Purchase order for services – How to increase PO adoption

purchase_order_for_services

Using Purchase orders for both materials and services is considered the best purchasing practice.

Yet, companies struggle to drive the adoption of the purchase order process within the organization. Disagree with us? We got numbers to prove it!

Purchase order adoption rate

As per research by the Hackett Group, best-in-class companies have 85% of their spend going through a purchase order process, whereas peer companies only have 33% of the spend going through an automated purchase order process.

purchasing order adoption rate metrics

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 purchases.

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

  1. Arcane systems make it hard for anybody to use the system.
  2. 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 orders and how to increase the adoption of PO in your company.

Bonus: The purchase order process is a good start for controlling expenses, but you need a comprehensive framework for cost control. Download our 3C Cost Control framework for free and learn how to build a cost-conscious culture.

Benefits of a purchase order process

There are, of course, various benefits of using purchase orders for external vendor spending.

The threshold of using purchase orders varies from company to company.

We have typically seen that companies who have more than $5M in annual revenue can benefit from a purchase order process.

We have covered the benefits of purchase orders here and in other blog posts. But a summary is as follows:

Cash flow visibility

Having a purchase order process allows the finance team to gain immediate visibility into its expenses and obligations.

There are many benefits to that:

  1. The finance team can accrue the expenses correctly without waiting for all invoices to be entered into the system.
  2. The vendors are paid as per the agreed terms. If you don’t have a purchase order, the chances are that your invoices would show up with due-on receipt terms.
If you are mainly purchasing intangible services, it is not uncommon for you to dismiss the effectiveness of a purchasing process. The common theme is, we are not purchasing widgets, so we don’t need a purchase order process.
The truth is that most companies don’t know how to implement an effective purchasing process for services.

Contractual obligation

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 both parties’ terms.

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 purchase terms or 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, 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 vendor raises the invoice.

This problem is easily solved if you have a purchase order issued to the supplier and issuing an invoice against that purchase order.

Most of the purchasing systems can 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?

However, there is limited purchase order adoption in small and mid-market companies even when they have a purchasing process.

Their purchasing process mandates 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 big vendors won’t give you a line of credit, so a credit card is necessary.

However, as the company grows, the practice continues, and employees still purchase the products on credit cards. It is a widespread 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, rolling out a PO program could further add to the challenges.

Lack of purchasing guidelines

It is not uncommon to see that companies don’t have a formal purchasing policy in place. A vital part of any purchasing policy is to inform the employees about the purchasing process.

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 clearly identifying the process for their employees, making sure the process is simple, and then training employees on the purchasing process.

This will enable a streamlined purchasing process – a process that is enabled by the purchase order process.

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 non-compliant 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 have an automated purchasing system, you are likely using a manual process with a PO created in a spreadsheet.

The process starts with the 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!

The manual process has a lower adoption rate, and that leads to fewer purchase orders.

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 the procurement space for more than 15 years, we can easily say that is not the answer.

Purchase automation is a crucial first step towards moving your organization to a purchase order-based purchasing process. But there are additional steps required to get your organization to adopt the purchase order process fully.

So if automation is not the complete solution – what else is missing

Change management

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 employees but also ensure that they are adequately trained.

Before you embark on the automation initiative, make sure that critical 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 support the initiative and provide support with the rollout.

Need for educating employees

If you have support from key stakeholders, you are one step closer to successfully implementing the purchasing module.

The next step is to ensure that employees are adequately trained. The training is not just about the new system but also how to use the new process.

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 flawed 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

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 to 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 pretty easy to set up the catalogs.

Accepting the orders

With a purchase order system, Suppliers can provide advance shipping notices and acknowledge whether they can deliver the order on time.

To make sure that happens, your key suppliers should be on-board with the new process.

If you are using a supplier portal, then the supplier onboarding must ensure that they can use the portal and submit their documentation through the supplier portal.

Invoice automation

If you want 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.

Bonus: The purchase order process is a good start for controlling expenses, but you need a comprehensive framework for cost control. Download our 3C Cost Control framework for free and learn how to build a cost-conscious culture.

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.

  1. Tangible products
  2. Intangible services

Tangible products

Using a purchase order for material purchases is pretty straightforward and the most common use case.

Most users are used to creating orders – whether it is online using eCommerce sites or for corporate purchasing.

Most 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.

