By Vinicius Brum, FALCONI partner
There is no longer any discussion about the relevance of the Purchasing departments for companies. In the past, there was a simple support process for the business’s core activities and eventually dispensable for operations in specific economic sectors.
However, the Purchasing sector has been gaining increasingly strategic relevance in companies, and has been the object of constant attention because it is directly related to the level of effectiveness of the organization and closely connected to its cost structure (it is estimated that just over 50 % of total company costs are generated by the purchasing department). Therefore, it has a major impact on the company’s market competitiveness.
The phenomenon of empowering Purchasing within companies also occurs because of the constant encouragement by managers to search for opportunities of continuous improvement for processes, and their integration in the production chain to reach increasingly bold goals and financial result.
That is where Procurement comes about as an evolution of the traditional purchasing role.
I have seen that the terms “Procurement” and “Purchasing” are commonly misunderstood, which keeps managers from identifying opportunities for improvement that exist with the evolution of the model, from focusing on appropriate initiatives to obtain them, and from gathering the organizational resources necessary to produce tangible improvements that become rapid and sustainable results that we can call “value generation.”
So what are the differences between “Purchasing” and “Procurement”?
The term Purchasing is about the process of acquiring goods and services for the company and managing the contracts resulting from this activity. Procurement, in turn, absorbs the Purchasing function and becomes strategic by including previous stages of involvement in the company’s strategic planning, commercial planning, and corporate project management. Procurement also considers post-Purchase stages, which include the company’s inventory management throughout the supply chain, participation in the production process, distribution, logistics, and relationships with clients and suppliers.
In summary, Purchasing is a relevant support process. Procurement is a indispensible Business function.
But do all companies need to evolve their Purchasing department into a Procurement function? Perhaps not. The best format can vary among companies, mainly due to the stage of life in which they are, the dynamics and level of competition in the sector in which they operate, and the intensity of the use of technology in the process. There are even cases of hybrid models being adapted that make selective use of characteristics from both formats with great success.
The following is a simplification of the main characteristics of a purchasing department evolving to Procurement, passing through an intermediate stage that I chose to call Strategic Sourcing, making use of this term that is widely used in the market. In this set up, it is possible to conclude that what characterizes this function in a company is how it views its purchases, which can be tactical, technical, or strategic:
Experience has shown that companies have dedicated efforts to build a model that advances properly to increase the effectiveness of purchasing management and its interaction with the other links in the supply chain, but does not associate with them an efficient expense management model or routines that promote the function to a strategic level within the organization where the supply strategy itself is defined!
In these circumstances we will have a Procurement function with a well-assembled structure of processes, people, routines and standards, but with limited performance and incapable of taking advantage of all possible improvement opportunities and the conversion into financial results.
Procurement that is capable of not only interacting but integrating the company supply chain, monitoring its dynamics, and converting all the intelligence generated from this management into actions that generate value for the business can be called Procurement Excellence, and is established on four key pillars that sustain the focus on increasing company profitability:
1 – Business Strategy
The CPO (Chief Procurement Officer) becomes a key player in the company’s strategic planning process. He is a provider of intelligence based on the information he obtains from the entire supply chain that he manages, especially predictive information that is a high value input for the process of analysis and strategic decision making. He supports business risk analysis, the design and execution of corporate projects (after all, they inevitably involve acquisition of materials or services), and above all, contributes to the innovation of products and processes. Since is interaction with the external environment fairly significant, he is a relevant eye for what happens outside the company that can be internalized to increase the business competitiveness. He is also involved in defining the company’s global sourcing strategy, which is based on the understanding of the complexity of the acquisition of each product and service required by the company for its operation, the cost of these acquisitions, and especially the impact of this input on the operation and supply risk for the business. The deployment of this global sourcing strategy into guidelines and targets for the entire supply chain will permeate the entire structure with planned improvement initiatives. In some more advanced processes, Procurement has been successfully involved in defining pricing policies, due to its knowledge of the cost structure of the company. I suggest that the reader consider the following:
Example of a simplified Sourcing matrix:
2 – Purchasing Management
The ordinary purchasing process is associated with a prior planning process that derives from the company’s global sourcing strategy. Managing purchases means (1) fully planning the acquisitions based on the understanding of short, medium, and long term demands and effect on inventories; (2) budgeting the good or service based not only on the understanding of its technical specifications but especially on the standardized purchasing modalities and channels for its category, defined expense goals, supply deadlines and inventory rules; (3) analyze and negotiate budgets received involving managers from various areas organized in a matrix; (4) to acquire the good or service, and finally, (5) to manage the contracts considering defined relationship parameters.
To have effective purchasing dynamics, some aspects should be evaluated:
Examples of improvement targets for the purchase of an item considering the opportunities identified in the purchase modality.
3 – Expense Management
Corporate expense management is often a area neglected by purchasing departments. Here we are talking about management, not just control. Unlike following an existing expense budget, a Procurement department should be a leader to its elaboration by incorporating a percentage of the captured expense reduction gaps or optimization of the consumption of a good previously identified by the company’s supply chain to the defined amounts. An expense budget that focuses on results brings improvement goals to your accounts that will require increasing the company’s efficiency with regard to corporate spending. Zero Base Budgeting or Expense Value Management are effective methods to improve the company’s financial performance without impairing the quality of consumption required for operations. Equally relevant is the establishment of a structure for deploying these expense improvement goals for the entire structure that includes those who spend, who buy, and who manage the department where the expenditure is located, which will also allow systematic monitoring of the results. This cross-control ensures the healthy means of reaching the targets, it allows the dissemination of new knowledge produced to achieve them, and prevents the usual budget offsets within the departments that, at the end of the day, reach the goal but do not bring no financial result to the company.
Regarding the quality of a company’s expense management, I suggest the following questions?
4 – Supply Chain Management
Perhaps this pillar is what in fact differentiates a Procurement function of excellence from the other traditional purchasing functions. The challenge of monitoring key production, inventory, distribution, and logistics indicators not only allows for better planning of the company’s acquisitions, but also contributes to improving the outcome of these indicators. Optimization of input and raw material consumption, reduction of inventory levels and losses, cost reduction with revision of models and distribution routes, increase of OTIF in logistics, and other possible outcomes directly affect the effectiveness of the supply chain and the generation of new money for the company.
Some questions may allow us to reflect on the degree of management that we have in the supply chain by the purchasing department:
In addition to the aforementioned qualified pillars, we must not forget the process structure that must exist to support the execution of the assignments that are the focus of the Procurement function. Processes that relate to vendor, risk, channel, market monitoring, and S&OP management will support Procurement’s final activities, and will help maintain its level of efficiency and its ability to generate results.
Another aspect of great relevance that is decisive for achieving much higher levels of procedural effectiveness, reduction of expenses, and increase in the quality of the services provided by the department is the degree to which technological solutions contribute to the process in all its stages. The digital transformation of the Procurement department in companies has been a critical factor for success in achieving the strategic objectives of the company and the defined sourcing strategy for the area. Powerful artificial intelligence solutions, cognitive analytics, predictive analytics, global marketplaces, mobile apps replacing traditional systems, and the use of blockchains for validating purchasing contracts are examples of technologies that are already available that are delivering speed, assertiveness, and increased reliability to processes and deliveries. Every day, new disruptive solutions are created, and quickly incorporating them into the process is something decisive for the speed and quality in achieving the expected results of Procurement Excellence and its long-term maintenance.