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Procurement

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Procurement

The ultimate goal of a business is to reduce the cost of production and increase profitability. Many aspects of the supply chain can help companies achieve this goal, including streamlining processes, identifying better suppliers, and reducing the cost of raw materials. The process of finding suppliers and acquiring raw materials for business is called procurement. In this explanation, you will learn about procurement and the role it plays in business.

Procurement meaning

Procurement allows the business to acquire goods and services in case of scarcity and reduce the cost of production. It is a prerequisite for seamless business operations.

Procurement is the process of contacting potential suppliers and negotiating a contract with them to buy goods or services for a business.

Procurement and purchasing are often used interchangeably. However, while purchasing is limited to acquiring goods and services, procurement refers to the entire process, from identifying potential suppliers to negotiating contracts and obtaining raw materials.

For businesses, procurement is of great importance. When done effectively, it can give the company a competitive advantage by saving money, resources, and time. Procurement also optimises business operations. As a result, many companies involve the head of procurement in senior management.

Procurement: Managing stock

Managing stock is crucial for businesses. It can be in the form of office supplies or raw materials. These stocks help businesses with their daily operations. The nature of stocks and the amount spent on managing them is different for every business. Ideally, two approaches are used to manage stock effectively.

Procurement: Just-in-time

As the name suggests, in this approach the stock arrives just in time to be utilised by the business for manufacturing or operational activities. If a business wants to minimize the holding costs of stock, this approach should be used. JIT offers lower stock-holding and opportunity costs, and less material damage.

Procurement: Just-in-case

In this approach, businesses keep more stock in case the need arises. Therefore, stock is available at all times. Businesses using this approach tend to buy supplies in bulk. However, this approach increases the stock-holding costs and makes procurement less efficient.

Procurement process

In the procurement process, there must be comprehensive planning and precise execution to get the desired results. Here are the seven steps to procurement:

  1. Identifying needs: the first step is to identify the need for obtaining goods or services. Every department in the company should be examined to determine which departments are over-spending and for which departments the company needs to procure. Once the area and the need are identified, a budget should be assigned for procurement.
  2. List potential suppliers: the company should shortlist potential suppliers after conducting research. It is important to find the right supplier who can ensure fast and cost-effective delivery of goods or services. If the company fails to find the right supplier, this could have a major impact on its operations. From the shortlisted suppliers, select the one that best fulfils the criteria.
  3. Negotiate: after choosing the right supplier, the company has to negotiate terms with them. A mutual agreement should be reached on the price, scale, and timeline of the project. A contract is only signed after all the terms are agreed upon.
  4. Release purchase order: after the contract is signed, a purchase order is released. This document has information regarding the goods or services, quantities, and costs. At this stage, the working partnership between a business and a supplier begins.
  5. Payment: when the supplier receives a purchase order, he sends an invoice to the company, which contains the price, the mode of payment, and the details of the order. Payment is then made to the supplier at the time agreed in the contract.
  6. Delivery and audit: the supplier delivers the goods or services to the company. The company should record the date on which it receives the delivery. Then it can see if the supplier has delivered at the agreed time or not. It's also important to audit the order to make sure every required product is delivered.
  7. Maintain records: last but not least, the business should keep a record of everything in the procurement process, including records of invoices and payments. This will allow the company to track the transactions and analyse how much it has spent on procurement.

Types of procurement

Based on the goal of procuring goods and services, procurement can be split into:

  • Direct procurement: the procurement of materials to produce an end-product is called direct procurement. Items such as raw materials and machinery are acquired through direct procurement. In this type of procurement, procurement officers and suppliers are key stakeholders.
  • Indirect procurement: the procurement that is done to manage daily business operations but does not contribute directly to the end-product is called indirect production. Equipment maintenance and office supplies are examples of indirect procurement.

Based on the type of products procurement is intended for, procurement can be divided into:

  • Goods procurement: The procurement of physical items is called goods procurement. It includes both direct and indirect types of procurement.
  • Services procurement: Service procurement refers to the procurement of people-based services. Individual contractors and on-site security personnel are examples of services procurement, which can be done via either direct or indirect procurement.

Procurement, Types of procurement, StudySmarterFigure 1. Types of procurement, StudySmarter

Procurement cycle

The procurement cycle consists of various stages that require proper planning and execution. Each stage plays an important role in driving procurement strategy for the company. Here are the six stages of the procurement cycle:

Procurement planning

In this stage, the problem is identified and an initial review is conducted to confirm the details of the problem. For instance, what kind of product is needed and which solution would be appropriate for solving the problem. Is the required product commercially available or is it custom-made? All questions related to problem identification and solution-finding are part of the planning stage.

Procurement: Requirement definition

Once the planning is done, the next stage is requirement definition. All the requirements of problem-solving are listed in a document called a statement of work. It is a crucial step because these requirements demonstrate how well the prospective suppliers understand the problem. Only by fully understanding the problem will they be able to give better solutions.

Procurement: Sourcing

During this stage, the business will contact the supplier and communicate all the details of procurement, including terms and conditions, delivery schedules, and product/service requirements. Suppliers will inspect, examine, and respond to a company’s offer with a proposal.

Procurement: Evaluation and selection

After evaluating proposals sent by suppliers, the company will select the best among them. The selection is based on how well the solution is defined in the proposal.

Procurement: Contract awarding

The contract is awarded to the chosen supplier. Further negotiations will be carried out in case the company needs more information about certain aspects of the proposal.

Procurement: Contract management

Once the supplier is given the contract, it is important to manage it to resolve any potential contractual issues. The aim is to make sure that the supplier is fulfilling all the requirements of the contract. From on-time deliveries to the cost of deliverables, everything is managed in this stage.

