What is procurement? A comprehensive guide
Procurement is the process of sourcing, purchasing, receiving, and inspecting all of the goods and services your business needs to operate – everything from raw manufacturing materials to software to office supplies.
The procurement function is often taken for granted – until something impedes it. Responsible for keeping a company’s wheels moving, procurement ensures that the right materials and supplies are on hand when needed. Operational in focus, procurement hasn’t typically been considered a strategic discipline – until now.
Cost containment continues to be a priority, particularly given inflation and the rising cost of supplies. However, cost control is only one of the pressures bearing down on procurement today. Squeezed between the threat of supply shortages and the expense of stocking extra inventory, procurement must somehow support supply chain resiliency, even when climate events or other disruptions impede delivery. The need to procure sustainable goods and comply with expanding regulatory requirements means companies must add an extra layer of data collection and scrutiny to their sourcing processes. Add geopolitical pressures and risk to the equation – with resulting material scarcity – and procurement is suddenly at the eye of the storm.
Today, the chief procurement officer (CPO) role is no longer a back-office function chiefly concerned with cost reduction and compliance.
Procurement definition
Procurement is a vital business function, responsible for securing all the goods and services needed by an organization. For manufacturing companies, supply availability is particularly critical as it’s impossible to create finished goods without the necessary materials. Procurement departments must liaise with internal stakeholders to gather their forecasts and requirements, and then source the best suppliers at the best cost.
Thanks to papyrus scrolls that record supply and transportation details, the procurement function can be traced back to the construction of the pyramids. Over time, procurement has undergone numerous transformations – evolving from a simple record-keeping task to a discipline that requires strategic thinking and negotiation.
During the Industrial Revolution, procurement gained importance as burgeoning manufacturing operations needed to source, purchase, and transport materials. In the mid-20th century, when the economy was booming, opportunity and competitive bidding helped redefine the practice again. Individuals were trained in various aspects of supply chain management, gaining professional status. Procurement became regarded as a management function rather than a clerical one.
Today, procurement is again going through a dramatic transformation – arguably as significant as any of the shifts in the past.
Why is procurement so important in business?
What has been a back-office management function is now center stage – a strategic partner in complex C-suite strategy decisions.
Procurement also controls a big slice of a company’s costs – 40% to 80% according to some estimates – so it is essential for budgetary considerations. But effective procurement practices also enhance risk assessment, supplier oversight, and the potential for value creation within the supply chain.
Here are some key ways procurement is important in business:
Cost savings: Procurement is the first line of defense for reducing cost and stabilizing cash flow in a business, affecting profit margins and the bottom line. Competitive product sourcing and contract negotiations can deliver significant cost savings. In addition, the streamlining of purchasing processes can have a real impact on financial results.
Quality: Procuring the right raw materials at the right time is crucial for manufacturing high-quality products. Quality encompasses every aspect of the procurement process, as the choice of materials and suppliers directly impacts product and service quality. Prioritizing quality is key to mitigating risks related to reputation, production, and legal concerns.
Goal alignment: Strategic sourcing aligns procurement purchases with a company’s goals. For example, if enhancing agility and resilience is a core value of your business, tools to meet these targets should be embedded in your procurement process. A detailed analysis of the market as well as your internal requirements can help identify suppliers best positioned to meet your needs.
Risk mitigation: Risk can occur at every step of the procurement process – from inaccurate needs analysis to supplier delivery issues. Additional risk comes from ineffective responses to compliance obligations, unclear ethical standards, weather-related incidents, global disruptions, and similar challenges. Today’s technology-powered procurement processes can provide the visibility needed to proactively identify, evaluate, and mitigate risks.
Sustainability and ethics: The procurement team must align with their company’s values around environmental impact, ethical sourcing, environmental, social, and governance (ESG) commitments, and more to ensure compliance and protect against risk, reputational damage, and unnecessary expense. Managing sustainable sourcing and compliance is a key responsibility of the procurement function.
Types of procurement management
There are four main types of procurement:
- Direct procurement: This includes procuring anything that directly supports the production of the goods a company sells, including raw materials, components, parts, services, and wholesale items. These all have an impact upon revenue, growth, and reputation, so supplier relationships are crucial in direct procurement.
- Indirect procurement: Anything not directly related to production, including materials, goods, and services for internal use and daily business operations, falls under indirect procurement. This includes items such as office supplies, utilities, and travel expenses.
- Goods procurement: Both direct and indirect procurement can fall under goods procurement, which includes procuring any tangible object, whether finished or unfinished – everything from equipment to raw materials to office chairs.
- Services procurement: Professional, people-based services such as consultancies, agencies, law firms, outsourced IT, security services, software as a service (SaaS) delivery, and facilities repair all fall under services procurement. These are necessary for efficient workflow and filling in any workforce gaps.
12 steps in the procurement process
While the procurement process can vary from company to company, it generally includes the following 12 steps:
1. Identify needs: The first step of any procurement process is identifying the specific materials, products, software, or services needed due to shortages, new projects, or regular operational requirements. This stage includes demand planning and forecasting.
2. Source suppliers: Researching and assessing the best potential suppliers for your business needs happens early in the procurement process. Developing alternative suppliers can help with risk management by giving you options in case of shortages or disruptions.
3. Submit a purchase requisition: Submitting a purchase request with specifications such as price, time frame, and quantity for internal review and approval triggers the purchasing process.
4. Evaluate and select suppliers: Choosing the best supplier through a competitive bidding process such as putting out a request for proposal (RFP), request for quote (RFQ), e-auctions, or “three bids and a buy” involves assessing vendors on cost as well as quality, reputation, reliability, speed, and sustainability.
