Using Purchase orders for both materials and services is considered as the best purchasing practice. Yet companies struggle in driving adoption of the purchase order process within the organization. Don’t agree with us, we got numbers to prove it!
As per research by the Hackett Group, best in class companies have 85% of spend going through a purchase order process, whereas peer companies only have 33% of the spend going through an automated purchase order process.
So if this is a best practice, why are companies not adopting it? Most of the companies struggle with PO adoption for non-material/ service purchase.
Or in other words, why are your employees not creating purchase orders for every purchase?
We feel it is a combination of the following factors
- Arcane systems which make it hard for anybody to use the system.
- Lack of understanding of employee parts on how and when to use a purchase order especially for services
In this post, we will cover different use cases for purchase order and how to increase the adoption of PO in your company.
Benefits of a purchase order
There are of course various benefit of using purchase orders for external vendor spend.
The threshold of using purchase orders varies from company to company. We have typically seen that companies who have more than $10M in annual revenue can benefit from having Spend on purchase orders.
We have covered the benefits of purchase order here and in other blog posts. But a brief summary is as below
Cash flow visibility
Having a purchase order based process allows the finance team to gain immediate visibility into its expenses and obligations.
There are many benefits to that
- The finance team can accrue the expenses properly and not wait for the invoices to put an entry into the system.
- The vendors are paid as per the agreed terms. If you don’t have a purchase order, chances are that your invoices would show up with due on receipt terms.
A purchase order is a contractual obligation between the buyer and the seller. When the buyer sends the purchase order to the seller, it mentions the terms which both parties have agreed to.
In case of a dispute, you can always refer back to the purchase terms to identify a path for resolution.
You should either have a separate contract with defined terms for purchase or you should mention the standard terms on the purchase order.
Easy reconciliation with invoices
Purchase order plays a significant role in improving the productivity of your Accounts Payable team.
If an invoice shows up without a purchase order, then the AP team has to spend time identifying the source of the purchase.
That is usually done by calling or emailing people and checking if they have received the goods or service for which the invoice is raised by the vendor.
This problem is easily solved if you have a purchase order issued to the supplier and the supplier is issuing an invoice against that purchase order.
Most of the purchasing systems have the capability to reconcile the invoice and purchase order and identify discrepancies if any.
Roadblocks to purchase order adoption in your company
As we mentioned above, there are tangible benefits to having a purchase order, but then why most companies don’t have a good handle on purchase orders?
We often see in these small and mid-market companies that there is limited purchase order adoption even when they have a purchasing process.
Their purchasing process mandates the use of purchase orders but still, the employees are not adopting purchase orders and companies have a low purchasing compliance rate.
Here are some common reasons for it.
The convenience of Credit cards
When you are starting up, credit cards are a convenient way to purchase products and services. Most of the big vendors anyways won’t give you a line of credit so a credit card is a necessity.
However, as the company grows, the practice continues and employees still keep on purchasing the products on credit cards. It is a very common practice to use credit cards for office supplies and ordering marketing promotional material.
It is not that these vendors don’t accept purchase orders, it is just that the employees are not used to placing a purchase order.
Moreover, if your purchasing is not standardized to one or two vendors, then rolling out a PO program could further add to the list of challenges.
Lack of purchasing guidelines
It is not uncommon to see that companies don’t have a formal purchasing policy in place. A very important part of any purchasing policy is to inform the employees on how to purchase product or services from different suppliers.
Since there is no clear direction on how to purchase from suppliers, employees use whatever method is convenient or what might make sense for them.
Of course, nothing is more convenient than picking the phone and calling the vendor.
“Please take my order and just send me the invoice” is not an uncommon scenario.
Companies can avoid this scenario by first clearly identifying the process for their employees, make sure the process is simple and then continuously train employees on the purchasing process.
This will enable a streamlined purchasing process – a process which can be better enabled by purchase orders.
Does this means that 100% compliance is guaranteed – the answer is NO.
But, it does allow you to set up a process and then work with the noncompliant users. You can adapt the user mapping technique for increasing purchasing compliance
A cumbersome manual process
Last but not least, if you have a manual purchase order process, that could be the biggest hindrance in the use of purchase orders for the organization.
If you don’t an automated purchasing system, it is likely that you are using a manual process with PO created in a spreadsheet.
The process starts with user filing the spreadsheet, then followed by email approval.
By the time process is over, many employees might be questioning – why I didn’t just put it on my credit card!
So more manual the process, the lesser the chance of it being adopted and hence lower number of purchase orders created by your employees.
The myth of Purchase order automation
Purchase order automation is the solution to all your problems!
I wish we could say that but after being in procurement space for more than 15 years, we can easily say that is not the answer.
Purchase automation is a crucial first step towards the journey to moving your organization to a purchase order based purchasing process. But there are additional steps required to get your organization to fully adopt the purchase order process.
So if automation is not the complete solution – what else is missing
The initiative to improve the purchasing process is generally driven by purchasing or finance department.
They greatly care about this cause and hence the effort and resource investment in making the process better through purchasing automation.
