Role of Procurement in Profit Maximization - Essay Example

Role of Procurement in Role of Procurement in Profit Maximization Introduction Like engineering, production, marketing, finance, human resources etc. procurement has long been recognized as a specialist function and organized accordingly. This is true of companies in manufacturing sector or service sector or in public/private/joint sectors. Companies procure capital goods, raw materials, finished or semi-finished subassemblies, consumables and spares to conduct their operations. Barring construction industry, service sector companies have fewer requirements of raw materials but generally need to deal with some or all the other categories of purchases mentioned above. In the manufacturing sector, it is generally accepted that the value of inputs materials forms a high percentage of the ultimate product price – to the extent of as much as 60% and even more in highly competitive industries. In companies that execute major construction projects in the different engineering fields like civil, metallurgical/other process plants, power plants etc. the value of inputs will be equally high. In this background, the importance of economizing and strategizing procurement can not be over-emphasized. This essay examines the various aspects of procurement, developments in this professional activity and the scope for maximizing profits. Core procurement activities Purchasing and inventory management are the two core procurement activities. Vendor development, buyer-seller relations through strategic procurement management Role of Procurement in profit 2 and use of information technology are all integral to economical procurement that maximizes a firm’s profits. Purchasing In a regular manufacturing company, depending upon sales forecast, production plans and budgets are drawn up and these help the Procurement to anticipate and plan the routine as well as non-recurring purchases. Purchasing activities can be broadly identified as tendering, bid evaluation, negotiations, vendor selection, ordering and follow up. Make or buy decisions are taken at strategic management meetings and once a decision is taken to procure an item from vendors, Procurement receives the requests for purchase along with quantities and specifications. Tendering for non-standard purchases is more time consuming and involves calling for quotations based on buyer’s specifications and terms like quantities, delivery schedule, supply conditions, payment terms, guarantees and warranties etc. Quotations are evaluated for technical and commercial comparison and to identify the preliminary list of suppliers for further discussions. Negotiations cover the technical specifications as well as other terms that differ from tender documents and to arrive at mutually acceptable terms of supply. Based on the success of such negotiations, one or more suppliers are selected and the purchase orders for going ahead with the supplies are issued. Regular follow up is part of the activities to ensure timely supplies and to resolve issues if any. Purchasing of raw materials, standard subassemblies and routine off-the-shelf supplies involves inventory and supply chain management. Role of Procurement in 3 Inventory management Procurement maintains and develops its supplier base to economize and expedite purchase of raw materials and routine supplies. Supplier base is an elaborate list identifying multiple sources of supply for a very wide variety of items and services. This list does not remain static but is reviewed and updated periodically depending upon the comfort level of long term buyer-seller relations and taking the market dynamics like new entrants, better prices, substitute products etc. into account. In this process, bids may be invited only from a previously selected list of approved vendors, even in public sector where rules and procedures are more stringent. Inventory holding is one of major costs associated with a company. Financial resources are locked up in inventory until the time the items are used in production and invoiced to customers. At the same time, shortage of materials or delay in receiving them can also hold up manufacturing process and lead to costly delays. Hence, a fine balance is to be maintained between steady/timely supplies and inventory carrying costs. ABC analysis is one of the earliest techniques in this respect, where by the criticality of a few high value items (A items), the insignificant carrying costs of a large number of low value items (C items) and the rest (B items) are analyzed and managed to minimize costly disruptions and maximize profitable operations (Supplychainmechanic.com, 2009). Procurement conducts ABC analysis of stock items, their values and lead times for procurement. Based on the movement of these items for consumption from the stores, minimum stock levels and re-order levels, re-order quantities are scientifically calculated and managed. Role of Procurement in 4 Supply chain management For mass production plants like automobiles, the concept of ‘just-in-time’ or JIT inventory management is another cost saving method. Perfected by Japanese automakers, this involves creation of a chain of suppliers and holding points to ensure that the components or subassemblies do not remain at any place for more than a few hours (Valuebasedmanagement.net, 2009). The intense coordination, trust and dependence between the buyer and his sellers in this regard are self-evident. This technique is now being used effectively in a number of industries and other businesses like supermarkets. Strategic procurement management and profit maximization Procurement is synonymous with managing external resources. ‘Managing’ involves planning, coordinating, executing and controlling, and, ‘resources’ involve supplies as well as suppliers. Efficiency of purchasing management directly results in maximizing profits of a company. Competitive advantage is secured by strategic procurement action that deals with identifying opportunities to enhance value proposition to a customer and thereby enhance profits to the firm. According to Porter, “Strategy is an internally consistent configuration of activities that distinguishes a firm from its rivals” (2004, p.xvi). Porter states that the way the activities of a firm are managed creates opportunities for the firm to offer value to its customers. Explaining the concept of value chain of activities of a firm, Porter states that a buyer and his seller have common interests and dovetailing their respective activities would bring in maximum benefits to both. Porter also identified activities which have direct relevance to procurement function as purchases and inbound logistics Role of Procurement in 5 involving receiving, storing and distributing inputs for a products or service (2004, p.88-92, 120-122). Supply arrangements should be designed to reduce overall transaction costs, and hence increase profitability to both parties. According to Cox and Lamming firms gain competitive advantage by adopting strategic procurement management using tools and techniques such as lean supply, partnership, networking and outsourcing (Cox, 1996; Lamming and Cox, 1995). According to Curtin University of Technology, “…strategic procurement results not only in financial savings, but