Procurement Management – A Quick Guide for Small Manufacturers
Procurement management is more than making phone calls and arranging the purchase of materials. It is a vital part of any manufacturing company and having a strategic approach to it could bring about immense benefits.
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What is Procurement Management?
Procurement management is a strategic way of organizing a company’s purchases and supplier relationships.
It aids in keeping material costs down, avoiding delays or inconsistencies regarding material quality, preventing overstocking and stock-outs, and dealing with other supply chain related issues.
Even though purchasing is an important part of the process, procurement is not just the act of buying the goods.
Instead, it encompasses all the steps that are required to acquire the materials and have them ready to be used in production, including:
- specifying the company’s needs
- conducting market research
- supplier qualification
- negotiating and agreeing upon contractual obligations
- ordering
- making sure that suppliers are paid on time
- monitoring the delivery process
- reception and review of the goods
- supplier relationship and supplier performance management
- forecasting
- keeping records
As you can see, the procurement process can be a very complex thing, and therefore requires a high degree of industry knowledge as it becomes more advanced.
By understanding that, companies can start to develop and implement strategies that would lead to better business outcomes while minimizing the risk of fiscal damage due to poor procurement practices.
Why is Procurement Management important?
Too often companies neglect their procurement policies in favor of improving other areas such as production planning or sales.
However, a lack of a cohesive procurement management approach may result in inefficient and flat-out harmful purchasing practices.
In fact, procurement plays a critical part in the operational success of a company.
According to Business Insider, material costs make up around 70% of the average manufacturer’s total manufacturing costs.
Therefore, 70% of the average manufacturing company’s expenses are racked up in the procurement department.
That is a very large margin, especially considering that labor accounts for only 16% and energy for around 2% of the costs in an average manufacturing company.
For this reason, a well-defined and executed procurement strategy along with the implementation of a procurement software could be an effective driver of cost reduction in a manufacturing business.
7 vital steps of Procurement Management
In order not to complicate things further, it is a good idea to draw up a plan that would give a general outline of your procurement processes.
Especially if you do not have a designated procurement manager, these basic steps will help you orient yourself in creating and realizing your procurement plan with a focus on supplier qualification.
Since procurement is just one, albeit important, part of your manufacturing business, the procurement department should be in close contact with sales, finance, and production planning in determining what needs to be acquired and which vendors are best for your business.
1. Define your needs and create an initial budget
First of all, specify the procurable goods in as much detail as possible.
What are they and why are they needed? What are their specifications? How much of them is needed in a set time-frame? How much should they cost? How long can their lead time be? What level of quality do you accept and how do you measure it?
Any details you can add that could set some vendor’s merchandise above others would be beneficial.
When you have answered these questions, you have already begun budgeting by defining the products, their amounts, and how much you would be willing to spend on them.
Other than giving you a good idea of what you can and cannot afford, a procurement budget allows for better planning while making the procurement department responsible for their finances.
And there is no better incentive than being accountable.
Now, you can start researching vendors and their offers.
2. Identify potential suppliers
In order to find potential suppliers, you can go to trade shows, ask around in forums, use the yellow pages, or internet search engines.
Researching the market for potential suppliers should be done by considering not only your own finances and time but also criteria pertaining to the operations of the suppliers.
For example, you can assess your vendors’ financial stability, reliability, availability, location, customer service, quality, social and environmental responsibility, range of products, ability to fill your orders, and so forth.
All those aspects might have an effect on your production processes or your company image.
A simple checklist could be a very useful tool in this early part of the screening process.
However, what you should not do is browse cheap suppliers from faraway lands, exchange a few emails, and then sign a contract.
In fact, some suppliers could offer a much lower than average price initially and then find ways to up the price as you go along.
3. Create a supplier shortlist
After creating the initial list of potential suppliers, narrow it down even further.
For instance, you can do background checks online on search engines and business directories to check if the potential vendors have been truthful about their size and capabilities.
Furthermore, you can ask the vendors for their customer testimonials, or the contact information of some of their customers to see what their clients have to say about their strengths and weaknesses.
You should also find out how professionally the business is organized: ask what kind of management methodologies they have implemented, which certifications they have, how do they ensure the quality of their products, etc. Even photos and videos of their production floor will tell a lot about how the business is run.
In the end, you should think about what your ideal supplier would be like and sift your potential ones through that filter.
4. Request proposals and choose your suppliers
As the final phase, forward RFQs (requests for quotation) to the suppliers that have made it onto your shortlist in order to compare their bids in an actual purchasing situation.
If possible, visit them at their sites to make sure everything is looking good and well-organized – this is a great way to be confident in your choices.
Conversely, if you cannot perform site visits, you can hire a third-party quality assurance auditor that specializes in serving SME manufacturers.
Also, when you are at the close of this last stage of selecting your vendors, there can be a fair amount of gut feeling brought into the process.
