The simple Supply Chain: Part II – Procurement

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Haggling

Introduction

In the first part of this series, The simple Supply Chain art I – Logistics, I presented the four basic categories of supply chain logistics, which included inventory control, tracking and transportation in the most basic of forms. In this article I present the case of the simple procurement process and explain the difference between procurement and purchasing.

Procurement or Purchasing

Purchasing is the buying process; it starts with knowing what needs to be purchased, and includes sourcing for suppliers, negotiating contracts and closing the deal. Procurement includes the logistic aspects that go with purchasing, as such, Procurement contains purchasing and logistic functions.

Everyone is a Buyer

From the moment you pulled out your first pocket money and bought your first gum, you became a buyer. Everyone knows how to buy, and a lot of the general public also know how to shop, and some are even good at haggling. The basics of purchasing, which is the buying process, is based on the simplest of principles, and even when you include Porters 5 Model, you still end up with the same process, but in a more informative manner.

There are many tools in purchasing, and the more complex the device or material, the more complex the choice, the negotiations and the contracts required to procure them. There is a big divide between being an informed shopper, and becoming a purchaser, and even in the purchasing business, there are three different categories of specialty that split the purchasing department through professional competence. These three specialties are sourcing and intelligence gathering, negotiating, supplier auditing.

So, while everyone is a shopper, not everyone is a successful sourcer, and most definitely not everyone is a great haggler or negotiator.

The Five Purchasing Factors

Purchasing is also very simple, it is broken down into five elements, and these include:

  1. Sourcing: the process by which you find different suppliers and different alternatives or substitutes for your materials.
  2. Intelligence Gathering: the process where you learn about the market, the different levels of influence that affect each item, and information about your suppliers.
  3. Negotiating: the process where you either haggle, negotiate or discuss purchasing terms with suppliers.
  4. Tracking: the process where you track your orders until they reach their destination.
  5. Supplier Auditing: the process where you audit your suppliers for conformance to standards and regulatory requirements.

Common Sense

Now, it might seem that procurement is complex and that when compared to the supply chain process, is extremely convoluted. However, procurement is actually a very simple process if you use the right tools. Sort of like using the right spanner with a dab of WD40 for the bolt.  Common sense is taking the procurement process and breaking it down into its five elements, and then concentrating on each one with a dedicated focus.

Elemental Simplicity

Before we take a look at each of the five elements of procurement and understand their simplicity, there is one key issue to comprehend: language.

Language can be simple or confusing and in the hands of those that want to seem clever than they really are, long weird and rarely used words become a common occurrence in their descriptors. The best suppliers use simple language, even when describing what some might consider being a complex piece of machinery or process, such as a micron electroscope, or a blockchain ERP system, or a special ink that changes color when egg’s go past their prime.

Simple language conveys a simple message; we are here to help you. Complex language conveys a complex message; we are here to confuse you.

Now that we have this message behind us, let’s look at the simplicity of the elements:

  1. Sourcing: Sourcing is based on two legs, the first is knowledge, the second curiosity. A great sourcing expert will know how to ask the question and ask it.

Knowledge of the product is not just knowing what you want to buy; it’s knowing what the product is for, what it is made of, which alternatives are available, and what substitutes can be considered.

Knowledge is knowing where the product originates, and how diverse its sources may be. Based on these data sets, the expert sourcer will start to ask questions that lead to larger and more diverse sourcing for the product. Unless a specific bespoke product is required, there are many sources for everything.

Good sourcing is about continuous exploration and updating the database of the product alternatives, substitutes, and suppliers.

  1. Intelligence Gathering (IG): Intelligence gathering is straightforward reading, listening, and recording information about suppliers and markets.

Unlike sourcing, IG is all about understanding the nature of the markets, the financial markets as well as the commodities, the IT markets, and all the information about shipping, transportation and related subjects around the product but not focused on it.

For instance, if you buy copper tubing, then your IG would be about the current copper prices, the state of global mining and stock levels, as well as the nature of the conflict that might affect your sources of copper tubing. You would also read up all about your suppliers and their competitors, understand the nature of their markets, their performance, and what is happening in their world. You will also investigate substitutes, such as Plastics and other metals that are used as substitutes, and discuss them with the engineering department when considering design changes to reduce costs and supply risks.

The bottom line is that IG is all about gathering knowledge and understanding the world around you and how it affects your supply chain.

  1. Negotiating: Some claim that the greatest negotiators are those that can haggle in a Moroccan Souk. Well, that is only partially true. When it comes to negotiating contracts, there are many elements in a contract that need to be considered, apart from the price.

Successful negotiation is not about beating the supplier and getting a great deal; it is about partnering with the supplier to provide a perfect service.

Negotiations are about understanding each other, the supplier needs to understand your needs, and you need to understand the supplier’s capabilities of meeting your needs.

The bottom line of negotiations has changed, and Porters 5 forces is still an important method that explains how to be prepared for a negotiation process. However, it does not teach you how to negotiate.

There are different levels of negotiation for different levels of purchasing. For instance, when purchasing office supplies, you tend to go for an annual framework contract, so negotiations will be around availability and price. The negotiations for a heat treatment using specialized metals such as Platinum to coat Jet engine blades will require much more careful consideration of the prices of platinum, the dates of the process, and the exchange rates.

As such, negotiations are all about focusing on the unique attributes of a contract, getting them agreed upon. After reaching an agreement on the technological issues, you will then need to agree on the supply chain issues. These include the type of delivery method, how many per time frame, and other issues that take into consideration understanding the supplier’s production process and planning a schedule together.

The bottom line is that true negotiations is not haggling in a souk, it is creating a partnership that benefits both sides so that both parties are happy with the contract. An unhappy contract will always end badly.

