What is Procurement?
- Procure to Pay
What is Procurement?
At its core, procurement is the process of sourcing goods and services for an organization.
This involves finding suppliers, negotiating and agreeing to terms, actually acquiring the goods or services and often involves running a competitive sourcing event to find the best supplier to meet your company’s goals.
While seemingly straightforward, the role of procurement is far more complex and strategic than many give it credit for.
We’ll dive into it all here in this comprehensive intro to “What is Procurement?”.
Indirect vs Direct: What’s the Difference?
Overall, how a company buys good or services may not seem complicated from the outside looking in, but there are several nuances that any procurement professional must know.
A couple of which are indirect procurement and direct procurement.
Understanding the distinction between direct and indirect goods or services will help you figure out your spend management goals and roadmap.
After all, there is a big difference in strategy when it comes to indirect vs direct procurement.
Like so many things in the world of procurement, indirect vs direct involves a lot more gray than black or white.
That said, we have created a guideline (listed below) to help you distinguish the difference between the two categories.
For more about indirect spend management: Read this white paper
For more on direct strategies: Read this white paper
Direct Goods and Services
Direct goods and services generally means a vital good that is a direct input to the success of a company.
Common in manufacturing organizations you can think of a direct good as a vital piece that is then used to build a finished product.
Because of that, direct goods are a very strategic part of the procurement puzzle, and which strategy you choose has a large impact on the quality, timing and price of your finished goods.
Here’s a quick checklist to help you distinguish direct goods and services:
- Typically, a tangible item that includes measurable specifications (size, type of packaging used, etc.) and ties to a bill of material.
- It falls under the umbrella of supply chain because the materials to make the product are direct from suppliers. Specifically, it falls within procurement, who will own the supplier relationships.
- The cost of the item can be broken down into raw materials, conversion, packaging and shipping.
- You can forecast total direct spend based on your projected sales via your ERP system.
- Samples of direct goods and services categories include: cost of goods sold, chemicals, packaging, metals, plastics, third party manufacturing, sub-assemblies, and transportation.
With direct procurement, you often share goals and responsibilities with the supply chain team. Some of these goals are:
- Lowering costs (or better yet, adding value)
- Decreasing waste
- Driving savings to the bottom line
- Reducing lead time
- Inventory management
- Risk management
- ESG goals
- Supplier innovation
Indirect Goods and Services:
Indirect procurement means dealing with “one-off” purchases, that are used internally, not in the direct manufacturing of a finished good.
Some examples of indirect goods and services are:
- Media & advertising
- Travel expenses
- Utilities & facility management
- Transportation and fleet management
- Office supplies
Indirect goods and services may or not be a tangible good. Often, they have no measurable specifications and no bill of material but will include a statement of work.
Here are a few things to keep in mind for indirect procurement:
- There is no pre-determined amount to buy. The cost is determined by the perceived value of the item. For example, when sourcing talent for your organization, you need to estimate compensation for a worker based on the level of value you believe they will bring to the organization.
- You can forecast the cost of indirect goods and services via a budget holder (a senior manager or director of the business).
- Often, indirect goods and services are managed by a three-way relationship:
- a business partner
- a supplier
- the procurement department.
Unlike direct, with indirect goods and services, your goals may vary by group or by project.
For example, your department’s goal may be to lower costs, while another group may increase the budget to reduce time spent on the project.
This means there is a lot more stakeholder management involved. Oftentimes other departments don’t know (or care) about procurements goals and strategy, so this means putting things in ‘them terms’.
Explain what’s in it for them if they help you achieve XYZ and often leads to a compromise.
For example, if your goal is to lower costs and theirs is to decrease project lead time, you need to look for suppliers against both price and lead time variables to find the best choice for everyone.
However, your goals may be harder to achieve because the indirect space sees more “one-time” buys than the direct space, which means there is often no historical spend by which to make a fair comparison.
Achieving spend management goals in this space may mean focusing more on cost avoidance rather than savings, but there are several strategies you can use to look beyond cost savings and focus on more value-adding goals.
No matter how you look at it, direct and indirect goods and services are both critical to your business.
When you have a stronger sense of understanding what they are, how they are different, and how each can be leveraged to achieve your spend management goals, the result is a significant contribution to your company’s overall success.
What is the Procurement Process?
As with any process, the first step is for someone to identify a need.
This may come from a brand new purchase or may be a recurring purchase when stock falls below a specific level. Either way, the first step is for the need to be flagged in order to get the process rolling. This typically includes a formal requisition to be made.
The next step is to do your research. What exactly needs to be bought? What are the technical specifications and how much of it do you need?
