Procurement strategy is an essential component of effective procurement for all companies irrespective of their size. Procurement team’s at large companies rely on effective procurement strategy to deliver continuous savings which increase a company’s EBITDA (Earnings before Interest, Tax, Depreciation, and Amortization). It is not uncommon for companies to see cost savings of up to 10% of the annual addressable spend because of an effective procurement strategy.
Executing a well-defined procurement strategy needs discipline and resources and that might deter some mid-market companies to have a procurement strategy at first place. Mid-market companies should not ignore the value of a well-defined procurement strategy. This article is focused on helping mid-market companies getting started towards a path of procurement excellence through effective procurement strategy.
1. What is Procurement?
Procurement strategy is about procurement, so let’s first define procurement. As per CIPS (Chartered Institute of Procurement & Supply) – “Procurement is the business management function that ensures identification, sourcing, access, and management of the external resources that an organization needs or may need to fulfill its strategic objectives.”
Simply defined, it is a process of acquiring product or services a business need, to deliver value to its customers. Value is defined in terms of physical products or services delivered to customers.
2. Steps in the procurement process
There are multiple steps in the procurement process, the basic steps are listed below
1. Need Determination
The first step in procurement is determining what needs to be purchased. The need could be new or recurring. For example, raw materials required to manufacture the products sold by an organization.
The need could be determined by an activity which is non-routine. For example – purchase of new procurement software.
2. Specification definition
This step is generally required for new purchases – products which are not purchased earlier. For example, the company has decided to add a new product to the product line.
This drives detailed discussion and collaboration between different departments to come up with the optimum specification. If you over-engineer the specifications, that limits the source of supply and increase cost.
If you keep the specifications simple, the results are reduced cost and increased availability from different suppliers.
3. Sources of Supply
The next step in procurement is to do an assessment of sources of supply.
Do you need a new supplier for this purchase or an existing supplier can fulfill the requirement?
Depending upon the type of product, this could be a simple google search or this could be elaborate research leading to RFP. If you are adopting a low-cost country sourcing strategy, then step needs a detailed assessment.
Supplier selection includes selecting the vendor and contract negotiations if required. This step generally involves an RFP (Request for Proposal) process which is followed by contract negotiations and execution.
5. Purchasing activity
This involves the activities required for purchasing the material. The process generally involves purchase approval, issuing a purchase order to the supplier and any follow up with the vendor.
The purpose of receipting is to inspect whether the vendor shipped per the purchase order. It is also a proof of delivery while approving the invoice.
The payment process is the issuance of payment to the vendor. There are multiple payment vehicles available to companies. For example, ACH process, Checks or purchasing cards.
This is the most important and often ignored part of the procurement process. This is especially critical for strategic vendors, managing supplier performance and relationship can lead to smooth operations and cost savings for both buyers and suppliers.
3. What is the Procurement strategy?
As per Wikipedia “ Strategy (from Greek στρατηγία stratēgia, “art of troop leader; office of general, command, generalship”) is a high-level plan to achieve one or more goals under conditions of uncertainty.
Procurement is defined as the process of finding right sources of supply, agreeing on terms and acquiring product or services an organization needs to deliver value to its customers.
Procurement strategy hence can be defined as a high-level plan to meet the purchasing needs of the organization through a mix of people, process, and technology. The purchasing needs of the organization are not just about acquiring the product or services but maximizing the value through an effective and fair selection of vendors.
4. Benefits of a procurement strategy?
The obvious question is why define a procurement strategy. Most of the mid-market companies don’t have even dedicated procurement departments so why define a procurement strategy. Let’s look at some of the benefits of having a procurement strategy
Corporate strategy and procurement strategy alignment
The biggest benefit of having a procurement strategy is to have alignment between the corporate goals and how procurement helps in achieving those goals.
Let’s assume that your organization competitive advantage is to offer custom products in the shortest lead time across the industry. Aligning your procurement strategy with organization competitive advantage will help determine the right partners who can help you deliver products faster and at the desired quality levels.
Let’s take another example, you are probably the Walmart of your industry. In that case, your procurement strategy should be aligned with the corporate goal of being a low-cost solution provider. A well-defined procurement strategy would help in identifying partners who are aligned with this goal.
Measurable outcome – Define clear goals and what to expect
A well-defined procurement strategy provides a mechanism to measure the impact of effective procurement on meeting organizational goals.