Procurement, Diagram showing the Procurement cycle, StudySmarterFigure 2. Procurement cycle, StudySmarter

Factors affecting the choice of suppliers

Value and quality – the procurement process must be value-driven, i.e., companies must look for products that offer value for money. A company should not select a cheaper option as it could compromise quality.

Open competition – there should be open competition among potential suppliers. This allows the company to select the supplier from a good pool of potential suppliers.

Transparency – the entire procurement process must be transparent. The decision of selecting a supplier must be fair. This factor improves the process and brings optimal results.

Reliability – the business should always aim to choose reliable suppliers, as an unreliable supplier can potentially harm daily operations.

Price – while selecting the supplier, price is also an important consideration. A supplier who provides supplies at a reasonable price is ideal for the business.

Effects of procurement and the value of supply chain management

The effects of procurement and the value of the supply chain are huge for the business. They help in optimising business operations by reducing the cost of production and ensuring the smooth running of business activities.

Effects of procurement on business

Procurement has a major impact on business: it helps in increasing efficiency and reducing unit costs in a business. For instance, having a credible supplier means there is less chance of raw materials being faulty; instead, quality supplies are used.

Procurement: Value of supply chain management

Effective supply chain management adds value to the business. The key activities include working with the supplier to ensure the supply chain is working efficiently and cost-effectively, procuring supplies that give more value at a reasonable price, and reducing the cost of production.

For businesses, the role of procurement is vital as it could increase profitability and reduce the cost of production. Therefore, it is essential to implement the procurement strategy effectively.

Procurement - Key takeaways

  • Procurement is required to run business operations smoothly, reduce the cost of production, and acquire goods and services in case of scarcity.
  • Purchase is limited to acquiring goods and services, whereas procurement involves all the processes from identifying potential suppliers to obtaining goods and services.
  • Procurement is vital for businesses. When it is done effectively, it can give a competitive advantage to the business by saving money, resources, and time.
  • Identifying needs, listing potential suppliers, negotiating, releasing purchase orders, payment, delivery, and auditing and maintaining records are all stages in the procurement process.
  • The four different types of procurement are indirect, goods, and services.
  • Procurement planning, requirement definition, sourcing, evaluation and selection, contract awarding, and contract management are components of the procurement cycle.
  • Value and quality, open competition, transparency, reliability, and price are all factors that affect the choice of supplier.

Frequently Asked Questions about Procurement

Procurement is the process of contacting potential suppliers and negotiating a contract with them to buy goods or services for a business. Procurement allows the business to acquire goods and services in case of scarcity and reduce the cost of production. It is a prerequisite for seamless business operations. 

The four different types of procurement are direct, indirect, goods, and services procurement.

A furniture store finds out that their current supplier is supplying poor-quality wood thereby identifying the need, and start taking steps to procure wood from a new supplier. The business makes a list of all potential suppliers that will provide them with better-quality raw materials (here, wood). The business negotiates terms with the suppliers. The purchased order is released after the contract is signed between the two parties. The supplier receives a payment from the furniture store at the agreed time, as per the contract. After the delivery of the product, the company audits the product to make sure that the supplier has fulfilled all the requirements, as agreed. The furniture store will also maintain records of all the activities and transactions between the supplier, as this will allow the company to track the transactions and analyse how much it has spent on procurement. 

Identifying needs, listing potential suppliers, negotiating, releasing purchase orders, payment, delivery, and auditing and maintaining records are all stages in the procurement process. 

While purchasing is limited to acquiring goods and services, procurement refers to the entire process, from identifying potential suppliers to negotiating contracts and obtaining raw materials.  

Final Procurement Quiz

Question

Define procurement. 

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Answer

Procurement means contacting potential suppliers, agreeing on terms with them, and negotiating a contract to buy goods or services for a business.  

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Question

What is procurement?  

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Answer

Procurement means contacting potential suppliers, agreeing on terms with them, and negotiating a contract to buy goods or services for a business.  

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Question

what are the types of procurement? 


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Answer

Direct, indirect, goods, and services are types of procurement. 

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Question

Name two main types of procurement.

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Answer

Direct and indirect procurement. 

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Question

what is an example of procurement? 


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Answer

Purchasing raw material from a supplier. 

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Question

what are the steps of the procurement process?


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Answer

Identify the need, list potential suppliers, negotiate, release purchase order, payment, delivery & audit, and maintain records.  

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Question

what is the difference between procurement and purchasing? 


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Answer

Purchasing is limited to acquiring goods and services whereas, procurement involves all the processes from identifying potential suppliers to obtaining goods and services.   

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Question

What are the components of the procurement cycle? 

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Answer

Procurement planning, requirement definition, sourcing, evaluation & selection, contract award, and contract management are components of the procurement cycle. 

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Question

Why procurement is important for a business?

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Answer

Procurement is required to run the business operations smoothly, reduce the cost of production, and acquire goods and services in case of scarcity. 

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Question

Why is an effective supply chain important

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Answer

It helps in reducing costs, waste, and meeting stock requirements.

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Question

What happens in the sourcing stage of the procurement cycle? 

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During this stage, the business will contact the supplier and communicate all the details of the procurement, including terms and conditions, delivery schedules, product/service requirements. Suppliers will inspect, examine, and respond to a company’s offer with a proposal.

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Question

What is direct procurement? 

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Answer

A procurement that is done to produce an end-product is called direct procurement. 

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What is indirect procurement? 

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Answer

A procurement that is done to manage daily business operations, but does not contribute directly to the end-product. 

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Question

What are the factors influencing the choice of supplier?

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Answer

Value, open competition, transparency, accountability, and price.  

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Question

What happens at the requirement definition stage? 

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Answer

All the requirements of problem-solving are listed and a document is generated which is called a statement of work. 

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