I am sure you would agree with me that any automation initiatives done right delivers productivity improvements and cost savings. Purchase order system is no different and done right can deliver significant improvement in productivity and provide better visibility into company spend.
Electronic purchase order system might not be a top of mind issue for many mid-market executives. It could be because that it is a back-office function or the purchasing volume is not high enough to demand automation. But if you are like any other executive or manager looking to reduce waste and increase efficiencies then you should count this automation initiative in low hanging fruits bucket. Implementing a purchase order system would increase the efficiency of your staff and simplify the experience for the end users.
In this article, we will cover, what are the benefits of a purchase order system, how you should evaluate different solutions available in the market and what are the implementation best practices. So, if you are in the market for a purchase order system, this article is for you.
Let’s define what a purchase order is and what are the different components of the purchase order system If you are familiar with what is a purchase order, please feel free to skip this section.
The official Wikipedia definition of a purchase order is as follows
“A purchase order (PO) is a commercial document and first official offer issued by a buyer to a seller, indicating types, quantities, and agreed prices for products or services. It is used to control the purchasing of products and services from external suppliers”
Like any other legal contract, PO has an offer and acceptance. Buyer sending the purchase order is just an offer to purchase from the supplier. The PO becomes a legal binding when the vendor accepts the offer by acknowledging the purchase order. The vendor can accept the order as is or ask for a change order. Having a purchase order simplifies this back and forth between buyer and supplier.
A sample purchase order is below
A purchase order has the following components
a) Purchase order header
A purchase order header consists of the following components
b) Key terms: This section lists key terms including shipping method, trading terms, and agreed or standard payment terms for your suppliers.
c) Purchase order line items
Order Line item details: this section contains line items that you are purchasing from the vendor. The key fields are the description of the item purchases, quantity, unit of measurement, unit price, and total.
c) Taxes and other information
This section lists the taxes related to the purchase and other charges like Freight etc.
Having covered what is a purchase order, let’s look at the basic process of creation of a purchase order. The basic purchase order process is depicted below
a) Requisition process
The requisition process generally involves, identification of the need or what needs to be purchased. If you have a procurement department, then this step would generally include sourcing and price negotiations (in case of a new purchase). In the case of existing items, this simply means purchasing items from existing suppliers with pre-negotiated pricing.
b) Requisition approval
The second step of the process includes authorization approval of the purchase. Depending upon the level of automation, this could be either manual or semi-manual or fully automated. It is not uncommon for companies to have a paper-based authorization process for purchase approval. Though it works, the process is highly inefficient. Your purchasing policy should clearly define who should be approving the purchasing request.
c) Purchase order processing
The third step includes creating the purchase order and sending to the supplier. If your system is completely manually, you are creating a purchase order using an existing template and then sending to the supplier via email or by fax. Automated systems create the purchase orders automatically and send it to the supplier based on their preferred transmission process
d) Supplier acknowledgment
The fourth step is the acknowledgment of the order by the supplier. This generally means that the supplier accepts the order including the terms printed on the purchase order. In case the supplier doesn’t acknowledge the order as is, then it must go through a change order process.
e) Change order process
The purchase order change process can be initiated by the buyer or supplier due to different reasons. Common causes for suppliers initiated changes include incorrect price, discontinued items or disagreement regarding purchase order terms.
On the buyer side, the change order is commonly initiated due to change in quantity of an incorrect unit of measure (UOM) for the item or list of items.
Having covered the basic purchase order process, let’s cover what benefits you can expect by implementing a purchase order system
a) Reduce the average cost to process a purchase order
When it comes to the cost of processing a purchase order, there is no simple answer. There are different benchmarks available from different research house. For example – a study done by CAPS research provides purchase order processing cost benchmark for different industries. For example, the manufacturing industry has an average cost of $59 and the petroleum industry has an average cost of $741. The reason for such a broad range is due to the process complexity and the number of people who are involved in reviewing the purchase order before it is sent to the supplier.
One should also consider the cost of processing change orders in case they are not issued correctly.
A simpler solution is to look at the total yearly cost and divide by the number of purchase order processed
The cost to process a PO = Total yearly cost/number of purchase orders issued
So even if you have a single employee with an average annual loaded cost of $75,000 and the total PO processed is 60 a month or 720 a year. Then the average cost per PO is $104. By implementing an automated purchase system you can eliminate the cost of processing the PO by 80-90%.
b) Productivity Improvement
A purchase order system not only saves cost but also saves the time required to process a purchase order. If you are manually processing the purchase orders, then every step takes more time, for example, approvals etc. By automating these activities, you should be able to save time and increase the productivity of your employees. Automation of the purchasing process is a very simple way to eliminate waste from your operations and increase the efficiency of your business processes.
c) Better relationship with your suppliers
A side benefit of automating the purchasing process is an improved relationship with suppliers. Automated purchasing process leads to
d) Visibility into Spend at a granular level
If you have a manual purchase order process, chances are you have limited visibility into company spend. Most of the companies rely on reports like Spend by the supplier or spend by GL accounts. Beyond that, you must dig up the purchase order documents to find additional information.
With an automated purchase order system, you can get granular visibility at the line item level which helps you better plan your budgets, understand cost trends. The granular visibility provides better spend data which you can use for negotiations with your suppliers. It is not uncommon for companies to find out that they are paying different rates for the same product across different departments.
e) Fraud prevention
One of the benefits of a purchase order system is that you can implement automated workflows. Hence, ensuring that all purchases require proper authorization before it can be sent to the supplier. Most purchase order systems maintain an audit trail and you can review the purchase approval history at any time.
With automation, you can build approval workflows so that employees don’t need to evaluate who should be approving the purchase. The purchase system automatically does that for you and helps in preventing procurement fraud.
