What is Procurement Management?
Procurement management refers to the process of acquiring goods, services, or works from an external source to fulfill the needs of an organization. It involves the planning, sourcing, selecting, and acquiring of products and services that are required to carry out business operations effectively and efficiently.
Table of Content
- 1 What is Procurement Management?
- 2 Understanding Procurement Management
- 3 Objectives of Procurement Management
- 4 Procurement Process Cycle
- 4.1 Identify Material Requirements
- 4.2 Issue Purchase Requisition and Review Requirements
- 4.3 Identify Potential Suppliers and Float Rfx
- 4.4 Evaluate and Select Suppliers
- 4.5 Negotiate With Suppliers for the Best Terms
- 4.6 Establish Contract With Selected Suppliers/generate Purchase Order
- 4.7 Receive Materials and Perform Related Procedures Like the Issue of Goods Receipt Notes, Etc
- 4.8 Match the Po and Make Payment to the Supplier
- 4.9 Manage the Contract Over Its Lifetime
- 5 Responsibilities of Purchasing Manager
- 6 Types of Purchases
- 7 Purchasing and Supply Procedures
- 8 Types of Requisitions
Understanding Procurement Management
The basic objective of procurement was to do the bidding for mainstream departments. Hence, the procurement manager’s role was only to fulfill the purchase requisitions raised by other departments. With an increased level of competition in the market, the role of procurement evolved from being transaction-based to strategic-based.
Today, procurement management is considered to be a vital part of operations management. Though purchase continues to be one of the major activities under the function of procurement management, it is no longer the only focal theme.
As a function, procurement management focuses on sourcing the right material, in the right quantity, of the right specifications and quality, at the right time, from the right source, and at the right price. To ensure that all these objectives are met, procurement managers need to play a larger role, which requires them to work closely with both internal and external customers.
This is because factors like the right time, the right quantity, and the right quality depend on several internal factors, which cannot be taken care of if the procurement function just aims to fulfill purchase requirements.
To achieve the procurement management objectives, the procurement department needs to work in collaboration with all the departments of the organization, including the product design and quality department, the shop floor and the materials planning department, the finance department, the production department, and so on. In addition, the procurement manager needs to manage the external environment to meet the objectives of procurement management. This involves developing long-term relationships with suppliers and vendors.
Procurement plays an important role in service organizations also. Each service has a tangible aspect. The quality of the service and customer satisfaction from it depends on the tangible aspects of the service. Service organizations need to procure these tangible goods from vendors.
For example, a restaurant requires food products or a hospital requires varieties of medicines and other supplies. These service providers need to conduct the procurement process effectively to ensure that their service delivery process is not interrupted.
Objectives of Procurement Management
Some major objectives of procurement management are to:
- facilitate an efficient flow of materials and services as required for manufacturing end-products
- establish processes and procedures that allow continuity of supply and effective procurement of raw materials leading to the best value for money
- build and maintain long-term relationships with suppliers
- develop alternate sources of supply for meeting future and planned needs
- collaborate with internal customers for meeting their present and future requirements
- provide market intelligence and product information to other departments and advise them on efficient procurement practices
- manage procurement activities by creating proper policies, procedures, and organizational structure for meeting procurement management objectives.
- address procurement issues strategically by implementing the procurement management plan and collaborating with other components of the supply chain for meeting the overall supply chain management objectives.
The procurement management function requires proactive purchasing with an emphasis on the total cost of ownership (TCO). The TCO concept embraces the notion of Total Acquisition Cost that goes beyond the objective of sourcing from a low-cost supplier.
It considers costs associated with waste, inspection costs, costs associated with delays, inventory-carrying costs, handling and delivery costs, and other costs related to procuring raw materials. Procurement management has also become a value-adding center instead of a service or cost center. Instead of reporting to production, it has now become an important and independent management function.
With reference to the wider Supply Chain Management (SCM) concept, procurement management is a subset function owing to the similarity of their core objectives. Supply chain management involves other functions like category management, inventory management, logistics, and warehouse management, designing a sourcing strategy, materials planning, demand planning, supply chain planning, capacity planning, etc.
