Basics of Procurement Management

Chapter One:

Procurement Scope and Development

1.1. Introduction

All organisations need inputs of goods and services from external suppliers or vendors. The
goods and services may include raw materials, office equipment, services and supplies, furniture
and facilities, IT and technical equipment & support, light, power, stationary,
telecommunications, travel related services, etc. Therefore, to acquire goods & services,
procurement is the basic common business function to all types of organizations. This function is
so basic because no business can operate without it.

Procurement is the biggest spending department of any organization. Purchased materials

consume over half of a manufacturing firm’s sales revenue. An analysis of financial statements
of a large number of private and public sector organizations indicated that materials account for
nearly 60% of the total expenditures. Thus, the importance of procurement management lies in
the fact that any significant contribution made in reducing materials cost and wastage will go a
long way in improving the profitability and rate of return on investment and the profit potential
of effective management of the procurement activities is enormous compared with other practical
management alternatives.

1.2. Defining procurement and purchasing?

More than often, when dealing with the process of acquiring goods or services, two terms are
interchangeably used, although their meaning and function is not identical; the terms
“Procurement” and “Purchasing”. In the following, we will try to make clear what each of these
terms is about, what is their difference and relationship.

Defining „„Procurement‟‟

 Procurement is the process of identifying, shortlisting, selecting, and acquiring suitable goods
or services or works from a third-party vendor through a direct purchase, competitive bidding, or
tendering process while ensuring timely delivery of the right quality and quantity.

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Basics of Procurement Management

 Procurement can be defined as “the business management function that ensures identification,
sourcing, access and management of the external resources that an organisation needs or may
need to fulfill its strategic objectives."

 Procurement refers to techniques, structured methods, and means used to streamline an

organization’s procurement process and achieve desired results while saving cost, reducing time,
and building win-win supplier relationships.

 Procurement exists to explore supply market opportunities and to implement resourcing

strategies that deliver the best possible supply outcome to the organisation, its stakeholders and
customers.

 Procurement applies the science and art of external resource and supply management through
a body of knowledge interpreted by competent practitioners and professionals.

 Procurement manages supply chain risks through the effective negotiation of contracts, cost
and price models, quality and other essential supply characteristics.

 It is the process of acquiring goods and services by purchasing, renting, or leasing.

Defining „„purchasing‟‟

 The purchasing process is a sub-process of procurement and focuses on the transactional phase
associated with buying products and services. The key focus of purchasing is being able to
achieve short term goals that include quantity, costs and timing.

 Purchasing is parts of procurement activity concerned with obtaining of materials and services
of the right quality, in the right quantity, at the right time, at the right price, from the right
supplier, with the right service to be delivered at the right place.

 Right quality: it is the satisfaction and suitability of materials for the intended
function.
 Right quantity: refers to the quantity adequate enough to serve the intended purpose.

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Basics of Procurement Management

 Right Time: is making the materials available when it is required. It is exerting

managerial effort to timely delivery of materials. fail to deliver a given materials on
time will result undesirable consequences such as:-
 Interruption of production
 increasing of operational cost e.g. wage
 Temporary lay off
 Bankruptcy (insolvency)
 decline in profit & sale
 laying behind planning horizon
 shift of customer to competitors, and
 loss of market share, etc
 Right price: is buying required quality and quantity material with maximum possible
lowest price.
 Right source (supplier): It is looking for right supplier that means eligible and reputable
supplier.
1.3. Difference & relationships between Purchasing & procurement

The difference between purchasing and procurement are discussed in the upcoming points:

 Purchasing is a tactical process, whereas procurement is a strategic one.

 Purchasing is a direct process involving buying the commodity for price. As against
procurement involves all the steps that lead to the obtaining of commodity, whether it is taken
before, during or after the purchase.

 Purchasing focuses on short-term goals such as fulfilling the five rights in a transaction (right
quality, right quantity, right cost/price, right time, and right supplier), whereas procurement
management focuses on strategic, long-term goals like gaining a competitive advantage or
aligning itself with corporate strategy or goals.

 While purchasing stresses on making the transactions efficient, and do not lay much emphasis
on developing a relationship with suppliers/vendors, procurement is a bit opposite. Procurement

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Basics of Procurement Management

focuses on developing a long and strong relationship with the suppliers. So, we can say that
purchasing has a transactional focus, but procurement has a relational focus.

 Purchasing is concerned with buying the goods or other stuff for a price. In contrast,
procurement is associated with acquiring the goods or services, machines, supplies, equipment
whether on rent, lease or contract basis.