Though it is ideal to have negotiated contracts for all the purchase, that is not always the case. In those cases, terms on the purchase orders is a good substitute.
Every purchase order should list the standard buyer terms for purchase and that provides the general agreement on how both parties will conduct business. A purchase order generally includes commercial terms like payment terms, product warranties etc. It also includes legal terms like the limitation of liability, indemnification etc.
In case there is a dispute, these terms can help resolve that dispute rather than leaving it open-ended. If a case ever goes to a court of law, the standard terms can provide the general agreement framework rather than relying on standard commercial terms.
I think by now you would agree that a purchase order system is a must for any organization including yours, with that said, let’s look at some of the considerations for selecting a purchase order system
a) Using your current ERP
Almost all ERP (Enterprise Resource Planning) tools have a purchasing module especially the enterprise-grade applications like SAP and Oracle. Before you decide – ask following questions
If you current ERP like Microsoft Dynamics offers this capability at a reasonable cost, use your current ERP purchasing module. If not, keep reading!
b) Ease of use
There are multiple purchase order system providers and on paper, have a similar feature set. However, the easier the system is to use, the better the adoption across the company. If the tool is cumbersome, you will never get the desired adoption and hence the benefits which come along with it.
Look for a system which has an interface similar to commonly used web applications, for example, if your purchase order system has a user interface similar to Amazon.com, you really don’t need to train users.
c) Installation and Maintenance
Another aspect to consider is the delivery model. Whether the solution is a cloud-based solution or the purchase order systems need to be installed and maintained by your IT team.
Internally deployed and managed system might seem cheaper in the beginning but if you do a Total Cost of Ownership (TCO) analysis over 5-6 years, cloud-based solution is always a better deal. There are multiple reasons for that
d) Flexible approval workflows:
When you are implementing a purchase order system, the goal is not just to automate the paper-based process but also to ensure that the system can help with your compliance needs. The selected system should support
The easier the tool, the better experience for employees because you can customize the workflow based on the requirements of the business and different business departments.
e) Easy to configure
When it comes to Purchase order system, one system doesn’t fit the requirements of different type of business.
The purchase order system should be easy to configure so that you can easily set it up to meet your unique business requirements. It could be specific business processes or special field structures which needs to be set up.
A word of caution, don’t overly customized the system to meet your business processes. There is value in choosing out of the box functionality because usually, that means it is the best practice. Ideally, do minor tweaking to adjust the system to your requirements. If required, review your processes to see if process re-engineering is required.
f) Integration requirements
Once the purchase order is generated, it should also be sent your ERP system for further processing. That includes posting it to correct general ledgers, receiving the goods, inventory management, invoicing and payment.
Make sure that the selected system can easily integrate with your current system/s. Ideally, the selected vendor should have pre-built and configured adapters for your ERP system so that your IT team can easily configure the system and it is a plug and play integration.
g) Modular system
The benefits of the purchase order system are not limited to just purchase orders, you can extend the capabilities to automated invoicing too. This makes it easy for suppliers to submit the orders electronically. You can expect similar benefits around productivity and cost improvement as in the case of purchase order system.
Our suggestion is that you select a system which is modular, which means it has an end to end modules for the entire P2P (Purchase to Pay) process including e-invoicing. This way you can start small and later expand into other modules.
I hope that the above-mentioned criteria would help in selecting the purchase order system.
So, you have identified the benefits, selected the system and started implementing the solution. But before you start implementation, consider the following points. This would increase the chances of a successful implementation.
a) Support from stakeholders
Like any other initiative, executive support is very critical for a successful rollout of a purchase order system. Make sure that key stakeholders are aligned with the objectives of the rollout of the program.
Most of the times these solutions are sold by the purchasing department to internal stakeholders as an initiative to improve the productivity of the back office. That is not the most appropriate approach. You should highlight the key benefits stakeholders will get, once the system is implemented. For example – better visibility into their budgets.
b) Effective change management
If you are implementing a purchase order system for the first time, make sure that change management is well handled.
Specifically, make sure that users of the systems are communicated in advance regarding the benefits of the system. Make sure that you update the users on a continuous basis before you Go live and they have a channel to voice their opinion and feedback.
When managing change, focus on the bright spots – what is working and then accelerate your efforts towards that.
c) Single ownership
Implementing a purchase order system includes technology implementation and process enhancements. It is helpful to have a single point of ownership so that the individual responsible for implementation can get feedback from different stakeholders. The selected individual should be a single point of contact for your internal and external stakeholders.
Ideally, a person familiar with technical solutions and process knowledge would be best suited for this role.
d) Minimize customization
Minimize the customization to the chosen solution. There is always a strong temptation to customize the solution to meet your specific business processes. This might be Ok if the solution is developed only for you but if you are selecting a cloud vendor, chances are that they have the exact same build for all customers.
Rather than customizing, focus on creating strong requirements and make sure you choose a solution which fits well with your current processes.
f) Process reengineering
This is often ignored step especially when you have limited resources. The general tendency is to implement the system and then improvise the processes once the system is up and running. That is a wrong approach.
Take time to do a current state process analysis and then come with the would-be process. Get buy-in from all the stakeholders regarding the would-be process. Once that is done, the requirements should become part of your selection process.
Purchasing automation done right by implementing a purchase order system provides many benefits. Key benefits include improved productivity, increased visibility into company spend and increased compliance with the corporate policies. Mid-market companies can gain a significant competitive advantage by understanding their buying patterns and strategic cost reduction opportunities.
I hope you find this guide helpful. If you would like to discuss further, set up a free consultation with one of our purchasing experts.