For example – assume that the goal of the company is to reduce cost and improve EBITDA (Earnings before Interest, Tax, Depreciation, and Amortization). The procurement strategy is then focused on reducing overall cost and the outcome is measured in terms of the dollars saved and impact on the bottom-line.
Since the outcome is measurable, it helps bridge the expectations gap between procurement and senior management of the company.
Standard operations procedures
Procurement strategy brings clarity and provides guidelines on how purchasing should work in any company.
For example – if the outcome of your procurement strategy is that you are adopting a low-cost country sourcing, then the approach for vendor selection doesn’t need to be discussed for every sourcing event.
It also provides guidelines for other employees on how to engage procurement, which in turns help achieve overall procurement goals.
5. Components of a procurement strategy
Having defined procurement strategy and its potential benefits, let’s look at the how to define the procurement strategy and the key components of an effective strategy.
Procurement strategy like any other strategy starts with a goal in mind. Generally, most procurement organizations are tasked to with one or more of the following goals
First and foremost, design a procurement strategy to support the needs of the business. For example – a credit card company wants to have local call centers to support the customers. The goal itself will drive the locations of the call centers. The procurement strategy is very different in this case as compared to outsourcing call centers to low-cost countries.
Procurement should be done in an effective manner
Hence the second goal is to reduce operations cost for direct and indirect materials. Direct material being raw materials which are used in products and Indirect materials are product & services required to support the operations.
Increase compliance with corporate policies
This is especially critical for public companies because well-defined procurement processes would simplify SOX (Sarbanes Oxley) reporting requirements.
Reduce supply chain risk
Depending upon the size and type of the business, this might or might not be a priority for business. For example, a manufacturing company wants to ensure that raw materials are available at the right time with the right quality. This means that the procurement strategy should be designed with the intent to reduce supply chain risk. There are different types of supply chain risk. Some of them are – the risk of delivery, risk of quality, risk of reputation, natural disasters risk.
So, before you move any further, define the key goals which you want to achieve and then start working on defining the procurement strategy. For example, reducing annual purchasing cost by 10% is a good example of a goal. Your goal should be SMART (Specific, Measurable, Actionable, Relevant and Time-Bound)
Once you have defined goal/s for procurement strategy, it times to start working on the design of the procurement strategy. The process can be broken down into the following steps
6. Assessment of the current procurement process
This is a no-brainer that you need to evaluate your current processes and how they currently support the goals of the procurement strategy. You should at least evaluate the following
a) Procurement policy
This step covers how you currently source the product and services and where your critical suppliers are located. The goal is to figure out whether your supplier base is local, national or International. This will help you identify levers you can use in the procurement policy. For example – if most of your purchasing is done locally, then does it make sense to expand to national or even adopt a low-cost country sourcing.
b) Bidding policy
Bidding policy defines the supplier selection process which includes competitive bidding. The assessment of the bid policy helps uncover opportunities for further improvement. Key questions to ask during this assessment
- What do we bid today? For example – some companies have policies that they don’t bid anything under $50,000.
- How do you bid? Is the process working?
- Is the process fair and set up in a way that it avoids any conflict of interest?
c) Engagement with stakeholders
The goal of this assessment is to understand how stakeholders view the procurement function, what they consider as a value-add from such a function. It is important that you have buy-in from key stakeholders on the expected value-add of the procurement function. If you don’t have an existing procurement function, it is still a good idea to assess if having such a function would add value and help meet company goals.
d) Tools assessment
Procurement toolkit might not be the first thing which comes to mind while designing procurement strategy but it should be an important component of your strategy. Things to assess
- What systems do we use today to purchase products or services?
- Can all employees use that tool to enter purchase orders or they must send paper requisitions to a single person?
- Do you have a way to ensure that spend is consolidated with your preferred vendors?
- Do you have tools to execute sourcing events like RFP (Request for Proposal) or e-auctions?
e) Skill assessment
The last step in the assessment process is to assess whether your existing procurement team has the skill sets to execute the procurement strategy. For example, Your strategy is to adopt a low-cost country sourcing strategy for cost reduction. So, do you have any team member who has experience in the low-cost country sourcing?
