Procurement / Purchasing

Procurement is the process by which a business obtains the external goods and services it needs to pursue its core activities and serve its customers. It has been determined that, due to the increasing degree of specialization and outsourcing of non-core activities, the companys on average today buy 60% of their total output as pre-products and services. This underlines the vital importance of a tight procurement operation, as a business will not survive if its price of procurement prevents a profit being made on selling the actual product. An average reduction in purchase cost of e.g. 12% will flow directly through the P/L account resulting in a 7% (12% x 60%) in profit margin improvement. Moreover, vital parts of a company's product quality and delivery reliability depend upon their supplier performance.

Correspondingly, in recent years, Supply Chain Management (S.C.M.) in general and procurement in particular have increased considerably in sophistication. The traditional emphasis on the best price/performance ratio still reigns, but complementary to this, further topics have gained in importance:
  • In particular for critical supplies, the careful consideration of the supply risk is an important factor when choosing one or more suppliers and shaping the relationship with them. Methods applied here may include vendor analysis, relationship management, procurement strategies and general risk management techniques.
  • "Naked" price considerations have given way to a consideration of Total Cost of Ownership (TCO).
  • The reduction of total cost at a constant level of supplier performance is the ultimate goal of the procurement function. Going beyond unit prices through a prioritization and reconsideration of planned purchases may play an important role in this. Supportive activities may include: overall spend analysis, design-to-cost, target costing and specification push-back
  • Companies are increasingly held responsible for the actions and behavior of their suppliers, as the public increasingly demands morally and legally just behavior. This has led to a field known as Corporate Social Responsibility (CSR) gaining much momentum. Many companies meanwhile employ dedicated CSR officers who are in an ongoing dialogue with suppliers to enforce an ethically high standard of production and supply.
  • Procurement may play an important role in relaying information about important supply market developments back to the production departments. These include in particular the emergence of innovative techniques and methods or new players .
  • Blogs in which consumer electronics are taken apart and their cost of production guestimated have inspired similar undertakings in professional procurement. By reverse-engineering sample products, and establishing a bill-of-materials, complemented by R&D and further mark-ups, procurement professionals can establish a benchmark price point based on production costs. This can be used in supplier price negotiations.
  • The continuing digitization/re-engineering of traditional corporate processes implies a need for procurement to inform itself of these initiatives, alternative implementation options and supplier options. This needs to be done at an early stage, before the concerned departments themselves go through the transformation process.

Strategic Procurement

The determination of the optimal procurement strategy regularly starts from a consideration of the position that one occupies on the impact/power matrix (see figure).
Classical procurement
            strategy matrix with power on the horizontal and impact on the vertical axis. Strategic procurement is
            the quadrant where power is with the vendor and impact is high.
Whereas the other fields are the common tools of the trade of procurement, the area of strategic procurement often represents a special challenge. In this quadrant, the impact of a loss of supply upon the customer profitability is high, due to the goods/services e.g. being essential for the creation/delivery of the customer's product. As however all power lies with the vendor, typically because the vendor holds a monopoly(-like) position in the supply market, this situation represents a particular dilemma for the procurer. With the category being essential for the company (high profitability impact), it is vital to obtain good pricing and include contract clauses which lower supply risk despite the balance of power lying with the vendor. At the same time, as the balance of power lies with the vendor.

This dilemma may be addressed by means such as:
  • A reinforcement of the social component by e.g. developing the relationship with the supplier through information exchange and/or mutual support.
  • Increasing one's attractiveness as a customer and becoming a preferred customer. This approach requires a good understanding and consideration of the vendor's interests and priorities.

Addressable Spend Analysis

Managing procurement sourcing is an ongoing struggle to commit limited resources to the most critical projects. A systematic analysis that identifies these priorities is needed. Addressable spend analysis can be such an approach. Addressable spend is obtained through subtracting personnel cost, sunk cost and commited spend from
            this period's (e.g. financial year) total spend. The method starts from the total corporate spend whereby personnel costs are not considered, as its management typically lies outside procurement. Similarly other costs not managed by procurement or spend already paid out or committed are excluded. What remains is the body of procurement addressable spend.

The addressable spend consists of that part of the budget foreseen for certain investments/running costs (CapEx/OpEx) and procurement needs to understand at least the big tickets in this area e.g. renewal of expiring contracts. The gold standard is where procurement is aware of the single positions as the budget is being created.

Artificial Procurement Intelligence

To date (early 2017), there is not much in the way of professional A.I. procurement software available on the market, with the possible exception of spend analysis s/w. There is however extensive research & development being carried out in this field. A number of consultancy firms apply internally-developed experimental A.I. systems to serve their clients. This comes as no great surprise, as virtually all core processes of procurement, with the exception of face-to-face negotiations, can benefit from machine learning initiatives:
  • Demand planning may profit from an analysis of year-on-year purchasing. As certain demand has shown peaks and valleys in the past depending on e.g. national bank holidays, the seasons or other, demand experience points may be used to discover correlations, and thereby project demand in the near future. For demand coming from business departments, A.I. may prove useful in identifying volumes that can be consolidated and/or individual price-drivers, which should be investigated and possibly challenged further.
    At the level of demand consolidation, Natural Language Processing (NLP) techniques can be of assistance, by identifying demands constituting similar spend categories that are however described differently.
  • Sourcing gathers business supply demand, consolidates it, identifies potential suppliers, carries out Requests for Information/Quote/Proposal (RfXs) and negotiates terms with the selected supplier(s). Whereas the first two tasks are discussed above, the identification of (potential) suppliers can easily be done well by A.I. systems applying NLP techniques. The technology's strengths become apparent when searching for new suppliers, and systematically evaluating the various suppliers regarding their ability and risks. Although automated creation of RfXs is not yet commercially available and will likely not be for some years to come, training a system on RfXs is an option. A system thus trained may well recognize RfXs that are incomplete, and similarly, offers received can be checked against the original RfX specification.
  • Contract and Catalogue Management is a task already automated today. A collection of valid and performant sourcing contracts is a valuable asset, and the most concrete output of a well-functioning sourcing team. Challenges often occur when the business plans to order, and the relevant contract(s)/catalogue entries are overlooked/not identified. Artificial Procurement Intelligence systems which go beyond the usual keyword-search, go a long way towards identifying and proposing existing contracts, and may fulfill business supply needs.
  • Order-to-Pay is today considered standardized, and is often outsourced. It is also the part of the procurement process where fraud is most likely to occur. If past fraudulent procurement cases have been documented, machine learning systems can be trained to raise red flags/send alerts to prevent suspect proceedings.
    Beyond this, contract-identification can be used for fast and direct issuance of Purchase Orders, thus decreasing the load on the procurement department, and speeding up the ordering process. Automated payment on invoice receipt is possible and, as above, suspicious proceedings can automatically be detected and escalated to the compliance office/area manager.
  • Supplier Management is an often overlooked and thus neglected area of procurement. Nevertheless, a supplier's delivery practice is the best predictor of future performance, and should be recorded. An automated system able to identify key individuals with the ability to judge such performance can be of great value. In addition an automated risk evaluation of suppliers for essential supplies may prove valuable in times of economic unrest.
Selected Experience
Spend Analysis
Big Data
Telco Corporate Spend Analysis incl. Purchase-Order and Contract Portfolios' Analysis
SEE 2015
Automated consolidation system for cost reduction project reporting
SEE 2015
Updating of corporate processes and procurement organization
SEE 2015
Chief Strategy Officer;
Franco-German procurement powerhouse
© 2017 Dr. Eduard H. van Kleef