Procurement | Definition, Types, Process, Challenges, and Technology
Understand the Procurement in Business
In this article, we will cover what is procurement, the procurement process, the types of procurement, and what are the future of procurement and technology.
The article is written by the ElectGo team with contributions from Mr. Colin Koh, an industrial educator and industry leader in smart manufacturing and automation.
1. What is procurement in business?
Procurement is a vital organizational function that involves acquiring goods, services or works from external suppliers to fulfill a business’s strategic and operational needs.
Procurement is crucial in managing supply chains, controlling costs, and driving value creation in business. Effective procurement strategies can lead to significant cost savings, improved quality, enhanced supplier relationships, and better alignment with the company’s overall goals.
2. What are the types of procurement?
Procurement can be classified into several types, each serving a specific purpose within an organization. Understanding these types helps businesses tailor their procurement strategies to meet different needs effectively. Here’s a detailed look at the various types of procurement:
Direct procurement
Involves acquiring goods, materials, and services directly used in the production process or core business operations.
Indirect procurement
Refers to purchasing goods and services that are not directly linked to the production process but are necessary for the business’s daily operations.
Services procurement
Involves complex negotiations and contract management, as services vary widely in scope, deliverables, and pricing structures.
Strategic procurement
Involves analyzing the total cost of ownership (TCO), supplier risk management, and value creation through collaboration. It focuses on long-term supplier relationships and sourcing strategies.
Tactical procurement
Involves routine purchases, smaller transactions, and short-term contracts. It focuses on immediate needs.
3. What is the procurement process?
The procurement process is a structured series of steps that organizations follow to acquire goods, services, or works from external sources. This process is critical for ensuring that the right products are sourced at the right price, from the right suppliers, and delivered at the right time. Here’s a detailed breakdown of the typical procurement process:
3.1 Identifying needs
Recognize a need or requirement within the organization. Production schedules, project timelines, or operational demands could drive this. Stakeholders from different departments submit their requirements, which are reviewed and prioritized.
3.2 Specification development
Define the specifications for the required goods or services. This includes detailing the quantity, quality, performance criteria, and specific conditions the supplier must meet. Accurate specifications ensure that the procurement team sources exactly what is needed.
3.3 Supplier research and selection
Research to identify potential suppliers. This involves evaluating the market, assessing supplier capabilities, and comparing their offerings. Factors such as reputation, reliability, financial stability, and previous performance are considered during this phase.
3.4 Request for proposal (RFP) or request for quotation (RFQ)
Issue an RFP or RFQ to shortlisted suppliers. An RFP is used when the procurement requirements are complex and may require creative solutions while an RFQ is typically used for more straightforward purchases where price is the main consideration. The RFP/RFQ documents outline the specifications, terms, and conditions, and suppliers submit their bids or proposals in response.
3.5 Evaluation and negotiation
Evaluate them against pre-defined criteria, including cost, quality, delivery timelines, and supplier reputation. After shortlisting the most suitable suppliers, negotiation to finalize the best possible terms and conditions. This phase is critical as it can lead to cost savings and better contract terms.
3.6 Contract award and management
A contract is awarded to the chosen supplier. The contract formalizes the agreement, including terms of delivery, payment schedules, performance standards, and penalties for non-compliance.
3.7 Order placement and fulfillment
The procurement team places an official purchase order (PO) with the supplier, outlining the specifics of the goods or services to be delivered. The supplier then processes the order and arranges for delivery. This phase requires close monitoring to ensure that delivery schedules are met and any issues are promptly addressed.
3.8 Receiving and inspection
The goods or services are inspected upon delivery to meet the required specifications and quality standards. Any discrepancies or defects are reported and resolved with the supplier.
3.9 Payment and record-keeping
Once the goods or services are accepted, the procurement team processes the payment according to the terms agreed upon in the contract. Proper documentation and record-keeping are essential for auditing purposes and future reference.
3.10 Supplier performance review
Post-delivery, the procurement team reviews the supplier’s performance against the agreed-upon standards. This includes assessing the quality of goods/services, adherence to delivery schedules, and overall supplier responsiveness. Performance reviews help in building long-term relationships and identifying areas for improvement.
4. Differences between purchasing, procurement and e-procurement
Purchasing, procurement, and E-procurement are interconnected concepts, each playing a crucial role in acquiring goods and services within an organization, but they differ in scope, focus, and methodology.