But most of the purchasing teams underestimate the change management process. You not only have to get over the resistant of employees but also ensured that they are trained properly.
Before you embark on the automation initiative, make sure that key departments are bought into the initiative.
You don’t have to sell the concept to everyone but at least the key executives in your company should be supportive of the initiative and should provide support with the rollout.
Need for educating employees
If you have support from key stakeholders, you are one step closer to a successful implementation of the purchasing module.
The next step is to ensure that employees are trained properly. The training is not just about the new system but also how to use the new process.
In the first year after you go live with the new system, you should continuously reinforce the system and process training.
The system is just automating the process you have put in place. That means if you have a bad process, you just made it worse!
Take continuous feedback about whether the process is working and what changes are needed to make it better.
Working with your suppliers
Suppliers are a critical part of your purchase to pay process and without successful adoption of the purchasing system, you are getting limited value from the process automation.
So how does the success of purchasing automation is dependent upon your suppliers?
There are a couple of ways suppliers are critical to purchase order automation success
Catalogs can be a great aid in ensuring that your users can easily find what they are looking for. Your suppliers would need to be engaged in the process so that they can provide data for you to set up catalogs.
Alternatively, most of the big vendors support external catalogs, also called punch-outs. With the help of vendors, it should be quite easy to set up the catalogs.
Accepting the orders
With a purchase order system, Suppliers can provide advance shipping notices as well acknowledge whether they can deliver the order on time.
To make sure that happens, your key suppliers should be onboard with the new process.
If you are using a supplier portal, then the supplier on-boarding is required to ensure that they can use the portal and submit their documentation through the supplier portal.
If you are looking to automate the invoice submission from suppliers then supplier onboarding to the new process is required. We will leave this subject for another blog post.
The typical use case for purchase orders
We talked a lot about the value of purchase orders and it’s use cases, but now let’s look at the top use cases where the purchase orders are being used across companies
On a broad level, anything you purchase from your vendors can be classified into one of the following categories
- Tangible products
- Intangible services
Using a purchase order for material purchases is pretty straight forward and the most common use cases.
Most of the users are used to creating orders – whether it is online using eCommerce sites or for corporate purchasing.
Most of the vendors won’t even ship you the products until they have received a purchase order from the company.
Given the reasons above, it is not uncommon to see 80-90% adoption for orders related to material purchases.
Not everything a company purchase is a tangible product. There is no good benchmark out there, but based on our experience, the services spend could be as high as 60% of the total external spend.
Most of the services fall in what a Company calls Indirect spend. Indirect spend is the spend which doesn’t hit the cost of good sold.
However, if you are a service company, this classic definition might not apply.
Given that up to 60% of spend could be serviced spend – it, of course, makes sense for companies to have greater visibility into this through a purchase order process.
Most of the companies, however, struggle with the adoption of purchase orders for services spend. There are many reasons for that, the main reason being that end users don’t understand how to use purchase orders for services.
In the next section, we will cover some examples of how to use purchase orders for services.
How to use purchase orders for services
Let’s now look at how a purchase order can be used for the following services scenario. One of the common questions is what “Ship to” address to use for services spend.
To make the process simple, just add an “N/A-Services” or something similar Ship to address, which the users can use for services based spend.
Purchase order for Software
Purchase of software is a very common scenario in any organization. Most common purchases include software maintenance services, software licenses or subscription services also called Software as a Service (SaaS).
Here is how to use the purchase order for a software service, Following is an example
Let’s say you are purchasing a database analyzer software license for the existing Oracle database license. You can use the purchase order in the following fashion
Couple of things to note here
- Item description would be of course the description of the item you are purchasing. In this case description of the software license.
- Unit of measure should be Each.
- The category should be a software license or equivalent category form your classification schema. Selecting the right category not only helps in identifying the type of spend but also helps in routing the requisition for approval to the correct stakeholders.
- Item type should be Service, not material. This is an important concept, so lets some time here. Assuming you are using some purchasing system or even a manual process – materials generally need a receipt to acknowledge that the product has been received.
So if you identify a software purchase as a Material type then the system would raise a request for receipt and that is an additional step in the process.
However marking it as a service item, it could go through a different process where the invoice needs to be accepted by the end-user however they don’t need to create the receipt in the system.
Purchase orders for facilities management services
Facilities supplies and services is a common use case for service purchase. Facilities supplies could come under material category and they are easy to identify.
Let’s take an example of cleaning services – we assume that you have a vendor who is offering window cleaning services. We assume the following
- You have a fixed monthly rate for cleaning services.
- They have a fixed schedule for cleaning services, for example twice a month.
In that case, you can create a purchase order like the following
Couple of things to note here
- The type of the purchase is of type “Service”. This is important because there is no physical receipt for this vendor.
- Make the description as descriptive as possible. In this example, you can see that it mentions what the service is for but also for how many months. For example, here we mentioned that it is a 12 months purchase order.
- Quantity and unit Price – Let’s spend some time on this because we see a lot of questions on this from users who are not used to a purchase order process.
