In nature, an ecosystem is a group of living organisms that live and interact with each other for mutual benefit. This results in a prosperous cycle that continues to grow and thrive so that no one organism has to survive solely on its own. The same principle can be applied to business operations.
Just like a natural ecosystem, businesses rely on external vendors and suppliers in order to grow and improve their bottom line. It’s nearly impossible to have a thriving business without obtaining and using third-party goods and services. Consequently, an efficient and sustainable procurement process is crucial for success.
What is procurement?
Procurement is the ongoing system of obtaining goods and services for business needs. The overall procurement process can be a lengthy one (discussed in more detail below), but each step is just as necessary as the last. To put it simply, the procurement process is about identifying what’s needed, seeing who can supply it, arranging the purchase, managing the order, and paying the supplier.
Procurement vs. purchasing
There is some overlap between the procurement process and purchasing. However, the main distinction is that procurement is a system and purchasing is just a part of that system. The procurement process includes every step before, during, and after a business has obtained something from a supplier. In contrast, purchasing is the act of buying a good or service and nothing more.
Procurement vs. supply chain management
When it comes to the difference between the procurement process and supply chain management, there is some nuance, but they do work closely together. In general, supply chain management focuses on logistics and operations, whereas procurement focuses on how the company sources, obtains, and purchases goods and services.
As mentioned, procurement is the process of obtaining goods in order to fulfill a business need. But more importantly, the procurement process sets the foundation for smooth, efficient supply chain operations. Once the Procurement team finds, negotiates for, acquires, and manages the best possible goods, the Supply Chain team is able to focus on where, when, and how those goods are obtained, as well as how they’ll be utilized and distributed to customers.
Why are procurement processes important?
An efficient procurement process can have a lasting impact on any business, from strategy and optimization to ethics and stability.
Influences strategic decisions
A well-defined procurement process can help with key components of a company’s strategy. Procurement can help in the long term—for example, in terms of identifying audiences within a target market and learning what customers are looking to buy. More importantly, it can help companies analyze and track financing, inventory, cost of production, and other spending, which can help influence future strategic decisions that will impact the company’s growth.
Boosts profitability
When done correctly, procurement can help improve cost efficiency. The procurement process is intended to streamline day-to-day operations, but it is almost impossible to have the perfect system in place from the get-go. As business owners experiment and change parts of their process, they will inevitably notice where they can correct inefficiencies and optimize operations. By cutting costs where possible and maximizing their return on investment (ROI), companies can start to see a boost in profitability.
Considers ethical purchasing decisions
Having an efficient procurement process also enables businesses to actively consider the ethics of how goods and services are obtained. The acts of finding, negotiating, purchasing, and receiving items get procurement teams very close to the source of those goods and services. While profitability and business growth are important outcomes, ethical procurement practices compel companies to consider the social, environmental, and even legal effects of their purchasing decisions.
Many businesses believe ethical procurement leads to a smaller profit margin, but that doesn’t consider the whole picture. Customers are actually more likely to buy from companies that have ethical procurement processes. In a recent survey, 83% of respondents said they would be willing to pay more for a product if they knew it was ethically sourced.
Maintains business stability
The procurement process undergirds business stability by establishing and maintaining long-lasting supplier relationships. If a business continues to make purchases with multiple suppliers, those relationships will become more reliable over time and more resilient to price fluctuations and the wider economic environment. Otherwise, having to constantly search for new suppliers can take time away from securing and developing the business, and result in a loss of pricing power.
There are 4 different types of procurement, and each can overlap with another. These procurement types are direct versus indirect procurement, and goods versus services procurement. By categorizing procurement into different types, companies can understand how much spending goes into different business operations.
Direct procurement
Direct procurement is the act of obtaining anything required for an end product that results in external profit. These are mostly goods but can also be services. Some examples of direct procurement are raw materials (for manufacturers), merchandise for a retail store, and contractors or freelancers (but not necessarily full-time employees).
Indirect procurement
Indirect procurement is intended for internal day-to-day operations. These can be both goods and services. Some examples of indirect procurement are office supplies, IT services, rent for a facility or office space, and furniture.
Goods procurement
Goods procurement involves items intended for direct or indirect use. They’re mostly physical items such as raw materials or office supplies, but they can also be items like software subscriptions or productivity apps.
Services procurement
Services procurement is mostly for indirect procurement use, but it can sometimes be used for direct use. These services could refer to contractors or freelancers, external IT support, law firms, and marketing agencies.