 In a purchase, more weightage is given to item’s price than its value. However, in case of
procurement the value of the item is given more importance in comparison to its price.

 Purchasing is a reactive process, in the sense first of all the requirement of goods is recognized
and then the suppliers are invited to bid. As against in the procurement process, first of all, the
market is surveyed to spot the potential suppliers and shortlisted suppliers is prepared, and then
the internal needs are identified after which the quotation is requested.

Purchasing is concerned with buying the goods or other stuff for a price. In contrast,
procurement is associated with acquiring the goods or services, machines, supplies, equipment
whether on rent, lease or contract basis.

In a purchase, more weightage is given to item’s price than its value. However, in case of
procurement the value of the item is given more importance in comparison to its price.

Purchasing is transactional focus and involves the following tasks:

 Co-ordination with user department to identify purchase need

 Discussion with sales representatives

 Identification of potential suppliers

 Conduct of market studies for important materials

 Negotiation with potential suppliers

 Analyzes proposals

 Administration of contracts and resolution of related problems

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Basics of Procurement Management

 Issuance of purchase orders

 Maintenance of a variety purchasing records

 In general, Procurement is a relational focus and performs the following activities:

In general, Procurement is a relational focus and performs the following activities:

 Participation in the development of material and service requirements and their

specification

 Conduct of materials studies and management value analysis activities

 Conduct more extensive materials market studies

 Conduct of all purchasing function activities

 Management of supplier quality

 Purchase of inbound transportation

 Management of investment recovery activities (salvage or surplus and scrap)

 In essence, procurement tends to be broader and more proactive, with some focus on strategic
matters, as compared with the typical implementation of the purchasing process.

 Both terms are similar in acquiring of goods, services and supplies

1.4. Objective of procurement

A well-known statement of the objectives of purchasing is: to acquire the right quality of
material, at the right time, in the right quantity, from the right source, at the right price. This
statement is criticized by some as being rather superficial and simplistic. This is undoubtedly a
valid comment, though the definition does provide a practical starting point for discussion. For
present purposes, the following broad statement of objectives is suggested

The general objective of all procurement is obtaining the right materials (meeting quality
requirements) in the right quantity, at the right time and from the source, and at the right price.

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Basics of Procurement Management

The specific objectives of procurement

 Provide Uninterrupted Flow of Materials, Supplies, and Services Required to Support

Company Operations.

 To Buy Competitively

 To Buy Wisely

 To keep Inventory Investment and Inventory Losses at a Practical minimum

 Maintain Adequate Quality Standards

 Develop Competent Vendor

 Improve the Organization’s Competitive Position

 Achieve Harmonious, Productive Working Relationships with Other Departments Within

the Organization.

 Accomplish the Purchasing Objectives at the Lowest Possible Level of Administrative

Costs.

1.5. Importance of procurement

 Keep the operations running smoothly by ensuring a reliable source of supply
 It impacts customer service and customer satisfaction
 Help to gain important information about new technologies.
 Support potential new materials or services, new sources of supply and changes in
market conditions.
 To determine the organization requirement

Procurement as organizational buying

Organisational buyers have been defined as: those buyers of goods and services for the specific
purpose of industrial or agricultural production or for use in the operation or conduct of a plant,
business, institution, profession or service.

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Basics of Procurement Management

Organisation buying; is the decision-making process by which formal organizations establish the
need for purchased products and services and identify, evaluate and choose among alternative
brands and suppliers.

• To classify procurement we may have different basis such as;

• The purposes (resale vs. consumption/transformation)

• The agent/stakeholder (government Vs. industrial)

• The scope (domestic Vs. foreign procurement)

The purposes (resale vs. consumption/transformation)

A. Purchasing for resale is generally associated with retailers and wholesalers.

Retailers and wholesalers are buy goods and services for the purpose of selling not consumption
or not to change it into other products through farther production process or assembly.

B. Purchasing for consumption/conversion. This is a procurement made for the purpose of

self-consumption/reprocessing or changing the materials into other further finished or semi-
finished products.

• The agent/stakeholder (government Vs. industrial)

A. Government Procurement is the process whereby a government obtains goods, works and
services at an optimum cost for vital public sector investments in physical infrastructure and for
strengthening institutional human capacities.

B. Industrial/commercial procurement is the process whereby firms obtains goods, works and
services at an optimum cost and effective operations for the sake of making profit and
maximising their wealth.

• The scope (domestic Vs. foreign procurement)

A. Foreign procurement is process of obtaining goods, works and services used in

organizations operation from other country.

