Overview of the Procurement Function

There are many ways to conceptualize a Procurement function. My favorite way is using a value chain diagram. Before getting to the Procurement function, here’s a quick primer on the value chain concept.

What is a Value Chain Diagram?

A value chain diagram illustrates the various activities and processes involved in delivering a product or service to the end customers of a business, from the initial sourcing of raw materials to the final distribution and after-sales support. Introduce in 1985 by Michael Porter, the underlying assumption of a value chain is that a business’ reason existence is maximizing value for end customers and capturing that value in the form of a profit margin.

The following figure illustrates a generic value chain in the context of a manufacturing firm:

Quite simply, a company has primary activities which are directly responsible for the creation of value to the customer through production, warehousing, 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 and minimizing overhead costs for the company (think: administrative functions). This aggregated creation of value is captured in the form of a profit margin when the good/service is sold 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 capture margins and generate profit. When I meet Michael Porter, I will 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 time… (“Without Procurement, how can you do anything else?! You don’t have any raw material!”)

Applying the Value Chain Concept to the Procurement Function

If we apply the “value chain lens” to the procurement function as a discrete entity, treating the rest of the organization as our internal customer, we get something like this:

Procurement can be divided into primary activities (the main processes that justify the function’s existence) and secondary activities (the supplementary processes that ensure a high-performing set of primary activities) that, together, generate value for the rest of the business.

Value is a fluid term… You need to define it in your specific context. For example, a Procurement function is of little importance if the business values quality of raw material above everything else, but your Procurement function has a single-minded obsession on cost savings instead.

Therefore, developing a high-performing Procurement function is about aligning and optimizing all of the function’s activities to maximize value generation for internal clients, as defined in your business.

With this assumption in place, we can examine the constituent parts of the “Procurement Value Chain.”

Procurement’s Primary Activities

1. Spend Analysis & Category Management

Spend analysis is the act of analyzing the overall company’s spend profile, breaking it up into logical categories of spend and spotting trends, patterns and opportunities to generate value for the business.

Based on your company’s spend profile, some categories of goods (e.g. chemicals, MRO parts, office supplies, professional services, etc.) will represent large portions of your company’s overall spend and will offer up more opportunity to generate value than others. Goods and services with similar characteristics and markets will therefore be grouped into purchasing categories for analysis and strategy elaboration.

Category Management refers to the activities related to developing Procurement strategies by purchasing category in an attempt to maximize business value. By considering our internal purchasing requirements in a given category and matching these with the dynamics of the external market (e.g. using tools such as a SWOT analysis), we can elaborate a strategy to maximize the value gained for each dollar spent by the business in that category. We then move onto sourcing processes to execute on our strategy.

2. Sourcing

Sourcing is the act of finding suppliers that best fit business needs. These needs could be the lowest price possible, but they could also be a given required delivery date or strict specification (quality, size, etc.). It’s important to define these needs clearly before engaging in a Sourcing process.

Sourcing is divided into three parts Strategic Sourcing, Tactical Buying and Ad-hoc Sourcing:

• Strategic Sourcing involves executing on a previously defined category strategy. We execute on this strategy using various go-to-market tactics. Sourcing projects will typically include one or many RFx events (ie. RFI - Request for Information, RFP – Request for Proposal, etc). In very complex sourcing projects where one supplier cannot supply all the requirements of the category (i.e. government ships, airplanes, etc.), this may be a huge undertaking. The goal of strategic sourcing is to lock in the largest, recurring, predictable portions of the company’s spend according to the company’s priorities (quality, price, etc.) with advantageous terms and conditions. This creates conditions of certainty needed for accurate financial planning and operations planning. Typically, strategic sourcing will feed into the contract management process.

• Tactical Buying involves running a quick query process with supplier with a well-defined requirement (e.g. a “3 bids and a buy” RFQ (request for quotation) 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 (i.e. call three suppliers and get the best price vs. buying from the first supplier you find). This is typically the process applied to managing Tail Spend. It can also sometimes result in a trigger for the contract management process.

