Optimization of purchasing and procurement processes

Kloepfel Consulting GmbH / Services – cost optimization for companies / Optimization of purchasing and procurement processes

Optimization of purchasing and procurement processes

The six pillars of healthy purchasing

More and more requirements, less and less trust. Today purchasers often face challenges and expectations which can’t be solved on one’s own anymore. Materials have to be procured fast, cheap and in high qualities, while causing no difficulties.

And what about employee training and an appropriate number of employees? For those things is no budget planned, because the purchasing department doesn’t account for its own profits. Ultimately it is “only about ordering something”, that can’t be that hard. But who approvingly nods to that, is far from the big picture because the reality is substantially different.

A strong foundation for successful – and cost-effective – purchasing and procuring rests on six pillars:

1. Strategy
2. Processes
3. Organization
4. Employees
5. Methods & tools
6. Controlling

Marc Kloepfel

Executive Board

T +49 211 875 453 23

Those pillars don’t stand for their own but affect each other mutually. Because of this interdependence, improvements are significantly less effective when they are not implemented together. Thus our holistic approach is the most effective way.

The essential importance of strategies for target achievement also holds true for purchasing and procurement. Thus strategic planning for purchasing and procurement departments is needed. The central aspect here lies in the analysis of materials and suppliers. Well though-out bundling of orders save costs and reduces the amount of work, which can be outcomes from more impulsive purchases. In parallel suppliers are organized in a new way, to optimally map the changed ordering processes.

Slimming of order processes is an essential part of process optimization. It shortens the distance between demand and delivery and offers a clear picture. This introduces a system through which employees can send their orders directly to the purchasing department instead of sending unorganised orders to suppliers that the purchasing department has to laboriously track.

Similar to processes it is also about making organizations leaner. One central aspect for that is a clear distribution of tasks and responsibilities in the purchasing and procurement department. Who are the right contact persons for each department? Who orders which product groups? Who signs which orders and contracts? The implementation of E-Procurement software enables a clearly laid out view of all orders and the supply chain.

Each organizational step forward can only be realized with productive employees. A lot of purchasers permanently get more tasks and responsibilities without taking the according training and education into account. The complexity of purchasing and procurement often gets overlooked and employees are not supported adequately. Furthermore trust, responsibility and appropriate salaries are the foundation, on which the management board should build. Motivation does not happen automatically. With individual incentives and adequately recognition purchasers will improve their performance, which in turn positively influences the whole company.

But, engagement is not everything. Execution also has to be done with the right methods and tools. Parts of those are the management of suppliers as well as managing groups of materials. Those tools can help to achieve cost savings in purchasing since e.g. discounts for higher volumes positively influence conditions.

Internal processes can be significantly improved by running ABC-analyses which outline priorities of materials and items as well as cost structures. Often enough there are cost saving potentials in obviously rigid processes, which free liquidity for other usages.

Above all single operations and processes is the purchasing controlling. Through its detailed monitoring of the whole process it ensures that purchasing remains cost-effective and capitalizes existing potentials. For that a structured system of indicators, which overviews all of the firms items, oftentimes is mandatory. Furthermore controlling insights are valuable for the development of material costs as well as aspects of risk management. By having this controlling position the purchasing department can react and decide faster and more flexible in case of market fluctuations.

Purchasing and procurement departments can become a significant driver for profit in just a few weeks, as soon as technical and purchasing departments work hand in hand. But in reality those opportunities are realized to infrequent. Manufacturing, production and development often don’t perceive the purchasing department as a serious partner. All departments speak their own language and have their own viewpoints. Some are technical, some are economical. From the economical perspective the technical departments are “sacred cows”. When revenue has to be increased, management often calls the technical and the sales departments first.

For the engineers, the buyers are often a red cloth. They have fears about cost savings regarding expense of their own department, product quality and security of supply. In addition, the technology is often so busy with projects that any additional change requests are perceived as a disturbance.

The purchasing wants to reduce costs. The technology wants to have the largest budget as possible for the best product quality. Both departments need a common goal and a common language. The common goal must be to always be one step ahead of the competition due to innovations and a better price-performance-ratio, Purchasing and Technology must not compete with each other, they must work together constructively.