Procurement Process Cycle
Business processes carried out in any organization can be classified into several business process cycles, which are performed repetitively, pertaining to different functional areas. The business process cycle that starts from the identification of material requirements (based on production planning schedules) to procuring materials to final payment to vendors is termed the ‘Procure To Pay (P2P) Cycle’. It is the procurement process cycle that involves purchase processes from several departments, such as material, purchase, stores, and accounts payables.
Let us discuss all the steps involved in the P2P cycle or procurement process cycle;
- Identify Material Requirements
- Issue Purchase Requisition and Review Requirements
- Identify Potential Suppliers and Float Rfx
- Evaluate and Select Suppliers
- Negotiate With Suppliers for the Best Terms
- Establish Contract With Selected Suppliers/generate Purchase Order
- Receive Materials and Perform Related Procedures Like the Issue of Goods Receipt Notes, Etc
- Match the Po and Make Payment to the Supplier
- Manage the Contract Over Its Lifetime
Identify Material Requirements
The P2P cycle starts with the identification of materials to be purchased. The whole exercise of demand planning and MRP is generally done through computerized MRP applications which are now the essential modules of any ERP package.
The MRP software automatically derives the quantity of various raw materials and component parts required for each product to be manufactured based on the production schedule and Bill of Materials (BOMs). The purchasing module of the ERP package can then automatically generate purchase requisitions/purchase orders without any manual intervention.
Issue Purchase Requisition and Review Requirements
Once the need for procurement of material from external suppliers/ vendors is identified, the purchase requisition form is created, indicating the detailed specifications of the material to be procured. The form may be created manually in the ERP purchase module by those internal departments which require the material. It may also be auto-generated based on the inputs from the MRP module.
The purchase requisition is then forwarded to the procurement department. The purchase manager reviews the purchase requisition for completeness, budgetary allocation, and purchase policy requirements before starting the supplier selection process or generation of PO. Based on the purchase requisition, the purchase order requirements are determined.
Figure shows a sample format of the purchase requisition form. Note the important fields in the form, like PR requisition number, requesting department, delivery location, delivery date required, item details, suggested suppliers, etc.
Identify Potential Suppliers and Float Rfx
The procurement manager is now required to identify potential suppliers who can manufacture and/or supply the required raw material or component parts. For standard routine items required for every product manufactured, the company usually has a supplier base with long-term commitment.
However, for new items or when a new long-term contract is envisaged, an elaborate supplier identification, selection, and evaluation process is required. For new products, the procurement manager may float a Request for Information (RFI) to gather market intelligence data. Based on the data, the procurement manager shortlists suppliers for obtaining proposals.
Evaluate and Select Suppliers
Evaluation of potential suppliers is normally carried out through the pre-set evaluation criteria which reduce the subjectivity involved in the selection of suppliers, as there are several factors involved. Each supplier is scored on various parameters, like cost, capability, past experience, reputation, management quality, etc. Companies develop their own supplier evaluation framework based on their purchasing policy.
The Chartered Institute of Procurement and Supply recommends the supplier evaluation framework proposed by Tan, Lyman, and Wisner (2002), which involves product and delivery assessment, capacity assessment, and informal assessment.
Negotiate With Suppliers for the Best Terms
For purchase requisition for one-off items or when new vendors are being identified for routine items, it is necessary to negotiate with suppliers for the best terms and conditions. Since price is just one of the parameters when considering the need for building a long-term supplier partnership, it is important that both parties discuss various factors involved and arrive at mutually beneficial order terms.
Other than price, delivery, quality, etc. are some important factors to be considered while negotiating with suppliers for the best terms.
Establish Contract With Selected Suppliers/generate Purchase Order
After receiving the purchase requisition (PR), the purchasing department will review it and generate the purchase order (PO) to be sent to the supplier (already selected and impaneled for the organization) for the material procurement.
Usually, a blanket purchase order (BPO) is generated for standard items, based on the long-term purchase agreement with the selected supplier. BPO is a shortcut method for ordering items that a supplier delivers to a buyer over a period of time. It is usually an open order, covering the repeated purchases of an item or family of items.
This removes the necessity of sending purchase orders every week or month for the same set of items to the same supplier. The BPO does not provide any single quantity or delivery date but is applicable for a particular period of time during which the supplier releases the order, based on the production schedule.
