Importance of Procurement Function in Manufacturing

importance of procurement function

Importance of Procurement Function in Manufacturing

What is the Procurement Function?

Procurement refers to an organization’s strategy to acquire goods and services for ensuring successful business operations. The procurement process ensures the right materials/products/services are obtained at the right price, from the right source/vendors, in the right quantity, meeting the right specifications, and delivered at the right time to the right users.

What is the importance of Procurement in a manufacturing organization? 

Companies involved in manufacturing and related sectors, typically incur about 60% to 70% of their total spend on the procurement of material and services. These materials and services directly impact the quality of the end product, final product price, timely product delivery, and customer satisfaction. Thus, Procurement is a strategic function that impacts operations, supply chain, quality, cost and profits of manufacturing companies. Hence it is crucial to have a good procurement strategy in place.

What is the importance of a good Procurement Process & Strategy? 

A good procurement strategy involves understanding & consolidating the procurement needs of all departments/units of an organization, finding suitable vendors, evaluating their terms and conditions, carrying out negotiations or bidding, identifying the right vendor/suppliers. This ensures, procurement of quality goods and services at optimum prices. This ultimately results in a lower cost of manufacturing and improves the bottom line.

How does the Procurement Function help meet Organization objectives? 

Let us now see how Procurement Function plays a crucial role in helping organizations achieve their overall business objectives such as optimum inventory, healthy working capital, reduced cycle times, improved supplier loyalty, cost reduction and savings, increased profitability and so on.

1. Procure Right Quality Material at the Right Price

One of the major objectives of Procurement is to ensure the best quality goods & materials. It involves gathering detailed specifications during need identification stage such as item description, item make, required quantity, specific quality requirements (if any), required date. Identifying suitable substitutes that can retain or improve product quality, selecting most efficient vendors who can deliver optimum quality goods, negotiating with vendors to supply at optimum prices, terms and so on.

2. Healthy Working Capital

By adopting various demand planning methods for developing a Procurement strategy, purchases are made just in time, only for the required quantities. This avoids situations of idle stock, overstocking and ensures a healthy working capital.

3. Reduced Purchase Cycle Time

Continuous focus on selecting the most appropriate source of supply as well as a wider network of vendors/suppliers, well laid out procurement policy all work towards reducing the purchase cycle time

4. Savings in Procurement Cost

Consolidating companywide Procurement requirements, long term forecast of procurements, conducting negotiations for staggered deliveries, identifying suitable alternate materials, having a larger vendor base all lead to having improved negotiation leverage; which eventually helps achieve significant savings in Procurement Costs.

5. Reduces Cost Per Unit

Significant savings in procurement costs, ultimately help to “Reduce the Per Unit Manufacturing Cost” and Improve Profitability.

What activities are involved in Procurement?  

 Step 1: Identify Procurement Needs

Identifying procurement needs and capturing detailed specifications such as item description, item make, required quantity, specific quality requirements (if any), required date, cost centers, requested by, etc.

Step 2: Purchase Requisition Review

Procurement Requisition should be verified by end-user, project/ department heads, store departments, and final approval should be obtained before initiating procurement

Step 3: Selecting appropriate sources of supply

The procurement team evaluates suppliers based on various parameters such as availability of material, location of supply, the urgency of requirements and shortlists vendors for sourcing. Procurement team’s most strategic function is to expand the network of relevant suppliers to improve negotiation leverage

Step 4:  Vendor  Development

Developing a good vendor relationship is a crucial focus area of Procurement. Having updated information on qualified vendors, the key items and categories served by them ensure that the company can contact the right vendors for its procurement needs.

Step 5: Sending Request for Quotation (RFQ)

Request For Quotation is sent out to shortlisted vendors to encourage them to submit their quotations or send invitations to take part in bids.

Step 6: Evaluation of Quotes/ Bids

Comparative Statements are prepared for easy comparison of offers and conditions, based on evaluation parameters like cost, taxes, freight, other charges, delivery terms, etc. after vendors submit their bids/quotes.

Step 7: Vendor Finalization & Approval process

Post stringent evaluations by multiple stakeholders in the organization, vendor/(s) are selected. They may have several rounds of negotiations and invite revised quotations before awarding the final contract.

Step 8: Purchase order

Purchase Order is the official document issued by an organization confirming the supplier for the order of material or services. As part of the best practices of Procurement, organizations should ask vendors for the confirmation of the purchase order.

Step 9: Receipt of Material & inspection

Vendors should deliver the material/ services within the stipulated time and as per the specified quality parameters. An organization should physically verify / count / inspect goods/materials received to ensure there is no discrepancy.

Step 10: Invoice Approval

Received invoices are checked against goods received note (GRN), and against purchase order for the price, terms conditions, etc. This process is also called ‘Three-way matching’. Once the invoice is approved, it is due for payment.

Step 11: Payment Process

The payment due date is decided by credit terms defined in the purchase order. The accounts department initiates the payment process against invoices due for payments.

Step 12: Record-keeping

Organizations have to maintain records of all activities in the procurement process such as Purchase Requisition, RFQs, Quotations/ Bids, Comparative Statements, Approval of Comparative Statements, Purchase order, Goods Received Note, Invoices, Payment for fulfilling audit, statutory and compliance requirements.

How to measure the impact of the Procurement Function?

Procurement KPIs and metrics are very powerful performance management tools. They provide clear visibility on the impact of procurement actions and areas of improvement. The result is a well-focused procurement function.  Some major KPIs that should be measured are as follows:

1. Procurement ROI: Procurement ROI provides a clear understanding of the performance of procurement function and is calculated as Procurement ROI = (Cost Reduction + Cost Avoidance)/Cost of Procurement Operation

2. Purchase Order Cycle Time: When an organization’s purchase order cycle time is shorter than before, it depicts the efficiency of the procurement function

3. No. of Suppliers: Good procurement teams make sure they maintain a healthy database of suppliers for all item categories

4. Supplier Ratings: Procurement teams that capture supplier ratings for their response rate, on-time delivery, material quality, etc help to identify & maintain a good supplier base.

5. Lead Time: An effective procurement function helps to lower the lead time and reduce the inventory level by considering all factors such as purchase order cycle time, order handling time, manufacturing lead time, delivery lead time, etc.

6. Cost of Purchase Order: This KPI measures the efficiency of the procure to pay cycle. Lower the cost of the purchase order, more efficient the procurement team

7. Cost Reduction: Effective procurement teams will lead to significant cost reductions, which are also referred to as hard savings.

8. Cost Avoidance: Examples of Cost avoidance achieved by an efficient producerement function are rate contracts or price protection, negotiation after initial quotes, asking for value-adds such as add-on services, continuous improvements for saving, finding substitutes.

9. Emergency Purchase: An efficient Procurement function means that an organization has to spend minimum amount on emergency purchases

Summary

It is thus evident that the Procurement function plays a pivotal role in the smooth business operations of a manufacturing organization. Procurement function ensures that all goods, materials, services are procured at optimal times and prices, an optimal level of inventory is maintained. This will result in optimum utilization of resources, efficient production, and ultimately result in significant savings in money, time and resources.

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