• Ad-hoc Sourcing is usually done in organizations where the business units (i.e. plants, offices) are responsible for finding their own suppliers (or at lower spend levels in organizations where central Procurement is in place). This is simply the ungoverned connection of a supplier with a purchasing need with various amounts of rigor. There is no central, consolidated view of requirements to determine the best way to purchase. Goods and services are purchased reactively when needs arise.

3. Contract Management

This set of activities aims to formalize the value captured during the sourcing process using a legal agreement and, when applicable, a back-end system compatible price list or catalog. Once the business is awarded to suppliers during the sourcing process, the contract management process starts and covers the initial authoring of the contract, negotiation, and signature of a final agreement. Contract execution (e.g. creation of a machine actionable price list, such as an outline agreement in an ERP system), post-signature management of the contract lifecycle, contract amendments and/or renewals are also part of the contract management process.

4. Operational Purchasing

Once a contact is signed and/or an ad-hoc sourcing exercise completed, we proceed to the actual purchasing of the goods or services with a supplier. This includes the creation of purchase requisitions by employees in different business units, the approval of these requisitions by designated approvers, 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 as needed, the back-and-forth communications with suppliers to confirm/adjust orders 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 (i.e. units can purchase for themselves). This is possible but usually when processes get messy, complicated and complex because everyone does them differently. Any special types of purchasing, such as subcontracting or vendor consignment in this sub-process.

5. Accounts Payable

This stream is an integral part of the end-to-end operational purchasing process (we need to pay after we purchase…) but is separated into it’s own process because in most organizations, finance is responsible for payments and not Procurement. The Accounts Payable process beings at vendor invoice receipt and concludes at payment, after any invoice exceptions are identified and resolved (e.g. pricing is wrong on the vendor invoice when validated against the purchase order).

6. Supplier Relationship Management (SRM)

The Supplier Relationship Management process supports the entire end-to-end process chain listed above. SRM activities begin during the first contact with a supplier and end when a relationship with a supplier is terminated. The precise activities differ by business but they include supplier onboarding, supplier classification, supplier qualification, supplier risk evaluation and mitigation, supplier performance management and, ultimately, supplier offboarding, when required.

These 5 core processes are how Procurement fulfills its fundamental purpose for the business. They are the function’s primary activities without which, the function can’t exist. The following secondary processes help the function achieve it’s mission more efficiently.

Procurement’s Secondary Activities

7. Organizational Design & Human Resources

This set of processes represents the organizational structure and people management processes set up by the company to carry out procurement activities. In Procurement, the organizational structure will typically include roles such as the Chief Procurement Officer, Category Managers, Tactical Buyers, Operational Buyers and AP technicians supporting primary activities while different type of analyst roles may support secondary activities. Performance management will either be tied to a corporate process or developed specifically for the function in smaller businesses.

If Procurement doesn’t take an active interest in managing this stream, Human Resources takes on most responsibilities given these processes are part of their core functional duties.

8. Procurement Technology Management

Procurement Technology Management represents the governance, architecture, implementation and support of systems and solutions that support procurement’s activities.

If Procurement doesn’t take an active interest in managing this stream, the Information Technology (IT) department takes on most responsibilities given they are part of their core functional duties.

9. Procurement Master Data Management

Procurement Master Data Management encompasses all the data creation/modification and governance activities around procurement master data. Who requests, approves and executes the requests affecting procurement data within the company?

For example, 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.

This might seem like a duplicate of technology management but managing data requires a different skill set. Even with great systems/solution in place, poor data quality will paralyze the function’s ability to generate value.

10. Process Management and Continuous Improvement

Process Management and Continuous Improvement is the rigorous, dedicated documentation, management and systematic improvement of your Procurement function’s business processes. Like master data, it may seem like this should just happen automatically within the other processes but, by experience, it requires a different set of roles and skill sets to achieve the desired results. You can see what I mean by reading my primer on Procurement Business Process Management.

There you have it. In a nutshell, those are the components of a high-performing Procurement function. There are many other ways to model the function, but this is the most complete (and satisfying) I’ve come up with during my time in the industry.