Intangible Services

Not everything a company purchase is a tangible product. There is no good benchmark, 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 that doesn’t hit the Cost of Goods Sold (COGS).

However, if you are a service company, this classic definition might not apply.

Given that up to 60% of Spend could be on purchasing services – 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 employees can use a purchase order process for the following services scenario. One of the common questions is what “Ship to” address to use for services Spend.

To simplify the process, add a “N/A-Services” or something similar Ship to address, which the users can use for services-based purchase orders.

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 called Software as a Service (SaaS).

Here is how to use the purchase order for a software service.

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

  1. Item description would be, of course, the description of the item you are purchasing – in this case description of the software license.
  2. Unit of measure should be Each.
  3. The category should be a software license or equivalent category from your classification schema. Selecting the right category helps identify the type of spend and helps in routing the requisition for approval to the correct stakeholders.
  4. Item type should be Service, not material. This is an important concept, so let’s spend some time here. Assuming you are using a purchasing system or even a manual process – materials generally need a receipt to acknowledge receiving the product.

So if you identify a software purchase as a Material type, then the system would raise a request for a receipt, which is an additional step in the process.

However, marking it as a service item could go through a different process where the invoice needs to be accepted by the end-user. However, employees don’t need to create the receipt in the system.

Purchase orders for facilities management services

Facilities supplies and services are a common use case for service purchase. Facilities supplies could come under the material category, and they are easy to identify.

Let’s take an example of cleaning services – we assume that you have a vendor offering window cleaning services. We assume the following.

  1. You have a fixed monthly rate for cleaning services.
  2. 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.

  1. The type of the purchase is of type “Service.” This is important because there is no physical receipt for this vendor.
  2. Make the description as descriptive as possible. In this example, you can see that it mentions what the service is for and how many months. For example, here, we mentioned the purchase order is for 12 months.
  3. 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 explain with the help of an example.

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 will 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 the second where you purchase 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 a 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 send you an estimate on the fees they have paid on your behalf.

If the fee is 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 the purchase order as shown below:

Purchase orders for legal services

Legal services is another category where we typically see lower adoption of purchase orders.

The challenge with engagement is minimal fixed price projects, and the fee is based on the hours billed by the external counsel.

So it is challenging to create a purchase order because you don’t know how much you will spend on legal services.

There are typically two types of purchases related to legal services – ongoing recurring service and the second specific to a specific matter.

So how do you go about creating a purchase order for these purchases?

For the 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 relatively 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

  1. The description is apparent, and it says that the services are to be billed every quarter. This is important so that the vendor clearly understands what needs to be billed.
  2. Since the billing is quarterly, we added a quantity of 4 (one for each quarter).
  3. The monthly billing is $25,000 in this example, so that is the unit price – making the total $100,000.
  4. Of course, this should be tagged as a service line so that no receipt needs to be created for this vendor.

This was an easy example of fixed charges, but legal expenses might not be a fixed fee in most cases.

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 that employees can use for any expenses.

Let’s say you spend 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 a blanket amount to cover expenses, and the vendor should attach a detailed breakup with every invoice.
  • Since we don’t know the billing frequency or the amount, we leave the quantity to one and the unit price the same as the anticipated Spend.
  • The vendor can now submit 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

This section covers consulting services, but you can use this for any scenario where the expense amount is not established, and the vendor will bill based on milestones or time and material basis.

We will take a few examples to explain the concept of how employees can enter non-recurring expenses 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, and you would make the payment 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

  1. 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.
  2. Each milestone has a different required date so that the invoices can be billed accordingly.
  3. The descriptions of the line items clearly describe the deliverable and condition when the vendor should raise the invoice.

If the PO is structured this way, not only does the vendor invoice correctly, 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 hourly – let’s say audit services.

Generally, if it is T&M (Time & material) based, you would estimate 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 of hours the vendor charges, 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.

Bonus: The purchase order process is a good start for controlling expenses, but you need a comprehensive framework for cost control. Download our 3C Cost Control framework for free and learn how to build a cost-conscious culture.

Conclusion

Looking at the end-to-end process from purchasing to invoicing, having a purchase order dramatically simplifies the processing of invoices and tracking if the product has been received.

Companies gain efficiency and get better visibility into cash flow and its obligations in the future.

Purchasing automation is a crucial 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, making 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 the adoption of purchase orders within your company – leave a comment!

 

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