanding firms’ needs through ongoing evaluations of supplier performances. These steps are:
- Identifying the Need: A need or requirement may arise from any function but is most often developed through the demand planning process. A need may be raw materials for production purposes or office furniture for administrative departments. User functions sometimes fail to identify needs promptly, which can result in urgent requirements and create challenges for procurement personnel; these challenges can include the need to expedite the supply of goods and the additional costs associated with paying a premium to expedite orders.
- Describing the Product or Service Needed: Requirements are communicated to the procurement function along with the appropriate documents, such as a purchasing requisition. The information contained in the requisition includes the date, originating department, account to be charged, complete descriptions and quantities of materials or services required, date when materials or services are needed, special instructions for shipping or service delivery, and the name of the authorized person initiating the request. As part of the procurement process, procurement professionals work with the person initiating the request to confirm that material and service specifications have been captured correctly. In many cases, engineering drawings and other documents accompany the requisition to describe complex and non-standard items accurately.
- Searching for Potential Suppliers: When appropriate suppliers are not available from a pre-approved list, procurement personnel assume the responsibility for finding other potential suppliers. This search can take place using catalogues, websites, professional organizations, and personal contacts.
- Evaluating and Selecting Suppliers: The critical task of evaluating potential suppliers is accomplished by a multi-function team that conducts a site visit to evaluate a wide range of capabilities, including management, manufacturing planning, process control, quality, and overall workload assessments. While procurement takes the lead, other functions support the evaluation process to ensure a supplier can actually meet the anticipated requirements with smaller standard-item and procurement and catalogue items bought through a published price list, the procurement professional may be able to perform an effective evaluation without assistance.
- Request for Price and Request for Quote Processes: This stage occurs when purchase requisitions are received by purchasing personnel and they initiate a request for price or request for quote (RFQ). Requests for price are initiated and sent to suppliers to obtain pricing for simple, lower-cost items while RFQs involve more complex and expensive items and are sent to suppliers to solicit specifications, pricing, delivery, and other requested information.
- Order Placement: After the request for price and RFQ responses are received, purchasing can place a PO. However, the purchasing buyer and supplier may have completed a negotiating process that included a final agreement on price, delivery arrangements, product requirements, and quality requirements before the buyer actually issues a PO.
- Evaluating Performance: After a supplier has been awarded a PO, it is continually evaluated to determine if its products satisfy the order details stipulated in the PO. Suppliers that provide acceptable products may receive additional orders in the future, but poor supplier performance may lead to removal from the approval database and a lack of future POs. Some procurement departments use supplier scorecards to evaluate supplier performances on quality, delivery timeliness, cost containment, and responsiveness.
Procurement is the management of all processes involved in obtaining the goods and services necessary for manufacturing products and providing customer services. Procurement focuses on sourcing activities, negotiations with suppliers, and the strategic selection of goods and services that enable an organization to achieve the best value from a select group of key supplier partners. Procurement functions must have close working relationships with other functions, including production, engineering, and sales and marketing functions because those areas use the products and services that procurement obtains. Organizations of different types are involved in procuring goods and services for different purposes, including commercial and public organizations, governments, and institutions. Stages in the procurement process include receiving requirements for purchase, describing the materials needed, defining and approving suppliers, soliciting suppliers using requests for price and RFQs, placing POs, and evaluating supplier performance.
Dwyer, F. R., & Tanner, F. T. (2009). Business marketing: Connecting strategy, relationships, and learning (4th ed.). New York, NY: McGraw-Hill.
Fill, C., & Fill, K. E. (2005). Business-to-business marketing: Relationships, systems and communications. Harlow, UK: Pearson Education Limited.
Fottrell, Q., & Scheck, J. (2009, January 8). Dell moving Irish operations to Poland. The Wall Street Journal. http://www.wsj.com/articles/SB123141025524864021
Kale, P., & Singh, H. (2009). Managing strategic alliances: What do we know now, and where do we go from here? Academy of Management Perspectives.
Monczka, D., Trent, R., & Handfield, R. (2005). Purchasing and supply chain management (3rd ed.). New York, NY: McGraw-Hill.
ProPhotoStock. (2014, January 5). World technology and business [Image]. Deviantart. https://www.deviantart.com/prophotostock/art/World-Technology-and-Business-424996906. Licensed for reuse under CC BY 3.0.
Creative Commons Attribution
This chapter contains material adapted from Supply Management and Procurement Certification Track. LINCS in Supply Chain Management Consortium. March 2017. Version: v2.26. www.LINCSeducation.org.