  1. Tracking: This is a very basic process, but a very key and important one. Tracking starts at the supplier and follows the resources all the way to the delivery site.

Tracking can be manual, such as calling a supplier and asking for a status report, or it can be digital, where RFID shows you exactly where and how much of a resource.

Tracking is key to successful supply chains, and the tracking process has to be as transparent as possible so that all the stakeholders are updated. This requires a comprehensive ERP/MRP system that has tracking status built into the software. It’s not enough that you have accurate lead times, you need to have a “memo” update blog in the system that is filled in on a frequent basis, stating the date and time of the update, so that everyone knows where the product is within the supply chain process.

A good tracking system is an integral part of any good ERP/MRP system, and a good tracker knows how to create constant transparent updates in the system.

  1. Supplier Auditing: After signing a contract it is imperative to maintain a vigil over the supplier’s capabilities to constantly deliver quality goods.

A quality good is a product that meets the requirements of the contract. Supplier auditing is understanding the supplier’s process, as such, different suppliers require different professional proficiencies, such as the difference between IT and Chemicals.

For manufactured goods, raw materials and such, the audit process must be performed by a skilled professional on-site at the supplier’s location. For services, or bought parts, it is sufficient to perform a rudimentary proficiency audit by either the procurement specialist or the stake holder’s representative.

The Procurement 5

Just as Porter has 5 forces, procurement has 5 basic tools for evaluating and deciding which product to take. These include:

  1. NLPP: Non-Linear Performance Pricing which is used for products and materials that have only one or two performance levels to meet.
  2. Full Specification Performance Comparison: Where complex equipment must be compared for key performance features, each unique to the specific device or tool.
  3. Supplier Performance: A process where you audit the supplier for meeting demands, which includes both quality and quantity of goods.
  4. Binary Decision Making: A stepwise decision-making process based on binary question results.
  5. Common Sense: Obviously I would include this, after all, some decisions just boil down to making a common-sense decision.

A word on NLPP and other comparative models. Essentially, it is down to common sense and a good Excel sheet, or perhaps a bespoke purchasing software that provides you with a lot of analytical models to compare between products. At the end of the day, no matter what tool you use, even deploying AI with ML and DL, will eventually lead you to make a decision based on what you think is better out of a number of equally high-performance products supplied by equally efficient and reliable suppliers.

Tip: Don’t rely on internet reviews, you are not going on a holiday, you are buying professional resources, and must rely on professional information sources.

A word on CAPEX

CAPEX is split into three categories: Direct, Indirect, and Administrative. It doesn’t matter which CAPEX you buy, the cost is always going to involve the higher-ups, and in most cases, the CEO or CFO will lead the decision-making process. As such, the role of a procurement executive is to support the decision-making process by providing as many alternative solutions that were provided by the stakeholder that owns the CAPEX.

Just know this, there are three methods to deciding when to spend on CAPEX:

  1. When starting something new; this is the hardest CAPEX to provide alternative solutions, since you do not have a benchmark to base your recommendations on.
  2. When upgrading something; Here you have a benchmark, and can perform some serious IG and Sourcing to provide alternatives and substitutes.
  3. When replacing an old CAPEX; like upgrading a line, in this case, the decision to replace an old CAPEX will either come from new technologies that demand you replace the old one, or from old CAPEX whose cost to maintain is too high.

RFx

Yes, those three letters that put fear into the minds of those that must write them, and trepidation into those that must apply for them. Essentially an RFx is a method to define exactly what you want. There are online formats and tools for creating a standard RFx, and most software companies provide such a module in their ERP systems.

The solution to RFx is the product definition sheet, which is a comprehensive breakdown of the product into its functionality, dimensions, materials, models, and alternatives. A good procurement system will have a database of comprehensive product definitions, and sending out RFx’s will become an automatic process, curated for specific requirements, but drawing on the product definition sheet to speed up the process.

The Commons Sense Principle

Procurement, purchasing, as part of a supply chain, or as a standalone is all about common sense. In some instance, where the decisions are complex due to the nature of the products being bought, the procurement executive will need to focus on only four aspects of the process:

  1. Does it conform or exceed the requirements?
  2. Is the source reliable (supplier and logistics)?
  3. Do I have alternative sources to mitigate risk?
  4. Do I have annual or long-term contracts for speeded PO fulfillment?

These four make up the basis of common sense:

  • Where you know if the product meets or exceeds the requirements, that’s common sense.
  • Where you established the reliability and quality of the suppliers, and the logistic routes, again, common sense.
  • Where you create alternatives for supply to mitigate supply issues, which is the most basic of common sense.
  • Where you create as many long-term contracts to speed up the request/PO authorization process, reducing time as frustration, this too is common sense.

A Word on Category Buying

The difference between a “standard” purchasing executive and a “category specialist” is in the mix of products the executive needs to handle. As such, a category executive is someone that concentrates on one category, such as coat hangers, or pneumatic drills, and knows the market inside out. Every product within the category and its spare parts, the maintenance and substitutes are all in the executives grasp and knowledge base.

Essentially, a category specialist is someone that knows all there is about a specific category and is the go-to person for that specific demand.

Conclusions

The procurement/purchasing side of the supply chain is a simple system that has its own complexities in place, but the basic process is based on five specific areas. Issues may arise in each area, to mitigate them you just need to view the system in its five elemental blocks and concentrate on providing a solution to each issue as and when it arises.

Final Tip: There are only a few individuals that are experts in all five elements of procurement, in most cases, the world is split between three definitive groups (which one are you?)

  • The Negotiators and Contract Specialists: great at negotiations and creating harmonious contracts.
  • The Sourcing and Intelligence Gatherers: Great at gathering information and processing data to provide key insights for decision making.
  • The Auditors: great at tracking, processing and auditing suppliers.