7. Procurement strategy design and execution
The next step towards defining the procurement strategy is the design of the procurement strategy and ensuring that you have the right resources to execute the strategies. Let’s assume that one of the goals of your procurement strategy is to reduce the purchasing cost by 10%. So, some of the common outcomes of this step are as follows
a) Supplier strategy
The supplier strategy would provide guidelines on what kind of partners you would work with to reduce cost. This might include the following scenarios
1.Single source supplier strategy, where you decide to purchase product and services from only one supplier. This not only helps in cost reduction but also helps with keeping a close eye on their performance. The single source supplier strategy has its drawbacks too; it increases supply chain risk. To mitigate that, you would need to put processes in place to track such risk.
2. We need to consolidate vendors so that we can route spend to top 2 vendors. This means that you need to buy in from all stakeholders and locations, in case you are a multi-location company.
3. We need to source from low-cost countries because the vendor consolidation efforts will not be able to drive the cost down enough to meet the savings goals.
b) Bidding strategy
Bidding strategy will provide guidelines on how would you use competitive bidding to meet the goals of your procurement strategy. Some of the common outcomes of this strategy are
- The bidding would be done for all purchases greater than $50,000. Anything under that can be purchased without a formal bidding process.
- A formal bidding process would include a 3 bid and buy process. All bids greater than the defined threshold would require proposals from three different vendors.
c) Procurement Tools strategy
The key component of execution of procurement strategy is the tool sets which would help in execution. Some expected outcomes from this step are as follows
- Tools for automating the purchase order process and ensuring that negotiated product/services rates are used across the company.
- Tools to ensure that the bidding process can be automated and scaled up as required.
8. Best practices of a procurement strategy
We close this topic with some best practices you should follow while implementing a procurement strategy.
a) Involve key stakeholders
Procurement strategy can’t and shouldn’t be defined in isolation. The key to success is to have a strategy which is well adapted and have the buy-in from key stakeholders.
It is no good to design a strategy where there is no consensus and hence no adoption. For example, you might conclude that vendor consolidation is the right procurement strategy but operations head might not agree with it because that increases the supply chain risk. So, an effective strategy is first to get feedback on the proposed strategy and address any concerns they might have. In the end, the strategy should be quantified into cost savings so that you can evaluate the true effect of the strategy.
If you don’t have a procurement team today, then start with getting feedback from different stakeholders. Then converge the feedback to a coherent procurement strategy which works for most of the executive team. It is difficult to get 100% buy-in.
b) Keep the bidding process simple
An integral part of the procurement strategy is the bidding process. In other words, a vendor selection process. Having a bidding policy is critical but ensure that it is practical.
The common advice is to have five step or seven-step strategic sourcing process. That is a good practice to follow but might not work for all categories and product or services purchases. The common feedback from stakeholders about the bidding process is that it takes too long to run a sourcing event. Though that is not true in all cases, sometimes the RFP process can drag on and extend the vendor selection process.
The key is to hear out feedback from your stakeholders and optimize the bidding process so that it can adapt to the unique needs of your stakeholders.
c) Transparency and reporting
Ensure that you provide complete transparency into the results of the procurement strategy. It is critical to support the claims of successful implementation of strategy with detailed reporting at each department level.
For example, if the key goal of the strategy is to reduce cost – then you should report overall achievement to senior management on a quarterly basis. For individual department owner, the reporting should be on monthly basis on how they are doing against their allocated budget and how procurement is helping them to reduce the overall cost.
Though savings is an important part of the equation, the focus solely should not be on just savings. You should evaluate the reporting needs of your stakeholders and accordingly support the reporting requirements. For example, procurement can help stakeholders with the forecast of expenses and avoid any surprises.
d) Continuous improvement
No plans survive the reality test, no matter how well planned. Procurement strategy is no different. Plan for revising procurement strategy based on the feedback from stakeholders.
Try to get regular feedback. The best way to get feedback is to have a quarterly review meeting with each key stakeholder. Ask interrogative questions, for example – What you think about the effectiveness of the procurement strategy and how we can further improve it.
Don’t ask how we are doing because you will not negative feedback.
An effective procurement strategy can deliver significant benefits for your company including cost savings. Whether you are a Fortune 500 company or a growing mid-market company, it is critical to review your purchasing policies. Document the desired goals and then design a procurement strategy to meet those goals.
Hope you found this article helpful. Read more on procurement in mid-market