What is Procurement? The Complete 101 Guide to Procurement Principles
Every company, regardless of industry, requires specific items to keep their businesses operational. These items range from the most basic products, such as light bulbs or bolts, to more complex items, like particular machinery or raw materials. In addition to these items, companies also often require a wide range of services, including repairs or training, to maintain their facilities and staff. But what is procurement in practice? We've created this guide to cover the basics around this field, including what it is, the stages and types of procurement, misconceptions around the term, and more.
Because businesses typically spend such a large portion of their revenue on these goods and services, most develop strategic procedures to ensure that their purchases are providing value in addition to resources.
This strategic process is known as procurement.
At face value, procurement may seem like a fancy word for purchasing, especially considering these two words are sometimes used interchangeably (although they are not the same thing). However, the procurement process stretches far beyond the straightforward act of exchanging payment for goods.
Procurement is a systematic process within the supply chain in which business leaders approach spending analytically. It is often considered a key component of a company’s overall corporate strategy as it aligns the company’s overall objectives with their short- and long-term goals. Because it touches upon so many aspects of the corporate strategy, the procurement process typically requires precise calibration between multiple departments.
Procurement in manufacturing, supply, and other privately owned businesses, however, is not the only type of procurement. While procurement in business makes up a large portion of all procurement activities, nonprofits and governmental organizations also depend on this process to get the products and services they need. However, for these bodies, increased transparency is necessary, and there are more regulations to follow.
The indirect and direct procurement process is the same, but it's extensive and involves many factors including:
- Determining company needs
- Strategically forecasting demand
- Planning purchases
- Conducting market research
- Evaluating and identifying potential suppliers
- Selecting suppliers with the best quality for the lowest cost
- Managing supplier relationships
- Defining standards and specifications
- Negotiating prices and terms
- Establishing payment details
- Developing contracts
- Making purchases
- Managing and controlling inventory
Successful procurement management can add tangible value to an organization’s bottom line and is best handled by a team of qualified individuals. With expertise in key areas like cost savings, risk management, compliance, centralized purchasing, and contract management, the best procurement teams streamline all of a company’s spend mechanisms into a singular system.
The procurement team is managed by the chief procurement officer (CPO). As a member of the executive team, the CPO ensures the company’s corporate objectives and initiatives are the driving forces that shape the procurement and supply chain management strategies.
Their main functions include managing overall procurement strategy, balancing the budget, developing supply chain standards, and tracking key performance indicators.
Procurement is generally divided into two subcategories – direct procurement and indirect procurement. Each of these procurement types plays a crucial role in keeping companies operational.
The ratio between direct and indirect procurement spending varies differently between industries and individual businesses. Some industries, such as manufacturing, are heavily reliant on direct procurement, while service-oriented companies rely more on indirect procurement.
The direct procurement process involves the of purchasing components, raw materials, and services that a company uses to produce its products. For example, automotive manufacturers need a wide range of parts and components to manufacture a fully functioning vehicle. All of these components are used in the direct manufacture of the automobile.
Indirect procurement is the process of purchasing products that support daily operations and overall business functionality. These types of products include items such as office supplies, cleaners, and support software. These products contribute to the business’s function in an indirect way.
Although procurement is an important component of a company’s business strategy, it often is used interchangeably with a variety of other related financial terms, such as purchasing, sourcing, and supply chain.
Many people believe procurement is also known as purchasing, but they are two separate things. Procurement is an umbrella term for a wide range of processes, as listed above. The difference between procurement and purchasing is that procurement, which is closely entwined with a company’s overall corporate strategy, deals with the complexity of managing the bigger picture, while purchasing is a smaller, straight-forward process that falls under the procurement umbrella.
Purchasing is focused on the actual exchange of currency for goods or services. The process involves a number of steps, such as price negotiation, sending a purchase order, scheduling delivery dates, invoicing, paying suppliers, and receiving products. By the time the purchasing process has begun, most of the complex details have already been figured out.
Like purchasing, sourcing also falls under the procurement umbrella. During the sourcing process, companies identify and locate potential suppliers of goods and services. Guided by the overarching procurement strategy, sourcing mainly focuses on finding the highest quality suppliers for the lowest cost but also considers supplier certifications, weather-related risks, political landscapes, financial risks, tariffs, and logistical costs.
Unlike purchasing and sourcing, supply chain management doesn’t fall under the procurement umbrella; instead, the procurement process is actually nested as an aspect of supply chain. While procurement is focused on the upstream processes involved in obtaining the goods and services required to keep a company running, the supply chain comprises all the upstream and downstream moving parts that are involved in preparing, creating, and distributing products.
In sales and operations, multiple departments collaborate to ensure all the moving parts of the business are working in sync with one another. To achieve this cohesion, teams gather data from key departments, such as sales, manufacturing, marketing, procurement, distribution, IT, and finance, to create a specific production plan that coordinates the company’s daily processes with the organization’s overall business strategy.
Demand planning is a key element of sales and operations planning. Once data has been collected, it’s analyzed to predict future customer demand for specific products and services. Using these forecasts as a foundation, the company develops a unified approach to production and delivery.
Industry 4.0 has had a major impact on industry far beyond the factory floor. Every day, strategic business leaders discover new ways to leverage this suite of digital technologies for a wide range of procurement and supply chain applications. Automated procurement systems such as eProcurement have emerged as ways to relieve procurers of more onerous work. Smart procurement, also known as cognitive procurement, has developed as the most recent advance, featuring technologies like AI, Machine Learning, Data Analytics, and Blockchain.
Also known as electronic procurement, eProcurement is a type of procurement system that overhauls the analog processes of traditional procurement models, such as inventory control and invoicing, by employing digital solutions. When connected with other technological innovations, such as IoT sensors in a smart facility, eProcurement platforms help companies identify both existing patterns and emerging forecasts.
By using digital technologies to take over these mundane processes, procurement departments are free to focus on more value-driven aspects of supply chain, such as transparency, risk assessment, and compliance improvement.
Artificial Intelligence (AI) technologies are programmed to learn and think. In supply chain, they are increasingly utilized for demand planning and forecasting. Using these tools, companies can accurately and quickly analyze massive amounts of data from multiple sources against variables such as weather patterns and customer reviews.
AI technology can process this data much more efficiently than a human and make extremely precise demand predictions, ultimately creating a more accurate mode of decision making, improving cost savings, and enhancing workplace safety.
Similar to AI, machine learning tools cull data from multiple sources to build a set of analytical predictions. Data is becoming increasingly important for supply chain and procurement management practices, as it proves to be key to optimizing spending, planning, logistics, visibility, tracking, and forecasting.
Often associated with cryptocurrencies, blockchain is a relatively new digital technology that some have heralded as the next step in supply chain evolution. As a distributed digital ledger, blockchain accurately records all transactions in real-time to help buyers and suppliers track products throughout all links in the supply chain.
Blockchain presents many advantages in supply chain and procurement management practices, including enhanced traceability, increased control, reduced data entry and paperwork, and the ability to automate various processes by working in combination with other digital technologies like IoT.
While blockchain has a lot of potential for procurement applications, some in the supply chain industry have been hesitant to fully adopt it as technology is still fairly new and not yet widespread.
Now that we've covered the basics around procurement, including what it is, stages and types of procurement methods, misconceptions, and new procurement technologies, we hope this will better enable you in your work. Feel free to visit our library of resources to learn more about procurement topics and other industrial subjects.