What does procurement mean? A commonly used term in business, but what does it actually mean for your business? The word ‘procurement’ simply means a transaction between a buyer and seller. However, the process of procurement is more complex and involves execution at several levels. This article explains what procurement means and also acts as a comprehensive guide to the procurement management system.
What is procurement?
Let us start by looking at the meaning of procurement. Procurement refers to the process of obtaining products or services from the market to ensure that the production is smooth. By definition, procurement is the overall process of acquiring goods, and services by means of purchase, lease, rent, or any other form of contracting.
The term ‘procurement’ is commonly used in business, especially in manufacturing as these organisations require services and goods in a large scale. So, by ‘procure’ we mean to source, obtain and pay for goods and services in a business context.
What is procurement management?
Another important term that you may be familiar with is procurement management. Also referred to as the source to settle process, it is responsible for the overall processes that are involved in sourcing products, materials, and services needed for business operations.
As can be guessed, procuring raw material can be challenging. It’s a crucial exercise and has a direct impact on quality, production, delivery timelines, and other aspects of the business.
With Tata nexarc Procurement, we make it easy for businesses to procure quality raw material (e.g., steel) at the best prices.
What are the types of procurement?
Procurement can be classified in several ways. One way is to classify it as direct procurement and indirect procurement based on how the company uses the procured goods. Another categorization is as goods procurement and service procurement depending on the type of items procured.
Direct vs indirect procurement
- Direct procurement: Direct procurement is the process in which anything that is required to produce an end-product is obtained. For example, for a textile manufacturer, this could include cotton yarn or equipment while for a retailer, it would be items that are procured from a wholesaler for resale. Since these are raw materials required to keep production running, it is important to develop a direct procurement strategy. When is direct procurement process used – it is used when a business needs to acquire any goods, services or raw materials needed for the production process.
Generally, Direct purchase order is used to procure goods and services which a business needs regularly for the production process. Direct purchase order is an agreement between the buyer and the seller to buy/sell goods at a decided price.
- Indirect procurement: This type of procurement refers to sourcing of those products that are used by the business for day-to-day operations but does not directly impact the company’s bottom line. Indirect procurement may comprise office furniture, maintenance of equipment, marketing campaigns, IT infrastructure, etc. Indirect procurement may not affect the day-to-day operation of the business directly. However, it is important as it may have significant impact indirectly. Therefore, it is recommended to learn indirect procurement best practices.
For example, having an IT procurement strategy. In this digital era, IT infrastructure plays a pivotal role. Therefore, it is best to learn about the IT infrastructure your business needs and adopt IT procurement strategy accordingly.
Goods vs services procurement
Let us understand the differences between goods vs. services procurement and direct vs. indirect procurement through this table:
|Direct Procurement||Indirect procurement||Goods Procurement||Services Procurement|
|1||Goods that are required to produce the finished product||Refers to sourcing of non-production goods||Tangible items that are sourced through direct or indirect procurement||People-based services that are sourced through direct or indirect procurement|
|2||Example: Raw materials, equipment, etc.||Office supplies, furniture, etc.||Raw materials, utilities, etc.||Security service, housekeeping staff, etc.|
What is the importance of procurement?
Procurement plays a crucial role in every business operation and supply chain management. It enables a company to find reliable suppliers to provide quality goods and services at competitive prices. Without efficient procurement management it would not be possible for businesses to function, nor projects and processes to proceed efficiently and successfully. Additionally, procurement acts as a competitive advantage when it is optimised to save time, resources and money and plays an important role in the company’s bottom line.
9 Steps in the procurement process
While every business has its own procurement process as per its structure and needs, these are the common nine steps that are generally followed by all companies.
- Identification of goods and services: This is the first step in the procurement process where a business identifies its requirement for a particular product or service. This involves finding the details of the required products such as technical specifications, service characteristics, materials, etc. This is a good time for you to do a need analysis taking into consideration all departments to ensure the purchased product fulfils the needs of the organization.
- Submitting of purchase request: Once the identification of the products/services to be procured is done, a formal purchase request or a purchase requisition is drafted. A purchase requisition comprises the description of what product/service is required along with specifications like price, quantity and timelines. This is raised by the department managers or the financial team. The corresponding department responsible for the purchase then approves or rejects the purchase request. On approval, the procurement team proceeds to the next step.
- Assess and select vendors: Once the requisition is approved, the procurement team identifies the best vendor in terms of quality, reliability, ethics and competitive pricing and submits a request for quote (RFQ). A detailed RFQ helps to identify the best vendor.
- Price negotiation: Once the vendor is identified, you would need to initiate the price negotiation process. The common practice is to select the three best quotes from vendors and examine it closely before negotiation.
- Drafting a purchase order: Post finalizing the vendor, you need to fill out the purchase order to be sent to the vendor. Make sure to make it detailed to enable the supplier to understand the specific requirement of goods or services.
- Checking received goods: Once the supplier delivers the goods, you need to carefully examine the same for any damage or errors. Tally the same with the PO to ensure that the quality meets your expectations.
- Mapping of accounts: Once the goods are procured, you should conduct what is called the three-way matching – where the purchase order, order receipt or packing list and invoice are mapped and checked. This is done to ensure that the goods/services delivered match the PO and there is no discrepancy. This helps prevent unauthorized payments.
- Invoice approval and payment: Once the three-way match is found to be accurate, you can pay the concerned vendors. It is essential for every business to have standardized process of payment to ensure that invoices are paid on time. This helps you from paying penalties and helps build good relationships with the vendors.
- Keeping records: It is a good practice to maintain records of the entire procurement process from the time of drafting the purchase requests to the receipt sent. This will help you to reorder the goods or services at the right price in the future and will help in audits.
What are the three components of procurement?
The three main components of the procurement process are people, process and paperwork.
- People: This is the first component of procurement and is responsible for managing every step in the procurement process. It comprises procurement managers, account payable and other stakeholders involved in specifying and approval of purchases.
- Process: An effective procurement process is imperative for the business to keep operations running smoothly within timelines and keep costs at minimum.
- Paperwork: As mentioned above, maintaining records of the procurement process at every stage is important. It helps keep track of payment terms and during audits and disputes.
The role of procurement is vital in the profitability and overall success of a business. Factors like an efficient supply chain management, timely deliveries, etc. play a great role in the procurement process. Demand aggregation can prove to be highly beneficial for large businesses and supply chains that not just help in cost savings, improved logistics and better timelines, but also aid in improving the efficiency of organisations.