What is Procurement and How Does it Work?

For large organizations, procurement is an important input to success. Understanding procurement is the first step to building a set of practical procedures that will lead to better business outcomes. Here, we explain what procurement is, types of procurement, and how it works. We will also cover the benefits of well-executed procurement management and answer some frequently asked questions.

What is procurement?

The role of procurement in an organization is to get the right material in the right amount to the right place at the right time and for the right price. This involves far more than just purchasing. Procurement involves all activities related to acquiring goods and services such as:

• Selecting vendors
• Establishing payment terms
• Strategic vetting
• Selecting and negotiating contracts
• Actual purchasing of goods
• Managing supplier relationships

Procurement is most commonly practiced in business enterprises and large public institutions. Procurement is a key input to organizational strategy that, when executed well, can lead to better business outcomes. For today’s dynamic and fast-paced organizations, procurement departments must be innovative, agile, and flexible. They must be able to respond to current market conditions and prepare to meet the future needs of the organization by employing new methods and technology.

Procurement organizations

Procurement organizations can be broadly classified into three categories:

• Centralized - All purchases are managed and controlled by a single department
• Decentralized - Each department locally manages procurement to meet their specific requirements
• Coordinated or hybrid - A combination of centralized and decentralized procurement, hybrid models balance both local requirements and corporate targets

There are advantages to each organizational type. Centralized procurement provides total visibility into the entire company’s spend, budgetary control, reduced duplication of staff efforts, and standardization of purchasing activity. Decentralized procurement provides greater autonomy so local managers, who better understand local needs, can make purchases more quickly that meet their specific requirements. The advantage of the hybrid model is that companies can meet local purchasing needs while still following procurement requirements and simplifying change management.

Types of procurement

Procurement can be classified into two main types: direct and indirect. Direct procurement includes the sourcing of raw materials and production goods that are tied to the manufacturing of a company’s core product. Indirect procurement includes purchases that a company needs but that are not tied to the creation of the core product. 

While direct procurement involves fewer purchases across fewer categories, those purchases are typically of higher priority and carry higher transaction price. Items acquired through indirect procurement typically carry a lower transaction price, but are purchased at higher frequency. Due to the varied and complex needs of internal stakeholders, indirect procurement involves a higher number of suppliers and elicits higher maverick spend (ad hoc purchases made outside of a negotiated contract, also referred to as "rogue spend" or "tail spend").

Examples of direct procurement

• Raw materials such as metals, plastics, and rubber
• Components
• Hardware
• Subcontracted manufacturing services

Examples of indirect procurement

• Office supplies and furnishings
• IT equipment such as computers and printers
• Safety equipment such as goggles, gloves, and aprons
• Janitorial supplies and services
• Utilities
• Maintenance, repair, and operations (MRO)
• Subcontracted business services such as marketing, legal, and HR

How does procurement work?

Procurement follows a process of steps for identifying a requirement or need of the company through the final step of receiving the product or service and ongoing management of the supplier. These steps form a process called the procurement lifecycle.

Step 1: Sourcing

When an organization has determined what goods or services it needs to effectively function, the first step is to select a supplier. The task of selecting a supplier is referred to as “sourcing.” For large organizations, sourcing is often a strategic event, such as a Request for Proposal (RFP), which occurs every few years in an attempt to reduce costs and show hard and soft savings. Organizations evaluate suppliers and often select those that deliver the best value (price, quality).

Challenge: Lengthy RFP processes require significant resources, energy, and time from multiple departments.

Step 2: Contract

Once a supplier is selected, the next step is to enter into a contract. This is where all terms and conditions, including spend thresholds, are outlined. Legal teams negotiate the terms until both parties accept the contract for signature.

Challenge: While a contract can lock in negotiatied prices, in some cases it may commit a business to those prices for the length of the contract. In those cases, if prices drop, savings are not passed on. Contracts may also lock a business into specific products.