Thus, with a BPO, the release of an order becomes a routine matter between the buyer and supplier. A release order states the quantity of material to be shipped at a particular point in time, based on the BPO specification.
The PO is a legal document with terms binding on both parties. A sample PO format is shown in Figure:
Based on the PO received, the supplier may confirm the sale by sending a sales order to the manufacturer. On the delivery date, the supplier ships the materials to the shipping address. He/she also sends the invoice document which specifies the billing amount.
The received materials are then verified with the purchase order number (or release order). This is done to compare the packing list and the actual goods received. The packing list is a document that states the number of goods being shipped. The procurement department then generates a Goods Received Note (GRN) to confirm the receipt of the material from the supplier. The accounts payables department is given the original invoice, which specifies the amount being billed against the PO issued.
Match the Po and Make Payment to the Supplier
The accounts payables department ensures that the payment is made to the supplier only for the goods received against a valid PO. This is done by matching the invoice with both the GRN copy received and the PO copy. This is called 3-Way Matching which ensures that the payment is only made for the goods ordered as per the PO and GRN.
Manage the Contract Over Its Lifetime
This step ensures that the performance of the supplier is as per the purchase agreement. The supplier’s performance is evaluated for long-term relationships. A supplier who constantly fails to meet the supply schedule requirement is replaced with a new supplier with better capabilities
Responsibilities of Purchasing Manager
The roles and responsibilities of a purchasing manager are based on these objectives. Let us discuss the major roles and responsibilities of a purchasing manager:
- Maintaining Supply Continuity
- Establish, Implement, Manage, and Control Purchasing Policies, Processes, and Procedures
- Vendor Management
- Proactively Manage the Procurement Management Function
- Design and Implement Procurement Management Strategies
Maintaining Supply Continuity
Ensuring an uninterrupted, high-quality, and cost-effective supply of materials is the primary responsibility of any procurement manager. As mentioned earlier, the procurement manager should be able to purchase materials at the right price, from the right source, of the required specification, in the right quality, and at the right quantity, and arrange for delivery at the right time.
Establish, Implement, Manage, and Control Purchasing Policies, Processes, and Procedures
The procurement manager is expected to establish purchasing policies, procedures, and processes; set up proper organizational structure and approval mechanism within the purchasing department; determine and recruit staff in association with the human resource department; set up procurement procedures and processes that are benchmarked with industry standards.
Manage procurement budgets; train and evaluate staff; implement electronic systems to handle the P2P cycle that has an interface with the other departments; and continually improve the procurement processes forming part of the P2P cycle.
Creating, developing, and maintaining a reliable supplier base that can effectively serve the objectives of procurement management is one of the primary responsibilities of the purchasing manager.
He needs to be actively involved in selecting the right suppliers, helping the existing suppliers to grow and improve their quality systems, scouting for new opportunities for better sourcing strategy, and evaluating the existing supplier base for monitoring their performance.
Proactively Manage the Procurement Management Function
The purchasing manager is required to go beyond the responsibility of just fulfilling the purchase requisition needs. We have already discussed how the function of the purchasing manager interfaces with other stakeholders of the organization.
He/she should, therefore, take an active interest in each of these interfaces toward aligning procurement management goals with organizational goals and supply chain management strategies.
Design and Implement Procurement Management Strategies
The purchasing manager is required to develop the procurement management strategy to decide how the entire procurement process should be managed. It is thus the responsibility of the purchasing manager to develop an action plan that details how organizational resources will be organized and utilized within the organization to meet the desired goals and objectives of procurement management.
The procurement management plan and strategy should be designed in accordance with the overall supply chain management objectives. The procurement manager should proactively participate in corporate strategic planning meetings pertaining to the designing and implementation of organizational goals and supply chain management objectives.
Types of Purchases
A finished product manufactured by an organization is the result of many inputs, some of which are manufactured within the organization and the rest are purchased from outside. No organization can manufacture all inputs required to manufacture a product in-house.