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Basics of Procurement Management

B. Domestic procurement is process of obtaining goods, works and services used in

organizations operation from suppliers found within domestic country

Procurement as supplier management

Supplier management may be defined as: The aspect of procurement concerned with
rationalizing the supplier base and selecting supplier, evaluating supplier and developing supplier
and, where appropriate, building long-term collaborative relationships.

 Supplier selection: is the process of selecting the best supplier based on different selection
criteria from among a number of suppliers that can provide the needed materials. The important
role of buyers here is to choose from the available suppliers the best ones that can provide the
best combination of value, cost and functionality. When selecting suppliers, companies need to
take into consideration many criteria. Those include financial health, technological capability,
geographical location, quality, domestic or international suppliers, low-cost sourcing and
delivery performance.

 Supplier development: the provision of finance, technology or other forms of assistance by the
buyer to the supplier to enable the supplier to offer a product or service which meets the buyer’s
needs, or to interface with the buying organization in a mutually appropriate way. It is a
systematic organizational effort to create and maintain a network of competent suppliers and to
improve various supplier capabilities that are necessary for the buying organization to meet its
increasing competitive challenges. Various reasons leading to supplier development include:

 Realization that products and services account for a larger amount of total cost since
sourcing is common,
 Suppliers are not capable of delivering required products,
 Suppliers are not performing as expected,
 Need to further develop the supply base to bring better goods and services, and improve
the interactions between buyer-supplier, and
 Technology has been improved quickly, and suppliers should be encouraged to specialize
on specific technologies.

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Basics of Procurement Management

 Supplier evaluation: the process of quantifying the efficiency and effectiveness of supplier
action. It is designed to support the decisionmaking of the buying company about evaluating
suppliers. Through that, it is possible for the company to implement or encourage changes in the
evaluated supplying company’s behaviors. Furthermore, this activity is used as a means to make
some effects on supplier action. Supplier evaluation is an essential task to manage successfully
the relationships between suppliers and buyers. There are two phases when it is carried out. One
can be seen in the selection task of the buying company. In this phase, evaluation plays a role in
placing preference order for potential suppliers in order to select the better one. Another phase
where supplier evaluation appears is in the end of supplier development activity with the purpose
of controlling and evaluating the buyer-supplier relationship.

Purchasing as external resource management

The new strategic function will probably not be called purchasing – that is much too limited a
word. The connotations of purse strings and spending money have no relevance to the setting up
and management of strategic inter firm relationships. This task is concerned with ensuring the
correct external resources are in place to complement the internal resources. The emphasis is
now on procurement.

1.5 Strategic roles of procurement

There are unquestionable operational and tactical roles of procurement, such as agreeing the
price; placing purchase orders; attending meetings; chasing overdue deliveries; handling
stakeholder queries and handling order acknowledgements. These are all necessary roles but they
fail to highlight any strategic dimension. The following are the strategic role of procurement:

 Due diligence

Due diligence is a structured methodology to help determine that a supplier has the necessary
qualities to become a partner of the buying organisation. The term ‘due diligence’ is more
usually associated with financial reviews in takeover situations. Within a procurement context it
includes consideration of the supplier’s:

 Financial robustness, including working capital

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Basics of Procurement Management

 Competence and availability of key resources

 Reliance and extent of sub-contracting

 History of legal disputes and litigious actions

 Experience of partnering relationships

 Existence of a robust five-year business plan

 History of insurance claims

 IT system robustness

 Risk Management of the supply chain

Identifying supply chain risks and developing acceptable risk mitigation strategies is a hallmark
of a strategically focused procurement operation.

 Relationship management

The adversarial approach to business life is an out dated concept, a fact that some procurement
specialists should realize. The skill of managing relationships with strategic suppliers
necessitates attention to, for example:

 Conducting regular blame free reviews of contract performance

 A joint commitment to continuous improvement

 Sharing long-term business goals

 Active involvement of senior people at both organisations

 Negotiations based on genuine business objectives

 Provision of accurate and timely business and contract management data

 Continuous improvement of supplier performance

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Basics of Procurement Management

The procurement community has a strategic role to motivate suppliers to continually improve
their performance. The performance on long-term contracts can be incentivized to reward the
supplier’s investment and initiatives. The contract can require continuous improvement as an
obligation. In some situations the buying organisation may jointly invest in new technology,
providing the supplier agrees to appropriate ownership of intellectual property and perhaps
licensing upon payment of a royalty on sales.

 The supplier’s investment in „right first time‟

An organization’s reputation for quality is a prime business asset. Suppliers have expert
knowledge, or should have, of the goods or services they provide. The supplier can add value to
procurement by ensuring that the specified quality is satisfied or exceeded. The supplier can also
advise on through life costs, maintenance support, inspection and testing and continuous
improvement. When the procurement specialist is engaged in pre-qualification processes, there
should be a penetrating analysis of the bidder’s quality management attributes.