Step 3: Procure

Once the contract is finalized, the company procures goods by purchasing from the contracted vendor. End users are expected to use contracted vendors for all purchases. Payment is often handled by the organization’s accounts payable team or by using a preferred payment method like a corporate credit card. The accounts payable team will process payment to the vendor within the agreed timeframe. Finally, the organization will carefully track and record purchases in a central location for transparency, future reference, and auditing and tax purposes.

Challenge: End user management can be difficult, especially for products that require frequent purchases by multiple users.

Step 4: Seller management

Managing suppliers includes having quarterly business reviews, auditing compliance to contract, and monitoring and reporting on financial health and risks for each supplier. Supplier management also includes cultivating the supplier relationships between new and existing suppliers.

Challenge: A business will often have multiple suppliers to manage, which can be time consuming and costly. Additionally, end users may get confused about who they are supposed to purchase specific products from, leading to an increase in maverick spend.

Benefits of well-executed procurement management

Procurement is critical to enterprise success. Historically viewed as a back-office support function, procurement is now at the forefront of business, helping companies maximize efficiency and respond flexibly to market demands. According Harvard Business Review¹, a well-executed procurement organization is one that:

• Aligns plans with business objectives
• Performs in-depth research on suppliers
• Strategically negotiates contracts
• Effectively manages supplier relationships and risk

As a result, procurement can yield a wide range of business benefits, including: 

Drives efficiencies

High-performing procurement uncovers cost savings that directly impact the company’s profitability. Through powerful spend analysis tools, procurement can track buying patterns, make smarter budgeting decisions, and optimize future savings.

In addition to negotiating lower prices on individual contracts, procurement has a bird’s-eye view across the company and the supply base, so they can make connections that reduce costs and drive efficiency. For example, as separate teams undertake new projects, procurement can identify opportunities to pool resources and buying power to benefit the enterprise as a whole.

An Accenture study shows that enterprises that implement strategic sourcing methods and processes can see returns of 5 to 10 times their original investment. High-performing sourcing and procurement functions save $82 for every $8 in cost to procure.² Cost savings free up more of the company’s working capital, which can be invested in other areas of the business.

Improves competitiveness

Positioned between the organization and the suppliers, procurement can engage with suppliers to come up with innovative solutions to the unique needs of the business, which can help the business move quickly in a fast-paced competitive environment and increase speed to market.

Well-managed procurement can also drive constructive competition among suppliers, which can give the company a competitive advantage through cost and quality of supplies. Suppliers who participate in a fair, objective RFP process are more likely to submit their best bids.

Manages risk and ensures compliance

For many industries, ensuring goods and services comply with internal policies and external regulations is challenging. Two important ways procurement organizations bring value to the business is through managing supplier risk and increasing compliance of indirect spend.

By effectively managing high-risk contracts, procurement ensures business continuity by avoiding disruptions with key suppliers. For indirect spend, procurement can prevent rogue spend and eliminate waste by using spend analysis tools to identify compliance issues, and by building guardrails into self-serve purchasing software to steer employees to approved products or suppliers.

Amazon Business can help optimize procurement

Amazon Business is a strategic supplier that can help organizations procure goods at scale without the need for a lengthy RFP process or contracts with each individual seller. Amazon Business consolidates and vets suppliers across hundreds of categories to offer comprehensive, business-relevant selection. Fifty-five of the Fortune 100 companies purchase supplies on Amazon Business. 

Amazon Business helps organizations digitally transform their procurement process, which contributes to better business outcomes, such as:

• Reduce business costs – Compare multiple offers from competing suppliers. Access business-only prices, quantity discounts, and reduced delivery costs with fast, FREE shipping on eligible items.
• Time savings– Integrate Amazon Business with over 90 leading procurement systems. Spend less time managing suppliers when they are centralized to one convenient location. Replenish supplies faster with Recurring Delivery, and speed up approvals by managing them directly on Amazon Business.
• Payment efficiencies – Consolidate purchasing into one invoice and pay using your preferred method. Plus, Amazon Business offers real-time visibility of line-item spend.
• Get greater visibility and control - Add your whole team to one account for full visibility. Create buying groups and approval workflows. Control purchasing with spending limits and compliance guardrails. Track procurement metrics to make better buying decisions.