If this is not a recurring purchase it’s best to bring in all possible stakeholders to weigh in, otherwise, you leave yourself open to potentially expensive and time-consuming changes down the road.
The more detailed the purchasing brief, the smoother the rest of the process will go for everyone.
Now that the research is done, you know exactly what needs to be procured and t’s time to actually hold a sourcing event.
If it is a repeat purchase there is typically a pre-existing supplier list to bring into the RFx process.
If this is a new purchase the process becomes much longer.
Pre-existing suppliers have already been vetted and scored across a variety of factors. You know the quality and reliability because you’ve worked with them, or at the very least have evaluated them before.
Net new suppliers need to go through a rigorous evaluation to ensure their reputation, speed, quality and price all align with your company objectives. Without this vetting process, you open yourself up to disruptions and risks that can become quite costly.
Luckily, there are several companies that can help expedite this step. JAGGAER, for instance, has a database of millions of pre-vetted suppliers and can help with the evaluation, onboarding and scoring of your new suppliers.
A good supplier management solution should include things like supplier performance management, risk management and relationship management, otherwise, you’ll be left with inefficient – and often risky – manual work.
Once the supplier list is confirmed, you’re ready to hold a sourcing event. It’s best practice to get at least three different quote before making a final decision, but that ultimately varies by company. Your RFx process can (and should) be automated to ensure suppliers are engaged, everything is fair and transparent and that nothing is being missed, but it can also be done by manually contacting suppliers and asking for bids.
This is crucial in the procurement journey to ensure you’re selecting a supplier that will provide the most value for your investment.
Strong negotiation skills are a must for any procurement professional.
A lot of the job, certainly with indirect procurement, is about getting the best deal.
You have to know what your goals are, what your must-haves are, how you want to approach the situation, and where you know you can compromise.
Good negotiation isn’t about strong-arming a supplier to give you want. That burns bridges and can end up costing you more down the road.
Good negotiation is more about supplier relationships and creating mutual value for all parties.
This is where it comes down to strategy. Are you wanting to go with a single, high-volume supplier or multiple smaller suppliers?
On one hand, volume usually means more bargaining power and therefore lower costs, however sole sourcing is a risky game to play and it’s usually better to have many options otherwise one disruption can halt your entire supply line.
5. Purchase Requisition
Essentially the contract, the requisition should spell out exactly what and when you are receiving the goods or services from a supplier. It’s typically best practice to involve both the buyer and seller in requisition talks so that both parties are well versed in the specifics of the order.
Requisitions need to be carefully reviewed against the original order specifications and the supplier quote to avoid any mistakes being made that can delay the order or add to the cost.
6. Purchase Order Creation
At this stage a PO is created and sent to all parties, this is the official document to act as the supplier-buyer agreement.
This can be handled via email or fax but can be automated and stored in your eSourcing Solution for consistency and transparency if you ran the event through it.
There is also the delivery timeline to consider and should factor in various risk factors to predict the likelihood of disruption. JAGGAER OTD Predictor is an example of how breakthroughs in AI and predictive analytics can help prevent late shipments.
7. Inspection and Quality Assurance
This one speaks for itself. Someone should always inspect the goods or service before accepting or rejecting the purchase order (both options will cause something to happen per the agreement, likely payment or arbitration).
After you take delivery of a good, it is usually implied that the goods are accepted, and the payment process begins. More than one busy professional has fallen prey to not inspecting goods and getting the short end of that stick.
In this stage, all relevant documents are reviewed for consistency, (PO, receipt and invoice). If there are any problems these are handled before any payment begins. If all checks out, the payment is processed via the agreed upon method.
You should keep thorough documentation both for audits and tax requirements, but also for analysis and supplier management.
Did everything arrive on time? What was the quality? Who was the point of contact? How could the process have been improved? What were the terms? These are all important questions to ask and can be a key in furthering that supplier relationship down the road.
Using a P2P solution is particularly helpful for this by always giving an electronic trail, prompting certain actions or questions and providing built-in analysis of every event.
Procurement KPIs are always the subject of great discussion, and everyone’s will look different.
It boils down to recognizing what’s important to you and your leadership and then finding a way to quantify that.
Sometimes it doesn’t have to be a hard numerical number either, softer qualitative insights can be just as powerful, especially when making a presentation on the ROI of procurement.
Here are some of the main ones that we’ve seen to help you start thinking about setting your own procurement KPIs.
- Spend analysis KPIs
- cycle time
- purchase cost
- lead time
- Number of suppliers
- Supplier compliance
- Total savings/cost avoidance
- Total ROI
- Maverick spend
- Amount of spend on contract
- Amount of spend under management
- Supplier diversity (# of suppliers, market share, spend through diversity)
- Supplier innovation
- Carbon emissions and other ESG related issues
The list really can go on and on. There are several technology partners out there that can help you figure out what your KPIs should be and how to go about setting them up.