 The supplier’s investment in inventory

The rapid business approach to Just-in-Time has focused attention on who pays for inventory in
the supply chain pipeline. Buying organisations are naïve to believe this is a ‘free of charge’
service, willingly entered into by the supplier. There are costs involved, including strategic
warehousing facilities, distribution network costs, danger of product changes, working capital
costs and so on. The concept of consignment stock is a proven concept in manufacturing, with
some suppliers very adept at completely satisfying the buyer’s needs for production line side
stock.

1.6. The evolution of purchasing through to procurement

The evolution of purchasing and procurement can be analyzed in seven periods.

 Period 1: The early years (1850–1900)

Some observers define the early years of procurement history as beginning after 1850. Evidence
exists, however, that the procurement function received attention before this date. Charles
Babbage’s book on the economy of machinery and manufacturers, published in 1832, referred to

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Basics of Procurement Management

the importance of the procurement function. Babbage also alluded to a ‘materials man’
responsible for several different functions. Babbage wrote that a central officer responsible for
operating mines was ‘a materials man who selects, purchases, receives, and delivers all articles
required’.

The greatest interest in and development of procurement during the early years occurred after the
1850s – a period that witnessed the growth of the American railroad. By 1866, the Pennsylvania
Railroad had given the procurement function departmental status, under the title of Supplying
Department. A few years later, the head procurement agent at the Pennsylvania Railroad reported
directly to the president of the railroad. The procurement function was such a major contributor
to the performance of the organisation that the chief procurement manager had top managerial
status.

The comptroller of the Chicago and North Western Railroad wrote the first book exclusively
about the procurement function, The Handling of Railway Supplies – Their Purchase and
Disposition, in 1887. He discussed procurement issues that are still critical today, including the
need for technical expertise in procurement agents along with the need to centralize the
procurement department under one individual. The author also commented on the lack of
attention given to the selection of personnel to fill the position of procurement agent.

 Period 2: Growth of procurement fundamentals (1900–1939)

The second period of procurement evolution began around the turn of the twentieth century and
lasted until the beginning of the Second World War. Articles specifically addressing the
industrial procurement function began appearing with increasing regularity outside the railroad
trade journals. Engineering magazines in particular focused attention on the need for qualified
procurement personnel and the development of material specifications.

Procurement gained importance during the First World War because of its role in obtaining vital
war materials. This was due largely to procurement’s central focus of raw material procurement
during this era (versus buying finished or semi-finished goods). Ironically, the years during the
First World War featured no publication of any major procurement books. Harold T. Lewis, a
respected procurement professional during the 1930s through the 1950s, noted that there was
considerable doubt about the existence of any general recognition of procurement as being

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Basics of Procurement Management

important to a company. Lewis noted that from the First World War to 1945, at least a gradual if
uneven recognition developed of the importance of sound procurement to company operation.

 Period 3: The war years (1940–1946)

The Second World War introduced a new period in procurement history. The emphasis on
obtaining required (and scarce) materials during the war influenced a growth in procurement
interest. In 1933 only nine colleges offered courses related to procurement. By 1945, this number
had increased to 49 colleges. The membership of the National Association of Procurement
Agents increased from 3,400 in 1934 to 5,500 in 1940 to 9,400 in the autumn of 1945.

A study conducted during this period revealed that 76 per cent of all purchase requisitions
contained no specifications or stipulation of brand. This suggested that other departments within
the firm recognized the role of the procurement agent in determining sources of supply.

 Period 4: The quiet years (1947–mid-1960s)

The heightened awareness of procurement that existed during the Second World War did not
carry over to the post-war years. John A. Hill, a noted procurement professional, commented
about the state of procurement during this period:

For many firms, purchases were simply an inescapable cost of doing business which no one
could do much about. So far as the length and breadth of American industry is concerned, the
procurement function has not yet received in full measure the attention and emphasis it deserves.

Articles began appearing during this period describing the practices of various companies using
staff members to collect analyses and present data for procurement decisions. Ford Motor
Company was one of the first private organisations to establish a commodity research
department to provide short-term commodity information. Ford also created a purchase analysis
department to give buyers assistance on product and price analysis.

