To understand the context of my procurement posts, which can often get very detailed, you need to have a basic understanding of procurement to build upon. Let’s take the tour.
The first place I like to start is the world famous Porter Value Chain as it is a good framework to use as a lens; I’ve drawn parallels from this model when examining the procurement function. Around since 1985, this thing has stood the test of time. A beautiful example that a good idea need not be complicated, this model aims to explain how companies generate a profit. The following figure illustrates this in the context of a manufacturing firm:
Quite simply, a company has primary activities which are directly connected to the creation of value for the eventual customer through warehousing, production, shipment, sale and maintenance of a good or service. These primary activities are supported by secondary activities which, while not directly related to the product/service sold, also help create value for the end customer by optimizing the company’s activities. This total creation of value is captured in the profit margin at the sale of the product/service to the end customer. Much could, and has, been written on Porter’s value chain but the important point is that without generating value for the customer, there is no way to generate profits. If I personally met Michael Porter, I’d want to debate the fact that he sees procurement as a support activity and not a primary one but that’s a topic for another post…
If we apply this same thinking independently to the procurement function, we should get something like this:
Before I get into the explanation of this model, let’s first define the parts:
I define sourcing as the act of attempting to find a supplier that best fits a procurement need. The need could be the lowest price possible, but it could also be to have the good/service for a certain date or which respects a specification (quality, size, etc). I divide sourcing into three parts strategic sourcing, tactical buying and ad-hoc sourcing.
Strategic sourcing involves deliberate procurement planning for a defined set of spend. It is usually driven as a project which includes multiple dependent steps and culminate in one or many RFx events (ie. RFI – Request for Information, RFP – Request for Proposal, etc). In very complex procurements where one supplier cannot supply all parts (ie. government ships, aeroplanes, etc.), this may be a huge undertaking. The goal of strategic sourcing is to lock in the largest, recurring, forecastable portions of the company’s spend according to the company’s priorities (quality, price, etc). This creates the conditions needed for accurate financial planning of purchases.
Tactical buying involves running a quick supplier query process (usually something like a “3 bids and a buy” RFQ (request for quotations) for any spend over a certain threshold which isn’t covered by agreements negotiated under the strategic sourcing process. This activity is usually executed by a dedicated, expert team and captures value simply because of the rigor it provides (ie. call three suppliers and get the best price vs. buying from the first supplier you find).
Ad-hoc sourcing is usually done in organizations where the business units (ie. plants) can find their own suppliers. This activity is simply the ungoverned connection of a supplier with a purchasing need, however this is done.
This set of activities aims to formalize the value captured during the sourcing process in a legal contract and a back-end system compatible price list. Once the business is awarded to supplier(s) during the sourcing process, we then start the contract management process which cover the initial authoring of the contract, the creation of a machine actionable price list (ie. outline agreement in SAP which can be read by MRP – Materials Requirements Planning), the management of the contract lifecycle and repository & the contract amendment or renewal processes.
This stream contains the nuts and bolts of the purchasing process; meaning the creation of purchase requisitions by employees in different business units, the approval of these requisitions by approvers in the business units, the creation of purchase orders by a central procurement department (which ensures the purchases adhere to corporate policies and are compliant with the contracts negotiated above), the approval of purchase orders from a treasury (cash flow) perspective, the back-and-forth communications with suppliers and the receipt of goods. Alternatively, if you don’t want to use a central procurement department organizational model, you can do away with the requisitioning process (ie. units can procure for themselves). This is usually where processes get messy, complicated and complex. I include the subcontracting, vendor consignment processes as well as integration with inventory management processes in this stream. Vendor business networks are also covered in this stream and the accounts payable stream as they serve as automation systems for these processes.
This stream is home to the vendor invoice receipt and the payment processes. These could easily be inserted into the operational procurement stream of activities however, as it usually lies in the finance function’s operational scope, I separate it out for clarity.
Firm Infrastructure & Human Resources
This stream represents the organizational structures that are privileged by the company to carry out procurement activities. There are integration points with the HR function in this stream.
Spend Reporting & Procurement Analytics
This stream is present and permeates all streams in the procurement value chain. It represents the activities associated with the access to and enhancement of the entirety of the company’s procurement data regardless of the stream where the data is generated.
This stream represents the governance and architecture of systems that support all procurement activities. This most likely involves integration points with systems used by other functions such as Enterprise Resource Planning (ERP) systems.
Procurement Master Data Management
This stream encompasses all the data governance and creation/modification activities around procurement master data. Who requests, approves and executes the requests affecting procurement data within the company? In an SAP ERP system this would represent the governance and execution activities around vendor masters, purchasing info-record, outline agreements, source lists, quota arrangements, material masters, etc. I also include vendor risk and performance management processes in this stream. I separate this stream from technology because data needs a special, dedicated consideration. If your data is of poor quality, it will paralyze the function’s ability to generate value.
Now that you understand the different parts of the procurement function, primary activities are the ones that directly contribute to the ability of the procurement function to create value for the business (whether that means lower Cost of Goods Sold (COGS) & prices, certain quality levels, deal terms and conditions or precise delivery dates, etc.). Support activities are the ones that support the primary, or “core” procurement activities. The business (or rest of the company) is the procurement function’s primary client and value needs to be the primary output of the procurement function. Value also needs to be defined in the business’ terms – A procurement function is of little value if the business values quality of product, but delivers cost savings instead. Suppliers can also be viewed as clients of the procurement function depending on the type of relationship the function has with them.
There you have it. In a nutshell, that’s procurement. Of course, I’m over-simplifying here but that’s what the rest of this blog is for! There are also many other ways to model the procurement function, but this is the most complete (and satisfying) I’ve come up with during my time in the industry.
What other ways have you seen the procurement function modeled? Do you believe pieces are missing or should be removed? Do you agree with my segregation of primary and support activities?
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