What is Procurement?

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Definition:

Procurement is a broad term that refers to all of the activities that go into obtaining products and services for your business.

🤔 Understanding procurement

Procurement is the process of seeking out vendors and acquiring goods and services for business purposes. Procurement is a core business function for many firms and takes up a significant portion of many company budgets. It includes a series of activities starting with the preliminary research of goods and services and ends with the purchase. Products that companies would purchase during procurement include raw materials, supplies, equipment, office supplies, and more. During the procurement process, firms generally work to reduce costs and time while building long-term relationships with vendors. The amount of money companies spend on procurement is an important number, as it goes on their income statements and factors into the cost of goods sold.

Example

Suppose that a clothing company is looking for a new supplier for the buttons it sews onto its clothing. The company starts the procurement process, which begins with researching the different options for button suppliers. The procurement process also includes the clothing company’s negotiations with the supplier and ends with the purchase of the buttons.

Takeaway

Procurement is like the process of going out to eat...

When you and a friend are going out to dinner, there’s a lot more involved than just purchasing the meal. You start by discussing which restaurant you should go to and then move on to debating what to order. Similarly, the procurement process begins with researching vendors and figuring out what products to buy. And just like going out to eat, the procurement process ultimately ends with paying the tab.

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What are the types of procurement?

Procurement falls into several different categories:

  • Single procurement: In this type of procurement, a company orders a single product or piece of material for a customer. A time that a company might use this type of procurement process is if they offer custom products. Perhaps you’re purchasing a product with a personalized message on it. The company can’t produce that ahead of time, so they procure the necessary item for a single order. A company might primarily use one of the other procurement methods, but also offer single procurement for custom orders.
  • Stock procurement: In the case of stock procurement, a company orders regular shipments of a product or material. For example, a retail store may order a specific number of a particular coffee maker once per month. They generally have an idea of how many of the products they sell per month, so they know how many to order.
  • Vendor-managed inventory: With this type of procurement, the vendor manages the supply of a good at a particular company. In this case, the vendor might track the stock the company has and deliver more when inventory gets low. This type of procurement might be beneficial for companies because it takes some of the work off of them. On the other hand, there’s a certain level of trust you must have to allow a third party to have inventory control.
  • Just in time procurement: In the case of just in time procurement, a company orders more products or materials when their current supply gets low. Rather than stock procurement, in which the company orders at regular intervals, they wait until they need more to place the next order. A company might use this type of procurement if they’re ordering a new product and aren’t sure how well it’s going to sell.

What is a chief procurement officer?

Depending on the amount of procurement that a company does, they might choose to hire someone whose entire job is overseeing supply chain management and crafting the company’s procurement strategy. This person is the chief procurement officer (CPO).

The chief procurement officer is responsible for overseeing the procurement process and finding efficiencies and cost savings when they can. This person might work with accounts payable to make sure all vendors receive payment promptly. They generally also work to find vendors for particular goods and services.

Chief procurement officers typically exist at large firms that do a significant amount of procurement. It’s an additional cost that the company takes on, but having someone solely focused on improving the procurement process can save a company a lot of money in the long run.

What are the costs of procurement?

Whether you’re purchasing raw materials, buildings, equipment, or anything else for your business, procurement can be a costly process.

There are a few different costs you’re likely to incur during the procurement process. The first, and the most obvious, is the purchase price of whatever item you’re buying. This cost should be your most significant expense — The fees for any given purchase shouldn’t exceed the total cost of the item itself.

Depending on the purchase, you also might have a procurement fee of some kind. This fee would be particularly likely if you’ve hired a broker or dealer to help with the purchase. In the case of purchasing a new building for your business, you’ll probably hire a real estate broker to help facilitate. You’ll likely end up paying them some kind of fee, though it will vary depending on the purchase.

Finally, be aware that there might also be other costs and fees along the way. If you are purchasing a building or large piece of equipment for your company, you may not have the cash flow available to buy it outright. You might need to take out a loan. In that case, you’ll also have the cost of interest on the loan to consider.

What is the difference between direct and indirect procurement costs?

There are several different costs you’ll incur in the process of procurement. Some of those costs are direct, while others are indirect.

Direct costs are those that are directly related to the goods and services your company offers. Direct costs include the cost of goods sold (such as raw materials and production costs). If your company doesn’t produce goods, but instead purchases them wholesale, then the price you pay for those products is a direct cost.

Direct costs look a little different in the case of service-based businesses. Rather than paying for raw materials and production, you’ll pay hourly wages as a direct cost. In this case, the services your employees provide with their time is your product.

Indirect procurement costs are those that your company incurs, but that aren’t directly related to the procurement of the products or services you offer. Many of the expenses a company has are indirect ones. These include office supplies, consulting services, overhead expenses, advertising and marketing, and more.

What is the difference between procurement and purchasing?

Many people use the terms procurement and purchasing interchangeably. While the two have a few things in common, they are two separate actions.

Purchasing is just one part of the procurement process. It is the transactional step in the procurement process where you exchange payment for a good or service.

There’s a lot more to the procurement process than the actual purchase, though. It’s about far more than just buying materials, and there’s a lot of strategizing that goes into it.

What is the process of procurement?

Procurement is a core function in many businesses. For that reason, it’s vital that these firms develop a systematic process that allows them to streamline procurement.

The longer a company works on its procurement process, the better it will typically become. They’ll build supplier relationships that might allow them access to better prices. They’ll also identify what delivery timeframes they can expect from specific vendors. Having a streamlined procurement process can save a company an incredible amount of time and money.

Let’s talk about the steps in the procurement process:

  1. Identify the need: The first step of the procurement process is determining that you have a need to fill. In this step, you determine precisely what good or service you plan to procure. This is also where you’ll begin market research on the products.
  2. Request purchase authorization: In many companies, whoever is requesting the procurement will likely have to request purchase authorization from your company’s purchasing department or management.
  3. Request review and approval: After you make your request, it’s up to the responsible party to review it and either approve or deny your request. They might ask for more information or limit you to a particular budget.
  4. Identify potential suppliers: You likely won’t purchase from the first supplier you find without shopping around. Instead, you’ll identify a handful of different vendors that offer the goods or services you’re looking for. You’ll probably ask for quotes from each potential vendor to see who can get you the best deal.
  5. Contract negotiation: Once you’ve narrowed your search down to a single vendor, it’s time to negotiate the contract. You can discuss specifics such as price, the scope of the work, delivery timelines, and more.
  6. Create purchase order: Once you have a final contract, you’ll probably create a purchase order and get the last sign-off from your company’s management or accounting department. It’s the part of the process where you’re making the actual purchase.
  7. Delivery: This is the part of the procurement process where you receive the item that you ordered. Be sure to do some quality control and make sure you received the correct item.
  8. Invoicing and payment: After they send the item, the vendor will also send along an invoice for the purchase. You’ll send this along to your company’s purchasing department or procurement department (or whoever handles purchases), so they can pay the invoice.
  9. Record keeping: You must keep records of every purchase. These records will have information that will be useful to you in the future, and documentation that you’ll need in the case of an audit.
  10. Analysis: This is where you can ensure the efficiency and effectiveness of your procurement process. First, you’ll want to make sure the good or service you received was as high-quality as you expected. Then, take a look at the overall process and see what you could improve. The goal is that the process will get better each time until you have a fully streamlined procurement process for your company.
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