 Period 5: Materials management comes of age (mid-1960s–late 1970s)

The mid-1960s witnessed a dramatic growth of the materials management concept. Although
interest in materials management grew during this period, the historical origins of the concept
date back to the 1800s. Organizing under the materials management concept was common during

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Basics of Procurement Management

the latter half of the nineteenth century in the US railroads. The combined related functions such
as procurement, inventory control, receiving and stores were under the authority of one
individual.

The behavior of procurement during this period was notable. Procurement managers emphasized
multiple sourcing through competitive bid pricing and rarely viewed the supplier as a value-
added partner. Buyers maintained arm’s-length relationships with suppliers. Price competition
was the major factor determining supply contracts. The procurement strategies and behaviours
that evolved over the last half-century were inadequate when the severe economic recession of
the early 1980s and the emergence of foreign global competitors occurred.

 Period 6: The global era (late 1970s–1999)

The global era and its effect on the importance, structure and behaviours of procurement, have
already proved different from other historical periods. These differences include the following:

 Never in industry history had competition become so intense so quickly.

 Global firms increasingly captured world market share, and emphasised different
strategies, organisational structures and management techniques.
 The spread and rate of technology change during this period was unprecedented, with
product lifecycles becoming shorter.
 The ability to coordinate worldwide procurement activity by using international data
networks and the World Wide Web (via Intranets) emerged.

This intensely competitive period witnessed the growth of supply chain management. Now,
more than ever, firms began to take a more coordinated view of managing the flow of goods,
services, funds and information from suppliers through end customers. Managers began to view
supply chain management as a way to satisfy intense cost and other improvement pressures.

 Period 7: Integrated supply chain management (beyond 2000)

Procurement and supply chain management today reflects a growing emphasis concerning the
strategic business importance of suppliers. Supplier relationships are gradually shifting from an
adversarial approach to a more cooperative approach with selected suppliers. The activities that
the modern procurement organisation must undertake require a different mindset than that

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Basics of Procurement Management

traditionally adopted. Supplier development, partnering, supplier-design involvement, the use of

full-service suppliers, lifecycle costing, long-term supplier contracts and relationships, strategic
cost management, and integrated Internet linkages and shared databases are now seen as ways to
create new value within the supply chain. Procurement is attracting high-quality people who
aspire to senior business positions once they have established their credibility in dealing with
challenging procurement scenarios.

1.7. The status of procurement and supply management/PSM

Within a particular organisation the status of PSM is influenced by leverage, focus and
professionalism.

 Leverage

Traditionally, leverage of procurement has been focused on enhancing profitability. This is

relevant in a manufacturing or purchase for resale context, but is irrelevant for procurement in a
central and local government environment where procurement has a direct impact on the quality
and timing of public services being offered. The same can be said of procuring goods and
services for the National Health Service.

Expenditure on materials and services that are purchased from third parties is where professional
buyers must demonstrate their effectiveness in obtaining value for money

 Focus

Syson (1992) states that the position of procurement within a particular organisation depends on
whether the focus of the function is transactional, commercial or strategic. Each of these foci is
appropriate to sustaining commercial advantage for different types of enterprise: ‘in terms of
effectiveness, the key question is whether the correct focus exists. In terms of efficiency, how
well are the key tasks discharged?’ Over time, the focus of procurement changes from
transactional to a procedure perspective. The more procurement becomes involved in
commercial and strategic areas, the greater will be its effectiveness and consequent standing
within the organisation. In other word when PSM moves from a transactional to a pro-activity
focus, performance measures also change from efficiency to effectiveness.

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Basics of Procurement Management

Efficiency is a measure of how well or productively resources are used to achieve a goal, while
Effectiveness is a measure of the appropriateness of the goals the organisation is pursuing and of
the degree to which those goals are achieved.

 Professionalism

Professionalism is traditionally associated with certain attributes, including:

 Skill based on theoretical knowledge

 Prolonged training and education
 Demonstration of competence by means of tests and examinations
 Adherence to a code of professional ethics

Professionalization is associated with the development of associations that seek to establish

minimum qualifications for entrance to a professional practice or activity and enforce appropriate
rules and norms of conduct among the members of the professional group and raise the status of
the professional group in the wider society. Thus, attempts to raise the external perception of
procurement have included:

 The establishment of institutions concerned with promoting the concept of ‘professional’

procurement, such as the Chartered Institute of Procurement and Supply (CIPS) in the UK and
the Institute of Supply Management (ISM) in the USA (in 2004, over 42 national procurement
associations were affiliated to the International Federation of Procurement and Materials
Management)

• the development of undergraduate and postgraduate courses with a procurement content

• the establishment of ‘Chairs’ in procurement or logistics at some universities

• research into PSM and related fields

 the publication of textbooks and specialist journals relating to procurement

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