Although the previous vetting should be done according to rigid, concrete assessment policies, when you have narrowed your options down to two or three best ones, you should pick the one you have got the best feeling about.
Do not be afraid to socialize with the upper-level management of your potential suppliers, down the road they could become some of your most important business partners.
Besides, an informal setting could be a great place to get better, more honest insight into the company.
After having your final pick, you should try to keep the other promising suppliers as second options in case something goes wrong with the chosen one.
Maintaining a supplier database would also come in handy in case you would like to analyze vendors per customer order.
For example, if you make to order and an order comes in with a longer than usual deadline, you can opt for a supplier with a longer lead time and lower price.
5. Negotiate contracts
Even if you are dealing with someone you trust very much, contracts need to be iron-clad.
The terms of the contract that you should discuss and specify with your supplier are:
- Product specifications
- Prices and payment terms
- Quality standards
- Total lead time
- Incoterms
- Copyrights
- Manufacturing site access
- Return policies
- Penalties
While these terms should be laid onto the table already in the previous stages, signing a contract will bind the parties to them.
6. Control purchase orders, deliveries, and payments
When a purchase requisition comes in from the internal consumers in your business, the procurement manager would need to approve it before creating the purchase order.
For that, they would need to determine whether there is a well-founded need for the products and if the purchase would fit in the procurement budget.
If a purchase requisition is approved, it will be turned into a PO – otherwise, it would be sent back to the requesting department with an explanation for the rejection.
In case you are already in a partnership with a supplier that could fulfill the order, the PO is forwarded to them. (Should the request be for materials your current vendors cannot provide, revert back to step number 1.)
Next, the procurement department has to make sure that the order has been received by the supplier, that all payments are processed within the specified timeframe, that the order is fulfilled within the predetermined conditions, i.e. on time, with the quantity and quality of the goods checked upon receiving them.
Additionally, procurement managers can use forecasting to improve ordering efficiency and to ensure that materials arrive in time for the start of the production process.
All data regarding the orders should be kept for accounting and auditing reasons, in order to assess the performance of both your company as well as the vendors.
Read about What Is Demand Forecasting and What Can MRP Software Do With It?
7. Evaluate supplier performance
Lastly, keeping and analyzing data about the performance of your suppliers gives you the opportunity to identify trends that could point to problems in their organization.
For this purpose, you should set some KPIs with which to assess each vendor, and create scorecards to easily track their results.
With this approach, you can spot and solve issues in your supply chain early on.
Read more about Supplier Performance Management.
Manual vs. digital Procurement Management
Sure, handling all that data is a daunting task.
In fact, using old fashioned pen-and-paper methods or even a spreadsheet makes it hard to account for all the moving parts in the procurement management equation, which could lead to an array of issues.
Invoices and other documentation could get lost in the massive amounts of files.
Time could be lost to tracking down vendors’ contact information, comparing quotations, reviewing contracts, etc.
Inefficient communication with both your vendors as well as between your departments could cause misunderstandings and inventory problems.
And opportunities for improvement could go unnoticed due to the unorganized and ineffectual practices.
In the meantime, companies you have considered your competitors are consistently polishing their procurement processes and thriving thanks to their approach to managing and analyzing data.
It is most likely that they are using a procurement software or an MRP system with an integrated procurement module.
Of course, this is purely hypothetical as SME manufacturers using advanced manufacturing software are still few and far between.
That means you could be the one that gets ahead from the bunch.
Procurement Management software benefits
Procurement management software centralizes all the important data a manufacturing company’s procurement department produces.
Vendor information, RFQs and purchase orders, forecasts, RMA orders, quality inspection results, critical on-hand, requirements, and procurement statistics – with a cloud-based manufacturing software, all this information can be accessed from anywhere with just a few clicks.
Consequently, procurement processes become more transparent and efficient, with some being automated almost entirely.
The centralized hub of information also comes with the huge benefit of becoming able to analyze data and create meaningful statistics in order to track and manage spending as well as supplier performance.
Most importantly, utilizing a procurement module of an MRP system allows you to expand your approach to procurement from tactical to strategic.
It enables you to shift your focus from the transactional aspects to the organizational side of procurement to bring more value to your business through strategic decision-making.
Conclusion
Procurement management is essentially a strategic way to approach purchasing.
Far from encompassing only the transactional aspect, procurement management includes everything from market research to data analysis and forecasting, assessing supplier performance to quality control.
Due to its complex nature, proper procurement management practices are almost unattainable with traditional methods like pen and paper or spreadsheets due to the lack of a centralized data hub.
This issue is solved today with the help of procurement software or MRP systems which help procurement (and all departments for that matter) to get better insight into their operations, to waste less time on tedious, repetitive tasks, and to focus on the strategic aspect of procurement management.
You may also like: How an MRP System Improves Purchase Planning
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