5. Top 4 challenges of procurement
5.1 Complexity of managing diverse supplies
Procurement is managing a wide array of supplies, which can range from simple items like cleaning supplies to complex machinery parts. Each item has its own set of specifications, suppliers, and lead times, making the procurement process a complex task.
Managing relationships with suppliers is a critical aspect of procurement. It involves more than just negotiating prices and delivery terms. A strong supplier relationship can ensure the availability of high-quality products when needed. It can also provide access to expert advice and technical support. However, managing a diverse supplier base can be challenging. It requires effective communication, regular performance reviews, and a commitment to ethical sourcing practices.
5.2 Standardizing diverse items in procurement
The need for more standardization in items adds to the complexity. Unlike direct materials that are often standardized, items can vary greatly in their specifications. This makes it difficult to compare products and suppliers, leading to inefficiencies and potential errors in the procurement process.
5.3 Unpredictable demand and inventory
Forecasting demand and managing inventory are critical aspects of procurement. However, these tasks can be quite challenging due to the unpredictable needs. It depends on various factors, such as equipment usage, maintenance schedules, and unexpected breakdowns.
Poor inventory management can lead to overstocking or understocking of items. Overstocking ties up capital and leads to obsolescence. Understocking, on the other hand, can cause unplanned downtime.
5.4 Striking the right balance: cost, quality, and reliability
While businesses aim to minimize costs to improve their bottom line, they also need to ensure the quality and reliability of MRO items to prevent operational disruptions.
Procuring low-cost MRO items may lead to frequent breakdowns and higher maintenance costs in the long run. Therefore, procurement managers need to consider the total cost of ownership, which includes the purchase price, maintenance costs, and the potential cost of downtime due to equipment failure.
Conversely, purchasing high-quality, reliable MRO items may involve higher upfront costs. However, these items can lead to lower maintenance costs and less downtime, resulting in overall cost savings. Therefore, striking the right balance between price, quality, and reliability is crucial in MRO procurement.
6. The future of procurement technology
Rapid advancements in digital tools and evolving business needs shape the future of procurement technology. As organizations strive to become more agile, cost-effective, and resilient, the role of technology in procurement is set to expand significantly. Here are some key trends that are expected to shape the future of procurement technology:
6.1 Artificial Intelligence (AI) and Machine Learning (ML)
AI and ML are transforming procurement by enabling predictive analytics, automated decision-making, and enhanced supplier management. These technologies can analyze vast amounts of data to identify trends, forecast demand, and optimize procurement strategies. AI-powered chatbots and virtual assistants are also being used to streamline communication and improve efficiency in procurement operations.
6.2 Blockchain Technology
Blockchain is poised to revolutionize procurement by providing enhanced supply chain transparency, security, and traceability. By creating a decentralized ledger of transactions, blockchain can help reduce fraud, ensure compliance, and improve supplier collaboration. It also offers the potential for smart contracts, which automatically execute contractual terms when predefined conditions are met.
6.3 Robotic Process Automation (RPA)
RPA is being increasingly adopted to automate repetitive and manual tasks in procurement, such as data entry, invoice processing, and order management. RPA can significantly reduce errors, speed up processes, and free up procurement professionals to focus on more strategic activities. As RPA technology evolves, its integration with AI and ML will further enhance its capabilities.
6.4 Cloud-Based Procurement Platforms
The shift towards cloud-based procurement platforms is gaining momentum, driven by the need for greater flexibility, scalability, and collaboration. Cloud-based solutions offer real-time access to procurement data, enabling organizations to make informed decisions quickly. They also facilitate remote work and collaboration across geographically dispersed teams.
6.5 Advanced Analytics and Big Data
Advanced analytics and big data are critical to enhancing procurement decision-making. By leveraging data from various sources, procurement teams can gain insights into supplier performance, market trends, and cost-saving opportunities. Predictive analytics can help anticipate demand fluctuations and optimize inventory management, while prescriptive analytics can suggest the best action based on data analysis.
6.6 Sustainable Procurement
Sustainability is becoming a key focus area in procurement, with organizations increasingly looking to reduce their environmental impact and promote ethical sourcing. Procurement technology is evolving to support sustainable procurement practices by providing tools for tracking supplier sustainability credentials, assessing environmental impact, and ensuring compliance with sustainability standards.
6.7 Internet of Things (IoT)
IoT is enhancing procurement by providing real-time visibility into the supply chain. IoT devices can monitor inventory levels, track shipments, and detect potential issues before they become critical. The data generated by IoT devices can be integrated with procurement systems to optimize supply chain operations, reduce costs, and improve efficiency.
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