Creating a strategic procurement process can be complicated because there are several steps and details to take into account. Luckily, the process can easily be divided into 3 separate phases:
- Planning: During this phase, employees will identify the business need for a good or service and submit a purchase request. The Procurement team will review the request. If approved, the Procurement team will assess suppliers and get quotes.
- Purchasing: In this phase, Procurement Management will select a supplier, negotiate terms, and sign a contract. Then, when the company receives the good or service, the Procurement team will inspect it to ensure it meets the company’s standards.
- Payment: This last phase is when the Procurement Manager collaborates with Accounts Payable to perform a 3-way match. Then, they will approve the supplier’s invoice, arrange payments, and file away all procurement records.
Nine steps in the procurement process
The procurement process may vary from business to business, meaning the following steps may differ for you and your business. However, the key is to ensure consistency throughout the procurement process. Only then can your business start to experience benefits such as streamlined operations, cost efficiency, and business stability.
Step #1: Identify business needs
The first step in procurement is identifying what your business needs. This could be new goods your company hasn’t purchased yet, or perhaps you want to renew a subscription.
For manufacturers, this could be raw materials for a new product (direct, goods procurement), new computers to send internal communications faster (indirect, goods procurement), or outsourced engineering consulting services (indirect, services procurement).
Step #2: Submit and review a purchase request
Once you’ve identified what your business needs, it’s time to submit a purchase request—otherwise known as a purchase requisition. This is an internal document used by employees, managers, or leadership to submit a formal request for the identified goods or services. It should include specific details, including the name of the good or service, the quantity, price, preferred supplier, and the reason for the request.
After the purchase requisition is submitted, it’s sent to the appropriate department or stakeholder. This could be department managers, purchasing staff, or other leadership—it all depends on your business structure.
Regardless of who reviews the purchase requisition, that team will evaluate it with the following questions in mind:
- Is this goods or services procurement necessary? Why or why not?
- Does the company have appropriate funding for them?
- How soon does the company need these goods or services?
- Will the company need a competitive bidding process for these goods or services? Or will they be easy to obtain?
Step #3: Assess and choose potential suppliers
Once the purchase request is approved, you can start looking for potential suppliers. Before taking this step, think about what’s most important to you and the company. Cost is a big contributor when deciding on a supplier, but also try to think about that supplier’s reputation, quality, speed of production, reliability, and ethics.
For companies that are B Corporations—or that have a mission dedicated to social and environmental responsibility—procuring a supplier that aligns with those values will be most important. But for a reputable goods manufacturer (for example, those in the automotive industry), quality and reliability will be more important. However, regardless of your company’s business objectives and structure, be sure that you and your team are aligned with what’s most important when seeking a supplier.
Step #4: Negotiate price, terms, and conditions
At this point, you should have a supplier—or a small selection of suppliers—to choose from. Get a few quotes and review them with your team. Be sure to look over their offerings, prices, schedule, and other important details. Then, make sure everyone’s on the same page before you return to the supplier.
Depending on the quote, you may negotiate the price, terms, and other conditions with the supplier. Just be vigilant if that supplier is in high demand or works in a niche area that’s hard to find. In this case, you may have to outbid a competitor for this supplier’s time and resources. If you have to walk away, keep in mind any backup suppliers that can supply the same thing or at least something similar.
Step #5: Create a purchase order
Now that you and your supplier have approved the agreed-upon quote, it’s time to fill out a purchase order. A purchase order is a legally binding contract between the buyer (you/the company) and the seller (the supplier). Purchase orders outline the exact goods or services the supplier will provide, along with the approved price and timeline. Once the supplier approves and signs the purchase order, it becomes legally binding, and you should be given an order receipt.
An important note to consider is that even if you have a long-lasting or friendly relationship with your suppliers, always get your purchase order written, approved, and signed. If you only settle a purchase order through a verbal confirmation or a few email exchanges, you may not end up receiving the supposed “agreed-upon” goods or services. Having a formal purchase order holds both parties accountable by setting legally bound expectations for the buyer and the seller.
Step #6: Manage and inspect orders
This step is when you and your company obtain your goods or services from the supplier. If you’re receiving physical goods, make sure your supply chain manager or office manager knows where, when, and how those physical goods will be delivered. If you’re receiving a service, make sure the respective team is ready for that service provider’s arrival.
