This article will be useful for CEOs and CFOs of companies with the revenue of more than 1 billion rubles, in which the share of procurement costs exceeds 20%.
Can you answer the following three questions?:
- How efficient is procurement in your company?
- What value does procurement bring to your company?
- Can procurement costs be decreased by 25-30% without losing quality and volumes?
If you can’t answer these questions right away, then probably your procurement is not 100% efficient.
Let’s go through the reasons preventing the Procurement department from becoming an effective tool for increasing the company’s profit.
I have analyzed 125 interviews with CEO’s, CFO’s, CPO’s, heads of functional departments and business units, dealing with procurement. And I would like to share the reasons why Procurement departments fail to buy goods and services of the required quality faster and at a lower cost.
Reason 1. Procurement departmentis an ordinary technical operation
Procurement functionsas a purely technical operation working according to established rules, ensuring document flow and preventing corruption.
Therefore, Procurement gets caught up in inefficient, routine tasks, not translating opportunities into actual profit growth for the company.
The latest poll held among 65 procurement managers demonstrated that they experience excessive workload, which prevents them from concentrating on key projects (implementation of import phase-out projects, electronic auctions etc.).
Though in reality →
Procurement is a tool which makes a company more competitive, implements new solutions and develops suppliers, brings measurable results in the form of savings and service improvement.
Reason 2. There is no separation between strategic and operational procurement
Procurement specialists are responsible for the whole process – from placing a purchase order to the execution of payment.
One and the same person is responsible for finding suppliers, holding a tender, concluding a contract for office supplies, and then placing ongoing orders. It is advisable to separate these two areas of procurement, as this will help to focus on strategic issues.
Reason 3. Goals and KPIs are not set for the Procurement department employees
Procurement service has a direct impact on the company’s financial performance – EBITDA and net income.
However, remuneration of the staff is often not dependent on the results of their work, or this relationship is purely formal and non-obvious. The employees are not motivated to achieve outstanding results and as a result they are focusing on the process.
Reason 4. Procurement service is considered a cost center in the company
To reduce the costs, salaries are set below the market level; attempts are made to save onpersonnel numbers.
As a result, poorly motivated Procurement staff perform functions that require strategic thinking and analytical skills.
Lacking motivation and proper expertise, they do not obtain any significant results and carry out projects for the sake of appearance.
Reason 5. The different responsibilities of Procurement and other departments areindistinguishable and not formalized
Subdivisions do not have detailed guidelines for action in situations when it is necessary to purchase goods and services.
There is no understanding of who should do what and in what order. Therefore, the employees are guided by the historically established practice and habits.
Reason 6. Other departments are purchasing goods and services at their own discretion
Sometimes, because of being overloaded with the core business tasks or due to the other reasons, the Procurement department is not involved in the search, selection and approval of suppliers for some indirect categories, like marketing, logistics or IT. This automatically raises the risk of cost increase.
The initiator is out of control spending finances of the company being guided solely by his/her own vision. The initiators do not have time and professional skills to select the best supplier in price & quality.
The Procurement department is often not involved in the project at the initial stage, and joins only at the stage of tender results’ approval or contract negotiation.
This is not rightas theProcurement department can help shape technical assignments, breakdown the cost of project components (value of goods, delivery, storage, ownership), and reduce the cost of each component.
Even if Procurement staff do not have expertise in the category, they must be involved in the selection of suppliers and contract preparation. Itcan improve the quality of decision-making and increase the level of cost control.
Reason 7. Low qualification of Procurement department employees, insufficient expertise in procurement categories
In this case, Procurement department employees follow patterned solutions, using sheer force at the stage of negotiations and selection of suppliers.
There is no creativity, no development of win-win solutions in cooperation with suppliers. Employees may delay the settlingof invoices or force the supplier to dump, threatening to withdraw the order.
In addition, there is no understanding of specific features of the purchased goods and services, and the vendors’ market. For example, in the procurement of services in the fields of marketing, IT consulting and outsourcing.
Reason 8. Procurement does not play a significant rolein the development of the company.
The following hierarchy of functions is usually established incompanies in terms of their significance to the bottom-line figures:
- Sales, Marketing, Production, Logistics
- Finances, HR, IT
- and only then finally comes Procurement…
I have rarely met heads of Procurement departments, who are part of the management committee or the board of directors.
Accordingly, the effect of the Procurement department on the company’s strategy is minimal, although the results of their work have a direct impact on the company’s bottom line.
Procurement department employees ensure the document flow. While the basic rules of the game are determined by the purchasing requests’ initiators.
The initiators conduct procurement on their own, justifying this by urgency, complexity, lack of alternatives or criticalness for business. At the same time, presenting the Procurement department with a ‘fait accompli’ and requiring only a signature in the approvals sheet to the contract, to create the appearance of complying with the procedure.
But the procedure IS NOT COMPLIED WITH!
And here comes the other side of the story →
Reason 9. Procurement – internal monopolists
Despite mistakes, failures and poor service, corporate policies require that initiators contact Procurement department for the search and selection of suppliers.
Because of this, procurement specialists are not motivated to achieve better results and to provide a high level of service to internal customers (Production, IT, Marketing, Administrative department). Why? The internal customerwill have to come to the Procurement departmentregardless of the outcome.
Reason 10. Procurement departments rarely use procurement and optimization automation tools
According to Gartner report of 2015 (“Review of Strategic Sourcing Application Suites”) the market of tools like e-sourcing (optimization and automation of sourcing process), contract management, supplier base management is growing, but such global tools are rarely used in Russia.
In Russia, local electronic trading platforms (Fabrikant, B2B Center, etc.) are popular. This is partly a result of the legislative requirement regarding public procurement, which makes up a large part of the market.
Without the use of modern IT tools, it is not possible to achieve spend visibilityand carry out analysis, necessary for strategic decision-making.
As a result, companies lose dozens of percent of potential savings, spending 20-40% more human resources on the procurement process.
Reason 11. The financial function controls the initiators in terms of budget execution
At the same time, procurement specialists are not involved at the stage of its formation.
Involving a procurement service in the budgeting process helps making the budget more accurate and set realistic goals regarding savings, services and working capital. This allows to considerably increase the profitability of the company.
Reason 12. Procurement department spends too much time on the approval of tender results and contracts
The number of the approving parties in some companies can be up to 10-12 people for the ordinary procurement categories.
In such cases, Procurement has to operate in the emergency mode, in order to satisfy internal customers within the designated time limits.
Often, when the market situation changes and the supplier is not willing to work according to the initially agreed conditions anymore the process starts again. The process of selection and approval of suppliers can be as long as 7 – 9 months.
The production process is suffering, the company spends more than it should have, and the motivation of employees is decreasing.
Which of the 12 reasons characterize the situation in your company? And what should be done about it?
Next time, I will offer you step by step instructions aimed at improving the efficiency of procurement operations.
If recommendations on improving procurement process are required urgently, please contact us directly.