5. Negotiate price and terms: After a supplier has been selected, the procurement team negotiates various purchase terms, including price, quantity, delivery timelines, and payment conditions.
6. Create a purchase order (PO): Once a supplier has been chosen and the terms finalized, the company issues a formal PO to that supplier detailing the exact goods, services, and terms included in the order.
7. Receive goods and check quality: When the goods have been received, the next step is to ensure that their quality and quantity match what was ordered by carefully inspecting them for damage or errors.
8. Process invoice and fulfill payment terms: Upon confirming a delivery of goods has passed the quantity and quality check, the supplier’s invoice can be processed through accounts payable (AP) to ensure timely payment. Depending on the terms of the contract, early-payment discounts may apply, and a variety of payment methods may be used.
9. Establish and manage good supplier relationships: It’s strategic for the procurement team to build positive ongoing relationships with suppliers. The benefits include better supplier performance, terms, discounts, collaboration, and reliability.
10. Manage contracts: Procurement contract management covers monitoring contracts, ensuring compliance, and renegotiating terms as needed. It’s important for identifying and addressing potential issues, to ensure that negotiated savings are being realized – and reaching your bottom line.
11. Manage risk: Part of what makes the procurement team so integral to an organization is their role in risk management. It is essential to anticipate and manage potential problems such as shortages, supply chain disruptions, and implementing measures to mitigate them. Staying on top of regulatory and requirements – and spotting any threat of noncompliance – is also an essential component of managing risk.
12. Review and analyze: This final step in the procurement process is ongoing. Reviewing and analyzing procurement KPIs to identify gaps and uncover new opportunities for savings and risk reduction plays a key role in business success.
These 12 steps are commonly thought of as the procurement lifecycle – as the tasks overlap and the process is continuous. A successful procurement lifecycle requires integration with other key business areas, such as budgeting, forecasting, and supply chain management.
Procurement vs. purchasing and other related workflows
Many organizations use the terms “procurement,” “purchasing,” “sourcing,” and “supply chain management” interchangeably, but they are not the same thing. Here’s how they differ:
Procurement vs. purchasing Purchasing is the part of the procurement process that focuses on transactions. It includes negotiating, ordering products, receiving goods and services, and submitting payments. While purchasing is a crucial part of procurement, the overall procurement process is much broader.
Procurement vs. sourcing Sourcing is an essential early-stage part of the overall procurement process, covering identifying needs, finding suppliers, issuing purchase requests, evaluating and selecting suppliers, and negotiating prices and terms. The sourcing stage is where strong supplier relationships can be built.
Procurement vs. supply chain management Procurement is the part of the overall supply chain management process that focuses on acquiring the goods and services needed to manufacture products and maintain internal operations. Procurement dynamically interacts with other supply chain segments, such as logistics, inventory management, and demand planning.
Sustainable procurement management
Sustainable procurement, which integrates ESG criteria into procurement practices and decision-making, isn’t just a procurement trend; it’s a critical consideration.
Sustainable procurement challenges include supply chain complexity and transparency, measuring performance, ensuring compliance with standards, and building capacity. It’s already hard to source materials with low emissions intensity, such as green steel and recycled aluminum and plastic, and it will only get harder. Plus, customers increasingly want to purchase from brands that can prove their sustainable bona fides, which makes sustainable procurement integral for business.
Take just one aspect of sustainable procurement – reducing supply chain emissions. The process can take years, so starting the transition now will set businesses up to be more competitive and resilient in the future.
Here are a few examples of sustainable procurement:
Green sourcing or green procurement: Green sourcing involves strategically purchasing products and services with a smaller environmental impact. Green procurement includes eliminating single-use plastics and other disposable items, incorporating recycled or upcycled raw materials, and adopting clean technology or fuel. Green procurement can reduce production costs, contribute to your company's corporate social responsibility initiatives, and even boost sales by appealing to environmentally-conscious consumers.
Ethically-sourced materials: Sustainable procurement relies upon ethical sourcing. This means purchasing products from companies that guarantee a living wage, offer good working conditions, don’t engage in child labor, make positive contributions to the communities they’re part of, and meet other ethical standards.
Reduced carbon footprint and energy consumption: Lowering your company’s carbon emissions and energy consumption isn’t just about reducing the emissions created directly from your day-to-day operations from factories and transport; it’s also about reducing emissions all along your supply chain.
AI in procurement: Smarter automation and insights
AI in procurement can automate and streamline complex tasks such as spend analysis, contract management, strategic sourcing, and compliance management. It can also support smarter analytics and decision making; help you spot opportunities, potential cost savings, and anomalies; and make it easier to identify new suppliers – while helping to eliminate procurement fraud and reduce errors.
AI can also be used to create business value by deconstructing what the business really needs, challenging established processes, leveraging knowledge from new points of reference, and designing the supply chain in new and different ways.
Generative AI also has huge potential for procurement. Its ability to automate tasks, provide insights, and improve transparency supports efficiency, productivity, and better supplier selection and management. Generative AI can also help mitigate risk and reduce spend.
Using AI to support procurement in making better decisions, identifying new opportunities, automating tasks, and improving operational efficiency means your procurement team can focus on where their human expertise is most valuable.
What to look for in procurement software
When selecting procurement software, prioritize tools that not only digitize and streamline your procurement processes but also enhance your strategic decision-making. Ideal software should boast robust cloud-based infrastructure and artificial intelligence capabilities, simplifying complex procurement tasks. Essential features include seamless integration with existing financial and supply chain systems, user-friendly interfaces, and comprehensive analytics for in-depth spend analysis.
Opt for solutions that provide real-time insights and reporting, facilitating proactive management of procurement activities. Ensure the software is scalable, capable of evolving with your business, and contributes actively to your company’s growth trajectory.
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