What is Procurement?

The simplest definition of procurement is the act of a business buying goods or services. However, the reality is more complex. There are several elements under the umbrella, including selecting vendors, negotiating payment terms, finalizing contracts, and more. 

Buyers and sellers are the two parties involved, but only the purchasing element, not the selling element, is considered procurement. 

Let's explore three distinct procurement definitions. 

Direct Procurement

Direct procurement involves any activities undertaken to obtain the materials required for a finished product. The production costs, or costs of goods related to the finished product, will directly affect the company's bottom line. Ultimately, an organization cannot function without direct procurement. 

For example, direct procurement for a company that makes cookies would include items such as flour, eggs, and butter. 

Indirect Procurement

Indirect procurement refers to obtaining supplies that are not directly related to production costs. Through indirect procurement, a company can amass the materials necessary to run its operation. 

For example, indirect procurement might include the costs to maintain the facility or employee travel. 

Services Procurement

Procurement doesn't end with obtaining goods. The process can be geared to procure services as well. With services procurement, a company would seek to obtain the necessary labor to run its operation. 

Depending on the type of business, the costs of services procurement can range widely. For example, a company might hire landscapers to maintain the area around the office building, or marketing consultants to help them with their next product launch. 

What is the Procurement Process?

Here's a closer look at the procurement process. 

Recognition of a Need

The first step of the procurement process is realizing that a good or service is required by the company. In this stage, stakeholders within the company will outline the reasons why a good or service must be procured. 

Purchase Requisition and Review

If a need has been established, purchase requisition documents must be created. Within these documents, the users who require the procurement team's help will outline specific information about the goods or services required. 

At this stage, the purchase requisition will be reviewed for approval by decision-makers within the company. In order to receive approval, most companies will need to confirm the need for the items or services. Plus, the organization will need to confirm that there is room in the budget for these items. 

After decision-makers approve the purchase requisitions, the procurement team will review the documents. At this point, procurement specialists may contact the internal users to seek more clarification on the finer points of the items or services. 

Solicitation Process

With the purchase requisition approved, procurement team members can start to research the available options. The complexity of this stage will vary dramatically based on the items or services required. But typically, a procurement department will send letters of inquiry to potential vendors. 

Essentially, this stage of the process is to gather the necessary information to make the right decision. 

Contract Evaluation

Once the team has the information they need, they will compare quotes and negotiate to find the right vendor. With the right vendor selected, the organization can send a purchase order to the selected supplier. 

Order Management 

If the vendor agrees to the purchase order, a contract will be initiated. At this point, the line between procurement and purchasing will begin to blur. 

A purchaser will place an order, and they will need to keep an eye on the order throughout the process. This will involve approving invoices, matching received goods to the purchase order, record keeping, and more. 

Procurement vs Purchasing

It is very common to confuse procurement with purchasing. However, there is an important distinction between the two. 

Procurement is an involved process that includes finding suppliers, vetting suppliers, negotiating contracts, and more. It can take an extensive amount of time and effort to go through the entire procurement process. 

On the other hand, purchasing is a less complicated part of the equation. Purchasing completes the transaction by placing orders and handling issues related to delivery and quality. 

In smaller organizations, the responsibilities of procurement and purchasing may fall to a single department. However, larger organizations tend to separate these functions into multiple roles for greater efficiency.

Procurement vs. Supply Chain

Procurement and supply chain management go hand in hand. Procurement is the process of obtaining the materials and services required to run an operation. But supply chain management is designed to keep an eye on the costs involved in the procurement process. 

Essentially, supply chain management has the goal of streamlining the production process by monitoring the costs of raw materials. With that, supply chain management strives to keep procurement costs low. 

Example of Procurement

A manager of a chain restaurant notices water damage on the ceiling after heavy rainfall and suspects a leak in the roof. He needs a roofing company to come and repair the damage. 

To get this taken care of he submits the necessary paperwork to corporate headquarters for approval, explaining the recent storm and the damage he observed. They may hire a roofer to inspect the damage and confirm the source of the leak and provide an estimate to repair the issue. Possibly even getting several estimates to make sure they pay a competitive price. 

If it is determined that repair is needed and the price is within budget, the company will select a roofing company to do the job. The procurement department will keep in contact with the roofers to make sure they do the job in a timely manner and get approval for any issues that may cause the job to exceed the initial bid. 

When the job is complete the roofer submits his invoice which is paid by the accounts payable department. 

How Procurement Contributes to the Success of a Company

An effective procurement process will allow a company to obtain the goods and services they require at the appropriate time. Beyond the right timing, an effective procurement team will ensure that an organization doesn't overpay for goods and services. 

A successful company cannot operate efficiently without the backing of a competent procurement team. 

Summary

Procurement is an important component of an efficient company. With a streamlined procurement process, a company can ensure the timely arrival of goods and services without breaking its budget. 

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All of our content is verified for accuracy by Mark Herman, CFP and our team of certified financial experts. We pride ourselves on quality, research, and transparency, and we value your feedback. Below you'll find answers to some of the most common reader questions about Procurement.

Why Is Procurement Important in Business?

Primarily, a procurement process ensures that the company's purchasing is competitive, fair, and well-priced for the market. A formal procurement process provides greater efficiency and hopefully leads to better profitability for the company.  

How are Procurement Decisions Made in Selecting Suppliers or Products?

The obvious answer is based on price, but more significantly the product or service has to first meet certain minimum specifications to be considered. The relationship and reliability of the supplier is also a factor, as a new supplier often overestimates their ability to provide the required quantity or timeline. 

Most procurement professionals will utilize a decision matrix that incorporates multiple variables based on what is important to the stakeholders. In addition, many corporations also have considerations for what is known as supplier diversity, which seeks to provide opportunities to smaller suppliers or those who are owned by women, minorities, or veterans as an example.

Mark Herman has been helping friends with financial questions since serving as an Army helicopter pilot. Since then, he’s gained valuable experience in the corporate world before moving on to become a Certified Financial Planner™.

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