On the one hand, the mutual need for assistance and discretionary competence must be defined. The roles of purchasing and technology as well as the rights and duties of team members must be defined. It must be clarified who supports whom, how and where, and who has which rights and duties.

But the prerequisite is that buyers and technicians speak the language of the other. The technicians need a basic business understanding and must be integrated into the management. The purchaser, in turn, must be able to read data sheets and technical drawings. Buyers need to be able to assess functionality, technical issues, compatibility and quality.

If the buyer sees himself as an interface, or rather as a connecting link between the departments, then a lot has already been gained. If these conditions are met, a simple measure, such as a joint barbecue evening, can help to break old patterns of thinking and behaviour, so that purchasing and technology can get to know each other better and openly address possible misunderstandings and conflicts. Building on this, a workshop on specific projects or components is recommended. The following key questions need to be clarified here: What does which department would have liked? Why had someone decided in a certain way? Who had what basis for decision? In this way, caste thinking can be reduced and everyone understands each other’s points of view much better.

The corporate culture and open communications are important to react to conflicts or misunderstandings at an early stage and to eliminate them. In addition, island knowledge must be disseminated across departments through active exchange.

But the buyer can do much more to gain respect.

By doing what the hidden champions, for example, do: Use the supplier as a source of innovation and ideas. It is well known that it makes sense to involve suppliers in product development on an ongoing basis but it is still done too rarely – partly out of habit, partly out of fear to open up, partly because the matching suppliers are missing. Purchasing acts as an interface to the supplier, who delivers ideas as a development partner and helps to accelerate processes.

A carmaker decided to hire an automotive supplier to design a cast iron box instead of constructing it himself. For this, the supplier should be provided with installation space dimensions, functionalities and 3D contour data. Through the cooperation from technology and purchasing, a suitable supplier could be selected to accomplish the task. The prerequisite was the special knowledge of the supplier as well as ongoing and open communication between development and purchasing. As a result, the product became thinner, lighter and cheaper, and everything was done within the time frame.

In general, the supplier does not have to supply only individual parts, but also can put them together and supply assemblies. This has several advantages: Less purchasing effort because fewer parts have to be scheduled, cheaper storage, simplification of procurement logistics, shorter replacement times, less capital commitment and lower production costs.

What sounds provocative at first glance for engineers turns out to be a real treasure mine for the company. A look at the following figures is undoubtedly worthwhile: In mechanical engineering, for example, around 60 percent of the costs consist of purchased material. Here, technically experienced buyers as well as suppliers must be involved in product development at an early stage. This involvement of purchasing and suppliers makes it possible to inform the technology about cost developments and to correct missing trends immediately. Therefore, purchasing must act as an interface between supplier and technology and must be able to moderate and systematically manage it.

Purchasing must be an active driver of cost reduction projects. But always shoulder to shoulder with the technology. This requires support from top management, but also regular reporting, transparency, de-escalation management and regular training.

Purchasing is not just an ordering department, but can take the reins and act independently. However, there is a considerable lack of this: while sales and marketing are still elevated as profitable departments, purchasing is usually neglected. Buyers lack elementary support from the management: Innovative ideas are not realized, suggestions for savings are dismissed as unimportant. Employee motivation? Not in purchasing. Thus, it is often not paid according to performance, but a fixed basic salary. Buyers with personal incentives would take far more opportunities, negotiate harder and strive for further optimization. Therefore, it is only advisable to give them exactly this motivation and to strive for performance-based compensation.

The daily routine of a buyer is often overloaded with operational work steps. Time for a well thought-out planning is short, people react instead of act. Trusting in proven patterns is not a bad thing, but it can become a disadvantage if the market environment changes and one’s own methods are no longer up to date. The danger of being pushed aside by their competitors because they have recognized their potential is constantly growing. Instead of simple data processing, a strategic purchasing would be much more profitable. For example by outsourcing purchasing and logistics or by establishing new analytical instruments such as the purchasing tracker.
Observe, plan, implement – The adaptation of own procurement to new developments takes place inside and outside the company and requires continuous attention.

“We simply order it ourselves, it works better”. This sentence is often used by specialist departments to order goods on their own authority. Many employees like to forget that there is actually a purchasing department responsible for this. Because many companies are struggling with “Maverick Buying”, the wild purchase. The departments order as they want, which often causes unnecessary deliveries. The reason for this is the lack of acceptance of purchasing. Employees do not trust the buyers to be able to order the required products correctly. The consequences: Excess goods, high costs due to individual orders and a too large number of overpriced suppliers.

