Procurement is a critical function in most small and medium-sized businesses. It can have a huge impact on your bottom line; it can even be what makes or breaks your company.
In a nutshell, procurement involves purchasing or acquiring the goods or services your company needs to operate. The way your company does this can directly impact profitability by helping get these supplies from reliable companies at the best price and quality.
But this function has faced severe disruptions over the last two years in many companies, with global events wreaking havoc on supply chains. It’s well over two years since the start of the pandemic, but many supplies are still much more scarce or more expensive.
As a small company, you can either pass on price hikes to customers, find savings elsewhere in the business, or take a hit to profits. If you can’t pass prices on, for example, if you are working on a fixed priced contract , this heaps pressure on your procurement team to limit price increases with existing suppliers, find cheaper suppliers elsewhere, or even source alternative products that do the same job.
“Companies who had to wait weeks or months to get materials have lost revenue because, without the materials, they were unable to produce,” says Amy LaSala, valuations manager at Vision Point Capital. “In such cases, it’s advisable to have multiple suppliers, not just for the lowest prices. Businesses that could source materials from multiple suppliers fared better during the pandemic.”
In this article, we will cover:
- What is procurement?
- Types of procurement
- How a procurement works
- What is the difference between procurement, purchasing and supply chain?
- Accounting and procurement
- Using procurement to boost profitability
- Final thoughts
What is procurement ?
The simplest definition of procurement is “the process of obtaining or taking ownership of a good or service.”
This can cover every activity involved in obtaining goods and services your company needs to support operations, including:
- negotiating prices and terms
- purchasing items
- arranging and taking delivery
- inspecting goods
- quality assurance checks
- performance analysis
- market reviews.
Some companies see procurement as covering all these stages. Others define it as a narrower range of activities, such as issuing purchase orders and making payments.
If you use enterprise resource planning software, the definition typically includes the entire process of acquiring goods at the best price, and at the right quantity, quality, and delivery cost. The process often involves building relationships with suppliers to ensure supply security and obtain better long-term prices and terms.
Types of procurement
Procurement activities are generally categorized as direct or indirect.
Direct procurement includes all goods and services used to produce a product, such as raw materials, machinery, labor, and components. This can also include wholesale items for retailers.
Indirect procurement involves goods and services that meet your operational needs but do not contribute directly to profits. This could include office equipment, furniture and marketing supplies such as advertising.
Services procurement obtains people-based services such as hiring contractors, contingent labor, accounting firms or security services.
Goods procurement obtains physical items.
How a procurement works
The procurement process generally divides into four stages – sourcing, purchasing, receiving, and reviewing.
- identifying your business needs
- finding potential suppliers
- requesting quotes
- assessing suppliers on factors such as cost, reputation, speed, quality, capacity, and reliability
- evaluating environmental, social and governance (ESG) criteria.
Purchasing includes negotiating prices, volumes, terms and contracts with the supplier; and completing the purchase order.
Receiving involves taking deliveries and checking them; then checking invoices and approving payments. Automated accounting software is critical for efficient execution of these tasks.
Reviewing includes checking the market to ensure you still have the best suppliers for your needs; monitoring performance management and quality assurance; and keeping a record of the entire process for bookkeeping, tax records and auditing. Accounting software is also essential for maintaining records safely and efficiently.
Meeting ESG criteria is an increasingly important part of procurement. Doing this mitigates risks in your supply chain – including operational, reputational, and regulatory risks. It also helps ensure the long-term sustainability of your products and services.
Levon Galstyan, accounting consultant at Oak View Law Group, says: “Bad procurement practices can be fatal in fields where people’s lives are at stake. Think about the procurement scandals in the US military, in which shoddy electrical work led to soldiers dying. And in London, an independent review into the Grenfell Tower fire found bad procurement practices contributed to the deaths of 72 people.”
Conversely, good procurement practice can improve lives, Levon says. For example, the Scottish Government revised its procurement policy to pay 99% of invoices within ten days and give more contracts to SMEs that do fair work. The strategy helped boost the Scottish economy and saved the taxpayer almost £160 million.
What is the difference between procurement, purchasing and supply chain?
Levon says the terms procurement, purchasing, and supply chain are often used interchangeably. But they aren’t the same.
“Supply chains are networks of companies working to produce and deliver products to the consumer,” he says. “For physical products, the link starts with the raw material producers and concludes with the entity that brings the finished product to the end consumer.”
Procurement activities such as sourcing goods are a critical subset of supply chain management. But the latter also includes wider logistical activities such as warehouse management, transport and distribution.
Purchasing is a subset of procurement. It is much narrower and simply focuses on managing the orders.
Accounting and procurement
In a siloed organization, procurement and finance functions can conflict if one wants to spend money and the other wants to save it. But an efficient procurement function should understand how to get the best out of spending budgets to help maximize profits. So if procurement and finance work in close collaboration, this can reap benefits for your bottom line.
Integrated supply chain management software connects information from across the business – such as sales, inventory, purchasing, and finance – to help these teams and others work together on improving business goals.
Using procurement to boost profitability
Too often, short-sighted small businesses cut corners in procurement to save money. These companies ignore essential factors such as innovation, risk management, resilience, and corporate citizenship.
Getting the best value for your spend is vital in procurement. But it’s also essential to find suppliers that have a track record of providing the quality of goods and services you need; and that can handle the capacity. It’s also in your interests to negotiate a fair deal that ensures the supplier can continue to serve your needs sustainably.
“Profitable businesses view the procurement process as a way to grow in the long run, not as a way to make quick bucks,” says Levon. “They follow the best practices for procurement, like setting clear standards, developing and following a strict process for screening and choosing suppliers, and using digital technologies.
“These practices can help you mitigate risk; build a culture of smart spending; centralize your data to make your procurement workflow more efficient; and improve your relationships with vendors. This will help you make money now and scale your businesses to new heights of profitability.”
Having said all this, exactly how procurement helps your company boost profits depends on a range of factors; and in some situations, companies can feel cost-cutting is unavoidable.
According to a report by McKinsey, heavy industries, such as oil and gas are currently facing huge cost challenges due to falling demand. But industries such as consumer goods are focusing more on vendor collaboration, perhaps due to the global nature of their supply chains.
Meanwhile, financial services are looking to transform their procurement functions—not due to cost pressure, but to accelerate adoption of digital and spend-analytics to unlock new opportunities.
Final thoughts: how processes and technology can help
A well-designed procurement process helps you promote accuracy and timeliness because each person involved knows exactly what they have to do and when. A disorganized process can lead to inefficiencies and costly errors. Take overpayments, for instance. They can impact your profits, and late payments can damage supplier relationships.
Technology can help in many ways. For example, supply chain management software can help you manage the end-to-end purchasing process seamlessly—from management of requests for quotes (RFQs), to input and replies, and integration into the price list base.
And a powerful ERP system can help you control procurement, business purchases and cash flow. It also helps you integrate this with inventory, sales, customer services, finance and more to help you build profitability and take your business to new levels.