also business improvement …concepts are now widely used across all major industry sectors including Government…” (2008). “Competitiveness is improved in terms of the quality and nature of inputs, their method of procurement and the relationship between the company and its suppliers, impacting in terms of the design, development and ultimate production of a superior final product to the customer” (Cox et al, 1998). In the words of Rockford Consulting: Strategic procurement is the development of a true partnership between a company and a supplier of strategic value. The arrangement is usually long-term single-source in nature and addresses not only the buying of parts, products, or services, but product design and supplier capacity. Partnering agreements allow the mutual exchange of confidential information, proprietary restrictions, non-disclosure, non-compete, certification of processes, routine audits, delivery performance, quality performance, as well as the transfer of control of a process or product (2008). Role of Procurement in 6 From the above discussion, it is seen that strategic procurement is a major tool to ensures a win-win situation for the seller and the buyer. It is characterized by long term buyer-seller relationships in an atmosphere of greater trust and transparency. The costs of suppliers and therefore their product prices are appreciated by the buyer; the need for economical inventory and supply chain management and the buyer’s competitive position in the market are understood by the seller. In this background, the buyer and seller agree to work for long term mutual dependence and at maximum operational efficiencies, ensuring that operations are economized, supplies are made in time and in minimum quantity per batch, quality is maintained etc. In order that the seller may not develop complacency and to encourage competition, multiple sources of supply are generally tied up. One significant aspect of strategic procurement management is gaining access to the resources of vendors like design, engineering or product development. In other words, a buyer not only buys materials but resorts to outsourcing with a view to economize on his higher overhead costs. In practical world, the feedback on buyer-seller relations is not very encouraging. Sales executives of supplier companies do not view the purchase departments of buyers favorably and blame them for failure to develop mutually beneficial or strategic relationships, stating that, “fewer than 40% of key accounts receive any preferential benefits” (CEBC, as quoted in Business Wire, 2006). Procurement has to ensure that such negative situation is corrected and strategic procurement is practiced in letter and spirit. Role of Procurement in 7 Outsourcing Outsourcing is now an accepted phenomenon around the world of globalized economic activities. The concept involves finding the most economical product or service that matches with identical product or service that can be made in-house. The driving force behind this development is the significant benefits in costs of materials and manpower. Usually, product design, material specifications and quality are defined and controlled by the buyer. Consumer items like electronic equipment, footwear, toys, clothing, and sports goods are some of the visible outsourced items. Branding and repackaging may be the only value addition activities done in the buyer country. What is true for consumer items is also true for many industrial products like steel, cement, cars etc. or IT and IT enabled services, with countries like China, India, Philippines and Ireland emerging as major destinations for outsourcing. Procurement plays a major role in developing such sources of supply. Use of IT in procurement Information technology can be exploited by Procurement for dramatically enhancing efficiency of its function. IT provides for online tendering, e-auction, spend analysis tools, decision support tools, contract management and vendor management solutions, dynamic sourcing tools, etc. ‘Procurement is only as good as its MIS’ underscores the contribution of IT to its efficiency. The Internet is of immense help in locating the most economical sources of supply. It provides for online verification of prices, specifications and comparisons. Transaction costs are greatly reduced either for communications or for ordering and Role of Procurement in 8 follow up. E-procurement business volumes are also estimated to reach billions of dollars according to various consultants. Conclusion Procurement has come a long way from being looked upon as a mere purchasing department and occasionally as an unavoidable organizational layer causing delays. Procurement is directly responsible for spending the largest share of capital and revenue budget of a company and the efficiency with which it discharges its responsibility has a direct impact on the company’s bottom line. Developments in improving procurement efficiencies center around building strategic buyer-seller relationships on a long term basis for mutual advantage. Such strategic alliances can be dovetailed to a company’s production plans in order to reduce inventory carrying costs, costly delays in receipt of materials, apart from exploiting the resources of sellers through outsourcing product design work, R&D, etc. Outsourcing is a development in this strategy for ensuring that the input products and services are bought from the most economical options available anywhere in the world. Extensive use of information and communication technologies coupled with software programs for generating MIS reports on all aspects of procurement are adding strength to procurement function in creating value for a company. Role of Procurement in 9 References Business Wire (2006). Procurement Strategy Council Announces New "Customer of Choice" Imperative. Retrieved April 20, 2009 from: http://findarticles.com/p/articles/mi_m0EIN/is_2006_Oct_10/ai_n27042636 Cox, A., and Lemming R. (1997). Managing supply in the firm of the future. European Journal of Purchasing & Supply Management, Vol. 3, No. 2, p. 53-62. Retrieved July 26, 2008 from: www.sciencedirect.com Cox, A., Harris, L., Parker D. (1998). The impact of privatisation on procurement management: Evidence from seven privatised companies in the UK, European Journal of Purchasing & Supply Management Vol. 4, p.87-96. Retrieved July 26, 2008. From: www.sciencedirect.com Curtin Newsletter, 2006.Vol.1, Issue 1, Retrieved November 16, 2008 from: http://procurement.curtin.edu.au/newsletter/index.cfm Curtin University of Technology, Strategic procurement Retrieved November 16, 2008 from: https://procurement.curtin.edu.au/about/ Inventory Solutions Logistics Corporation (2009), JIT Manufacturing: What is JIT? Retrieved February 14, 2009 from: http://www.inventorysolutions.org/def_jit.htm. RCG University (2008). Strategic procurement. Retrieved November 2008 from: http://rockfordconsulting.com/spr.htm. Porter, M.E., (2004). Competitive advantage, Free Press, New York. Supplychainmechanic.com (2009). ABC Analysis: How to carryout ABC analysis of inventory, Retrieved April 15, 2009 from: http://www.supplychainmechanic.com/?p=46 Value Based Management (2009). JIT Philosophy. Retrieved April 21, 2009 from: http://valuebasedmanagement.net/methods_jit.html. Read More