What is Agile Procurement
One of the more popular procurement strategies is agile procurement.
Before we examine what agile procurement actually looks like, we should be clear about what exactly it means. There are two common areas in procurement where the term agile gets used.
On the one hand, some use agile to describe an implementation methodology. Borrowed from software development, the term refers to starting with a small implementation (a minimum viable product) and then building on it in short bursts (called sprints) while reevaluating your plan as you go.
On the other hand, some use the term agile procurement to mean a source-to-pay function that can adapt quickly to changing circumstances. To JAGGAER, these two areas are heavily related, so let’s take a look at both.
Lean Agile Procurement Implementation
Agile implementation is built on the idea that you can introduce a more basic tool to your users, then use their feedback to shape the solution as you add more features or functionality. One primary competitive advantage of this approach is that it helps users feel engaged and heard, increasing the likelihood that they’ll adopt the solution and follow protocol.
We’ve written previously about how you can achieve agile procurement, but we continue to receive questions about how an agile approach can help, and whether it might even be harmful to newly digitized procurement organizations. On a recent webinar, JAGGAER SVP of Customer Engagement Michael Roesch was asked whether providing a minimum viable product might decrease user involvement. His response was very clear:
“We’re doing projects every day, and we see only in very rare cases that companies start with an MVP – a minimum viable product – and then let this product grow. They do it completely the opposite. They ask for a budget, they get a huge amount of budget, and they want to do it “right.” And then they do an implementation project taking 6-12 months or longer… and then they find out, “Hey, we’ve designed a monster.” People don’t like it so change management is quite difficult, and the project is not going in the right direction.”
Instead, Roesch urges customers to consider an agile approach, saying, “We want them to start a little bit smaller, with something a little bit more than an MVP, roll it out to some suppliers, learn from that, measure the success, think about the optimizations and then go to the next step.” Learning and measuring are the key points here – without taking the time to reevaluate your progress and reorient at each phase, you risk getting too far down the wrong path.
🎧 Listen to Andrew Bartolini, Founder and Chief Research Officer at Ardent Partners on Why Agile Procurement is Essential for CPOs in 2021 or read the article.
Agility within your Procurement Organization
The second area of agile procurement is a bit more self-explanatory. It’s mainly just about building a procurement team that can react with agility, adjusting to changing circumstances and market fluctuations. It’s pretty clear why that’s still necessary in 2021. It’s still the wild west in a lot of procurement areas, with some suppliers unable to meet demand as companies scale back up to full operations.
At the end of 2019, Chief Research Officer and Founder at Ardent Partners Andrew Bartolini made the case that 2020 would be the year of the agile CPO. He didn’t know at the time just how right he would be. He emphasized that positioning your organizing team to make quick decisions and act on the fly was one of the most valuable traits in a CPO, and as Coronavirus played out we saw this very prediction in action. That’s the core of an agile procurement team – having the confidence and knowledge to make quick business decisions when needed.
How Technology Can Help
Importantly, agile CPOs and their teams rely heavily on technology to help them achieve such flexibility. Having a solid foundation of supplier and risk data allows you to quickly examine potential weak points in your supply chain and address them before they become a problem.
Moreover, the newest developments in autonomous procurement provide specific recommendations to strengthen supply chains and respond to threats, all faster than humans can. The platform itself makes your team far more agile than you would be without it.
The Future of Procurement Technology
Procurement will continue to evolve, just as it has the last 25 years.
However, we do see quite a few “big shifts” coming, both in a mindset as well as technology.
Procurement has historically been considered a desktop function. You do paperwork, run reports and save the company money. Rise & repeat until retirement.
Now procurement is shifting into a much more strategic role, truly becoming a competitive advantage for a business.
With technology advances and some modern change management philosophies, procurement teams are becoming more data driven and strategic.
Instead of running reports and RFPs and filling out supplier info, that’s all been automated. Now it’s a shift towards stakeholder management, developing supplier relationships and exploring value add opportunities instead of cost reduction.
This is due in large part due to the journey towards autonomous procurement.
Autonomous procurement doesn’t mean a robot taking your job, instead, it means using technology to augment and automate much of the routine tasks associated with procurement to free up your time to make truly strategic decision.
No one joins procurement because they love paperwork, this will allow you to realize a more fulfilling career.
Want an in-depth guide to all things autonomous procurement and how to set your organization up for success in the years to come?
Join 1000+ plus of your peers on the journey by downloading our free practical guide to autonomous procurement.