Once the goods or services have arrived, perform an inspection to ensure they match your purchase order. If anything is missing or the delivery doesn’t meet your standards, have a conversation with your supplier to sort out the issue. Once everything looks good on your end, your supplier will give you their invoice.
Step #7: Perform a 3-way purchase order match
Your Accounts Payable or Finance team is in charge of performing this next step, the 3-way purchase order match. This is the act of comparing 3 vital documents to each other: your purchase order, the supplier’s invoice, and the supplier’s receipt. At this point, you should have all 3 of these documents, and each one should have identical details of your purchase, such as quantity and price.
If there are any discrepancies between the 3 documents, make sure to resolve the issue with the supplier quickly. If there aren’t any discrepancies, you can move on to paying the supplier’s invoice.
Step #8: Pay the supplier invoice
Now that the 3-way purchase order match is approved, you can start the payment process with your Accounts Payable or Finance team. Always be sure to pay on time—and with the correct amount—to maintain good supplier relationships with all your suppliers.
Step #9: File all procurement records
This last step is habitually an afterthought, but it’s essential for continuing the procurement lifecycle: Be sure to file away all procurement records! This is essential for not just bookkeeping, but also future price negotiations, auditing, and tax purposes. Organize everything including the initial purchase requisition, potential supplier list, supplier quotes, purchase order, supplier receipt, invoice, and confirmation of payment.
Tips for optimizing the procurement cycle
Now that you know the steps within a typical procurement process, here are some tips on how to optimize that system for business growth.
Establish a clear procurement strategy
Once you have a procurement team together, you should map out a procurement strategy. While every company has different business objectives, this is key to getting the most out of each procurement cycle and maximizing your ROI.
First, think about the long-term goals you want to focus on. Most strategies focus on reducing costs, streamlining operations, and business growth, but your strategy can also focus on ethical sourcing, risk management, and lead times. However, try not to tackle too many at once, or else your procurement strategy may feel disorganized and unfocused.
Then, think about how your goals align with your company’s needs and the supply markets. If, for example, your goals are business growth and ethical sourcing, determine what your company would need to reach those goals as well as how the market can supply your necessary goods and services.
Once you’ve aligned your goals with your appropriate business needs and the market’s availability, start setting clear objectives for how to move forward. This includes, in no particular order, creating a procurement department, using procurement software, defining procurement policies, and aligning with your Finance team. From there, you can start the procurement process.
Put together a procurement team
If you don’t have a procurement department yet, now is the time to define one. This team will be responsible for sourcing appropriate suppliers, negotiating contracts, inspecting the received goods or services, and collaborating with your Finance team to ensure invoices are paid.
While hiring new employees to build a procurement team may sound pricey, procurement professionals can help businesses save money. Not only are they great at sourcing goods and services at competitive rates, but they’re also skilled in negotiating contracts for maximum profitability.
Streamline processes with procurement software
Having manual processes or too many paper documents can cause disorganization and inefficiencies. That’s why adopting procurement software is vital for having your process run smoothly.
While an experienced procurement team is important for creating contracts, you should have software that can manage them. With a procurement software subscription, you can also centralize all supplier information, perform 3-way purchase order matches, and automate tedious workflows in each stage of the procurement cycle.
Conduct a spend analysis
As your procurement process runs, your Procurement and Finance teams should perform a spend analysis. A spend analysis is a multistep activity of collecting, inspecting, and visualizing spend data. It provides information about your company’s spending, revealing opportunities for where and how to save money in the future. It’s also helpful to do different spend analyses for different areas of business, such as direct or indirect procurement spending.
Consider ethical procurement processes
Having an efficient procurement process also enables businesses to actively consider the ethics of how goods and services are obtained. The acts of finding, negotiating, purchasing, and receiving items get procurement teams very close to the source of those goods and services. While profitability and business growth are important outcomes, ethical procurement practices compel companies to consider the social, environmental, and even legal effects of their purchasing decisions. [WH2]
Many businesses believe ethical procurement leads to a smaller profit margin, but that doesn’t consider the whole picture. Customers are actually more likely to buy from companies that have ethical procurement processes. In a recent survey, 83% of respondents said they would be willing to pay more for a product if they knew it was ethically sourced.
Take ownership of your procurement process flow
Procurement may be a complicated process, but it’s essential for every company, from strategy and optimization to profitability and stability. The final procurement process flow may look different for your business, but the key elements should all be there. Once you have a procurement plan, your business will be ready to grow efficiently, sustainably, and profitably for the long term.