Some major categories of purchases, which are handled by the procurement department, are as follows:
- Raw materials
- Semi-finished products
- Finished products
- Maintenance, Repair, and Operating (MRO) items
- Production support items
- Capital equipment
- Transportation and logistics
Raw materials refer to basic items, such as steel, coal, petroleum, cotton, wheat, etc., used for manufacturing finished goods. The term ‘raw material’ is used as these products are generally mined (or grown) and are not manufactured by any suppliers. Different organizations require different types of raw materials based on the finished goods they manufacture.
Apart from raw materials, there are several other components that are required for the manufacture of finished goods. Though theoretically all these components can be manufactured in-house by purchasing relevant raw materials and capital equipment, it could be highly unprofitable due to a lack of the economy of scale and specialization involved. Hence, companies procure these components from external specialized suppliers. These could include components like carburetors, assemblies like steering systems, sub-systems like gearboxes, etc.
Semi-finished products are normally manufactured according to the specification given by the buying organization and, therefore, are not sold as finished products to the outside market. Some of these products may come under the wider ‘sub-contracting’ concept where a long-term association with a supplier is envisaged with the supplier possibly dedicating plants and production systems to the purchasing organization.
These products include the actual finished products meant for resale under the brand name of the buying organization. When the final finished products are sourced from external vendors, these are termed as ‘outsourcing contracts’.
This requires the procurement department to give entire specifications and technology to the vendor for manufacturing finished products. For example purchase of Heating, Ventilation, and Air Conditioning (HVAC) equipment to perform heating and/or cooling for residential, commercial, or industrial buildings, comes under the finished product purchase category.
Maintenance, Repair, and Operating (MRO) items
These include items that do not become part of the finished product but are nevertheless required by the organization. These could be spare machine parts related to capital equipment, office supplies, etc. There could be several types of MRO items that the organization might require.
Considering that these are low-cost items that are required in volumes across the organization, managing the procurement of these items in a cost-effective manner could be challenging for the procurement department.
Production support items
Like MRO items, production support items also do not form part of the final product but they are required for the production process. Electrodes, lubricants, packing material, shipping material, etc. are a few examples of production support items that are outsourced from external vendors to support and run the production process smoothly.
This is entirely a different category compared to all the previous items. These actually constitute production machinery, which is used to manufacture products. These tend to be ones that require huge capital expenditure and are supposed to be used for many years into the future.
The purchase of capital equipment is closely related to the concept of Return on Investment (ROI). ROI is a ratio, which is used to describe the amount of money earned/saved when compared to the amount of money originally invested. ROI is also known as the payback period and is often expressed in a period of time, such as weeks, months, or years. It is calculated on the basis of how long it will take to earn back or return the cost of investment, made in purchasing a piece of equipment.
Let us understand the concept of ROI in relation to the purchase of capital equipment. Suppose a buyer purchases a piece of equipment for $5,000. Also, assume that this equipment will save $1000 per year for the buyer for a five-year period. Then, the ROI for the purchased equipment can be calculated as:
Money earned on (funds invested)/ (funds invested) = ROI
($5,000 earned)/ ($5,000 invested) = 1.00 or 100% over five years
Evaluation and decision of capital expenditure are part of the financial decision and is taken by the finance department in collaboration with the production and purchase department. Once the items are decided, the purchase is routed through the procurement department but in a different set of procurement processes.
For example, some items may be leased out instead of being purchased outright. The purchase of capital equipment is generally a one-off event unlike routine and regular purchases done in the case of previous categories.
Organisations also sub-contract services to other organizations. These might be ordinary support services like management of the cafeteria, maintenance of cooling and electric systems, machine repair services, transportation, security, housekeeping, engineering services, catering services, etc., or more specialized services like design contracts, software testing, implementation of software packages, data entry, etc.
Transportation and logistics
This is a specialized service that is usually outsourced to external vendors. This involves the management of inbound and outbound material flows. Several transportation and logistics providers are available who can provide these services based on long-term contracts with the organization.
Purchasing and Supply Procedures
The purchasing policy refers to rules, regulations, and guidance that apply to all purchasing activities, like purchase requisitions and approval, purchase specifications and review, supplier selection, supplier negotiation, etc. carried out by the employees of the procurement department. The policy is meant to provide a set of guiding rules and principles with regard to managing procurement within the organization.