So how do you determine the unit price and quantity information? Let’s us explain with the help of an example.
Let’s say the vendor charges $500/month for cleaning services and you want to create a purchase order for the entire year worth of services.
So since you are going to make 12 equal monthly payments to the vendor, you can use 12 as the quantity and then add $500 as the unit price. The total amount of the purchase order is $6,000.
The vendor can then invoice once every month for the unit price of $500.
Purchase orders for marketing spend
Every company spends money on marketing. The spend could be for advertising, creative works or agency services.
Let’s take an example of agency services – where an agency provides creative work.
We will see two example purchase orders – one where we have a fixed monthly fee and second where you purchasing ad hoc services.
In the first case, the agency charges a fixed monthly fee for various services
You can create purchase order lines are as follows
Since it is fixed amount per month, it is straightforward to create the purchase order with monthly price as the unit price and 12 months as the quantity (assuming you are creating a purchase order for the entire year)
In the second case, you are paying the agency for purchasing media on your behalf. The agency might just send you an estimate on the fees they have paid on your behalf.
If the fees are spread out over multiple months, you can create a purchase order to reflect that. If it is just a one time purchase, you can add that to purchase order as following
Purchase orders for legal services
Legal services is another category where we typically see lower adoption of the purchase orders.
The challenge with engagement is that there are very limited fixed price projects and the fees are based on the hours billed by the external counsel.
So it is definitely challenging to create a purchase order because you don’t know how much you are going to spend on legal services.
There are typically two types of purchases related to legal services – ongoing recurring service and second which are specific to a specific matter.
So how you go about creating a purchase order for these purchases?
For a fixed type of services, you can always create a recurring payments schedule. Of course, you don’t want to create a purchase order every time you need a service.
Let’s say that your external counsel helps you file your quarterly reports. In that case, it is a recurring expense. Since it is recurring expenses, it is fairly easy to identify the total cost in advance.
So in that case, your purchase order line item should look like the following
Couple of things to note here
- The description is very clear and it says that the services need to be billed every quarter. This is important so that the vendor clearly understand what needs to be billed.
- Since the billing is quarterly, we added a quantity of 4 (one for each quarter).
- The monthly billing is $25,000 in this example, so that is the unit price – making the total to be $100,000.
- Of course, this should be tagged as a service line so that there is no receipt which needs to be created for this vendor.
This was an easy example of fixed charges, but in most cases – legal expenses might not be a fixed fee.
Let’s take an example where you don’t know the expense amount. In that case, you should rely on the historical amount and create a blanket line which can be used for any expenses.
Let’s say you spend on an average of $150,000 on legal services with one of your external counsel advisors.
In that case, the purchase order line can look like the following
Few things to note here
- The line item clearly describes that this is a blanket amount to cover expenses and the vendor should attach detailed breakup with every invoice.
- Since we don’t know the billing frequency or the amount, we are leaving the quantity to one and the unit process to be the same as the total anticipated spend.
- The vendor can now keep on submitting the expenses against the purchase order until the whole amount is exhausted.
These are just two examples of how purchases orders can be used for procuring legal services. You can use the same concept across the board for any other type of legal service.
Purchase orders for Consulting services
We call this section as consulting services but you can use this for any scenario where the expenses are not fixed and the vendor is going to bill based on milestones or time and material basis.
We will take a few examples to explain the concept of how non-recurring expenses can be entered on a purchase order.
Let’s take an example of a project where the amount is fixed but the billing would be billed on milestones – for example, an IT consulting project
Let’s assume you have contracted a vendor to develop a new website where the payment would be done based on certain delivery milestones. Assuming there are three different milestones, the purchase orders lines could look like the following
Few items to note here
- Each milestone is a new line item for the purchase order. In this case, the deliverables are spread across three different milestones – Design, build and launch.
- Each milestone has a different required date so that the invoices can be billed accordingly.
- The descriptions of the line items clearly describe the deliverable and condition when the invoice should be raised.
If the PO is structured this way, not only the vendor invoice properly, it is also easy for the approvers to track the deliverables against which the invoice is raised.
Let’s take another example where the vendor is engaged on an hourly basis – let’s say audit services.
Generally, if it is T&M (Time & material) based you would have some estimate on the number of hours the vendor is going to bill.
You can always create a purchase order based on the initial estimate and refine it if need be.
A sample is as follows
Few things to note
- The unit price is the per amount hour charged by the vendor and the quantity is the total amount of hours.
- Please note that you might have to revise the hours after the purchase order is created – in the case the actual hours are more than the estimated hours.
If you look at the end to end process from purchasing to invoicing, having a purchase order greatly simplifies the processing of invoices and tracking if the product has been received.
Companies not only gain efficiency but also get better visibility into cash flow and it’s obligations going forward.
Purchasing automation is a key piece for increasing the adoption of the purchase order within your company – To get there companies need to do the following
- Simplify and automate the purchasing process, make it easy for employees.
- Educate employees on how to use purchase orders, especially for services.
We look forward to hearing your feedback on how you are driving adoption of purchase orders within your company – leave a comment!