When sourcing and procurement are aligned with top-level vision, and use data, collaboration, and automation to guide purchasing decisions, the entire organization reaps the benefits. 

Procurement FAQs

What is maverick spend?

Maverick spend, also known as rogue spend or tail spend, refers to purchases made outside a negotiated contract with a preferred supplier. In other words, maverick spend means purchasing from suppliers outside the organization’s procurement policy. There are various reasons why employees make maverick spend purchases, for example:

• Access to more vendors - Employees want access to a high number of vendors compared to the number restricted by procurement.
• Unaware of contracted suppliers - Poor internal communication can cause certain departments to not be aware of the suppliers on contract and the rates fixed with these suppliers.
• To avoid complexity - Traditional procurement process and purchasing tools can be time-consuming and complex.
• Low spend visibility - When departments can’t see historical spending, ad-hoc purchases are often the result.
• No enforcement - When no penalties or enforcement are implemented, there is less incentive for end users to purchase from contracted suppliers.

Maverick spend is a problem because it is difficult to oversee. Limited visibility into spend data inhibits procurement from enacting necessary oversight and forces companies to absorb unbudgeted expenses. Maverick spend prevents procurement from effectively measuring or quantifying a large portion of an organization’s indirect spend. 

How is procurement different from purchasing?

Procurement is the overarching umbrella that involves all activities related to acquiring goods and services for an organization. Purchasing is just one aspect of the wider procurement function and involves activities associated with buying such as development and review of product specifications, and the receipt, inspection, and processing of goods received. Beyond purchasing, procurement additionally includes activities associated with selecting vendors, establishing payment terms, and negotiating contracts.

Where does procurement fit in an organization?

The majority of procurement departments sit within the Supply Chain function, Finance, or both. While Chief Procurement officers (CPOs) most commonly report into Supply Chain or Finance, there is a steady shift toward CPOs reporting into the C-Suite or Operations. The role of the CPO as a strategic business partner has solidified over the past several years as procurement becomes a key input to business strategy that can unlock value across the organization.

Is procurement the same as supply chain management?

Procurement is the process of getting the materials you need to run your business and manufacture your own products. The supply chain is the entire infrastructure you need in place to execute a product’s flow from acquiring raw materials through production and distribution to the final customer. Procurement is a strategic part of overall supply chain management. For example, if your company manufactures cars, then procurement is the process of sourcing the materials you need to build the cars. The supply chain is the entire process involved in producing and delivering the cars to the end consumer.

What is a procurement specialist?

The primary duties of a procurement specialist are to source goods and services for an organization. Procurement specialists oversee the ordering of materials and manage contracts with the company’s vendors. They analyze costs, negotiate contracts, manage inventory, track orders, resolve price disputes, and offer strategies to help companies better manage supply costs and vendor services.

What is strategic sourcing in procurement?

Strategic sourcing is the process of continually evaluating and improving a company’s purchasing. Strategic sourcing involves data collection and spend analysis, market research, the RFP process, negotiations, contracting, implementation, and continuous improvement.

 What is the difference between an RFI, RFQ, and RFP in procurement?

 A request for information (RFI), a request for quotation (RFQ) and a request for proposal (RFP) each serve different purposes within the sourcing phase of the procurement process.

• A Request for Information (RFI) is used to solicit information about the capabilities of various suppliers for comparative purposes. It is typically used prior to an RFQ or RFP.
• A Request for Quote (RFQ) is used to request information on how suppliers would meet your needs and how much it will cost.
• A Request for Proposal (RFP) is the most formal process, with strict rules for content, timeline, and responses. It outlines the requirements for a specific project, then requests bids from qualified vendors.

Sources:

1.      High Performance Sourcing and Procurement; Harvard Business Review (2017).

2.      Procurement’s Next Frontier; Accenture (2015).