The purchasing policy may elaborate on the following policy elements:
- Roles and responsibilities of the purchasing department
- Operational issues and authority
- Supplier qualification and selection
- Buyer-seller relationship
- Conduct of purchase personnel
- Ethical and sustainable purchasing
The purchasing procedure manual details operating instructions pertaining to purchasing. It is largely a how-to-do manual in contrast to the policy document that provides principle-based guidance.
The purchasing procedure describes the following aspects of the procurement:
- High-level business process map of the P2P Cycle
- Business process map of procurement activities
- Detailed information on individual business processes with inputs, outputs and tasks involved in each of these processes
- Steps involved in major tasks and processes within procurement
- Operational procedures
- Instructions regarding the usage of various forms, documents, and electronic modules
- Procedures for entering into legal contracts
The purchasing and supply procedure usually involves a number of steps which are discussed as follows:
- Identifying a suitable supplier
- Involving in different supply contracts
- Analyzing supply cost
- Evaluating supplier performance
- Controlling materials provided by suppliers
- Handling defective parts and over-shipments
- Authorizing supply procedures
- Managing purchase documents
During the purchase process, the purchasing manager must consider the authority matrix, which shows the authorities of different levels of decision-makers. In addition, he/she needs to ensure that the purchase procedure abides by the ethical purchasing codes of the organization.
Types of Requisitions
The material purchase requisitions could be generated through any of the following means:
- Standard purchase requisition form from internal users
- Auto-generated requests from Material Requirement Planning (MRP)
- Forecasts and customer orders of supply chain management and demand planning systems
- Re-order systems of inventory management
- Inventory planning systems
- Material requirements based on new product initiatives
Let us now discuss the major types of requisitions that are raised in any manufacturing organization.
Purchase requisitions can be raised by the user department for the respective material as specified in the purchasing manual. Once purchase requisitions are received, the procurement department should verify the same for budgetary allocation, completeness, eligibility, and for other purchasing policy guidelines.
In most of large organizations, purchase management software is used to manage the purchase demands of various internal users. All the validations and verifications may be built into the software during implementation as per the purchase procedure manuals and business processes
In organizations, where ERP software is implemented or where supply chain management applications are installed, purchase requisitions/orders are automatically generated into the purchasing module for standard and routine items. For blanket purchase orders, release orders may directly be sent to vendors with whom the procurement team has a long-term contract. In the case of service contracts, it is termed as the ‘Statement of Work (SoW)’ which will provide the nature of work to be performed by the vendor along with various milestones and related payment mechanisms.
Traveling Purchase Requisition
Though, not frequently used, traveling purchase requisition is a purchase requisition mechanism designed for repetitive use. Traveling purchase requisitions are used in small companies where the P2P cycle is not automated. These are meant for repetitive purchases of standard items ordered by stores.
To avoid issuing a detailed purchase requisition every time (when stores need to be replenished), a standard card containing details of the request, either in the form of codes or bar codes, is used. This card contains details like a description of the item, vendor code, price, etc. Once the card is received by the purchasing department and a PO is created, the card is sent back to the store for later reuse.
As the name suggests, in traveling purchase requisition, the card travels between originating and purchasing departments. In the case of barcode-based traveling requisitions, electronic scanning by the store’s personnel can create a standard purchase requisition in the PO module to be processed further by the procurement department.
Bill of Materials (BOMs)
BOM is a hierarchical listing of sub-assemblies, intermediates, parts, and raw materials required to produce one unit of the final product. It is used to determine the items for which purchase requisitions and production orders should be made.
The BOM can be of various types and used for different purposes. For example, an engineering BOM includes details related to the materials required for product design, whereas a sales order BOM specifies the materials required by customers. Therefore, the BOM is classified based on its usage and the business needs of the organization.
The BOM not only lists all the required parts but also outlines the sequence of steps required to produce the end product. The BOM has a series of levels, and each level represents a stage in the manufacturing of the end product. The first level may represent sub-assemblies that are combined to make the final assembly. The next lower level that comes below this one might represent the parts needed to make sub-assemblies, and the bottom-most level might represent the raw materials from which the parts are made.