This problem can be solved by the principle of material group management. For this purpose, goods are classified into different categories in order to cover similar materials with as few suppliers as possible. The groups are selected by competent employees from purchasing and other departments. In addition, it is extremely helpful to standardize products instead of redesigning each item from scratch, as large quantities of identical components allow the negotiation about discounts.

If production stops, it costs money. It disturbs the internal process and must be avoided in any case. But if important materials are missing, service life is unavoidable. It is possible to order large quantities of products and store them. However, storage costs as well as the risk that the value of the goods will be reduced due to damage or price fluctuations are contradictory. The financial liquidity of the company is also burdened when large delivery quantities have to be paid.

A delivery of goods according to the just-in-time principle is a remedy. It states that goods are delivered at regular intervals and always in the exact required quantities. This prevents the company from getting stuck and at the same time eliminates the risks of storage. However, the supplier must also coordinate his storage and necessarily needs a fixed ordering cycle with constant delivery dates. As a result, purchasing must set clear deadlines by which the orders of the departments are still accepted and processed in order to arrive with the next scheduled delivery. This does not apply to orders for special items that may be required at short notice.

Especially, established companies have supplier contracts that often exist since years. They were set up under the best conditions at that time and did justice to all parties. But over time, both external and internal factors change. The conditions, which were previously favourable, are now no longer acceptable to the company. So if the supplier strictly sticks to the agreed purchase quantities and prices, there will be no happy end in the business relationship.

A renegotiation of the contracts is pending: The prices have to be adapted to the market level and unnecessary costs have to be saved. Purchase quantities are made more flexible and aligned according to the needs of the buyer in order to be able to compensate for order fluctuations. If one approaches the suppliers as a customer with these wishes, experience shows that about half will meet the requirements. The rest will either negotiate compromises or reject any negotiations. Thus, three quarters of the suppliers can conclude new contracts.

Of course, it is extremely practical if all required goods can be ordered from one supplier. But this also creates a relationship of dependency. When an entrepreneur relies on a supplier and even gears production towards him, he puts himself in an unfavourable position. A supply bottleneck leads to downtimes and the company can hardly oppose a price increase with any leverage. If the supplier changes the design or quality of his products, the buyer must also change.

The situation is different when several suppliers offer product standardization. If one of them fails, this can be compensated quickly and easily. Multi sourcing is more complicated to coordinate, but it is worth it. Through the existing competition suppliers will make better conditions and offer more flexibility. Equally helpful is the bundled allocation of orders, whereby all similar goods are covered by one or two suppliers. Thus, maximum volume discounts are achieved for the same purchasing volume.

Have you ever wondered if foreign suppliers could be worthwhile for you? Many entrepreneurs will deny now. Lack of quality, long delivery times and high shipping costs. In addition, the problems with language barriers and foreign customs. The effort does not seem to outweigh the benefits.

But in reality, global sourcing has potential. Suppliers from Eastern Europe or Asia may be far away, but their quality is approaching western European standards, with prices remaining low. Supply chains are becoming ever more stable and faster, and the global language of English makes communication better than before. Although low delivery volumes are not profitable yet, larger orders are well worthwhile. For this, a company needs two essential prerequisites: Firstly, a strategically enterprise resource planning in order to be able to place orders ahead of time. This intercepts fluctuations in the delivery time. On the other hand the possibility to store larger quantities of goods and thus to secure volume discounts and bundled shipping costs.

So there are numerous possibilities to realize savings in purchasing. The prerequisite for this is the willingness to make even major changes. Interim solutions and half-hearted experiments will bring about the same improvements. In order to achieve clear profits, you need competent personnel and expert knowledge. Many buyers can come up with this, but are limited by the management in their scope and cannot apply their knowledge. In other situations, the appropriate employees simply lack the necessary knowledge to identify the weak points in their company. Here often only external support helps, be it through specialized consulting firms or advice from the business environment. Even a look at your competitors in some cases reveals new possibilities. No matter how it’s approached: A look at procurement is worthwhile.

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