Procurement Process and Cost Analysis

Almost all purchasing decisions include factors such as delivery and handling, marginal benefit, and price fluctuations. Procurement generally involves making buying decisions under conditions of scarcity. If good data is available, it is good practice to make use of economic analysis methods such as cost-benefit analysis or cost-utility analysis. An important distinction made between analyses without risk and those with risk. Where risk is involved, either in the costs or the benefits, the concept of expected value may be employed.

Direct procurement and indirect procurement TYPES Direct procurement Indirect procurement

Raw material Capital Maintenance, repair, and production goods and and operating supplies goods services Quantity Large Low Relatively high Low Tactical Low Low High Strategic Crude oil storage facilities

Frequency High Value FEATURES Nature Industry specific Operational

Crude oil in Examples petroleum industry

Lubricants, spare parts

Based on the consumption purposes of the acquired goods and services, procurement activities are often split into two distinct categories. The first category is direct, production-related procurement and the second being indirect, non-production-related procurement. Direct procurement occurs in manufacturing settings only. It encompasses all items that are part of finished products, such as raw material, components and parts. Direct procurement, which is the focus in supply chain management, directly affects the production process of manufacturing firms. In contrast, indirect procurement activities concern operating resources that a company purchases to enable its operations. It comprises a wide variety of goods and services, from standardized low value [1][2] items like office supplies and machine lubricants to complex and costly products and services; like heavy equipment and consulting services.

What is procurement? The procurement process can be divided into five steps. Define the business need You need to understand what the fundamental business requirement is. At this point, it is important to understand the difference between a requirement and a solution. For example, the business requirement is to source some software to help to get information published on the company intrantet. An item of software to publish information on the company intranet is a solution not a requirement. The requirement is to be able to publish information on the intranet. It may be that an outsourced solution is a better option. Develop the Procurement Strategy Depending on the scale of your project, there could be a very wide range of potential solutions and approaches to your business need and a number of ways of researching the market and selecting a supplier. Supplier Selection and Evaluation After researching the market and establishing your procurement approach, you need to evaluate the solutions available. This may involve a formal tender process or an on-line auction. You criteria for comparing different solutions and suppliers are critical. Weight the key criteria heavily and dont attach too much importance to aspects that will have little impact on the solution. Negotiation and award. Even when you have selected a supplier it is important that detailed negotiations are undertaken. This is not just about price. Think in terms of Total Cost of Ownership. A cheap product is not so cheap if the carriage costs are huge or if the maintenance contract is onerous. Consider carefully the process by which the goods or services will be ordered and approved; how they will be delivered and returned if necessary; how the invoice process will work and on what terms payment will be made. Considering the whole Purchase to Pay process (P2P) at the outset can reduce costs and risk significantly Induction and Integration No goods or services should be ordered of delivered until the contract is signed, but this is not the end. It is vital that the supplier is properly launched integrated. The P2P process needs to be in place and need to be understood on both the buy-side and the supplier side. Any service levels that have been agreed need to be measured and KPIs put in place. Regular reviews should be established.

Strategic sourcing relates to the procurement of direct inputs used in the manufacture of a firm's primary outputs. Such transactions are usually very large (in total quantity and the dollar value) and require the use of special price negotiation schemes that incorporate appropriate business practices. Typically, bids (in response to an RFQ) in these settings have the following properties: 1. The transaction volume is large and the suppliers provide volume discounts that are specified as a curve with a quantity range associated with each price level (e.g., $1000/unit up to 100 units, $750/unit over 100 units), and 2. Often the suppliers provide all-or-nothing bids on a set of items where a special discounted price is offered on a bundle ($150 for 30 units of item 1 and 20 units of item 2, and will not sell the items partially or separately). After receiving such bids the procurer needs to identify the set of bids that minimizes total procurement cost subject to business rules such as: 1. The total number of winning suppliers should be at least a minimum number to avoid depending too heavily on just a few suppliers, 2. The total number of winning suppliers should be at most a maximum number to avoid the administrative overhead of managing a large number of suppliers, 3. The maximum amount procured from each supplier is bounded to limit exposure to a single supplier, 4. At least one (or some fixed number of) supplier(s) from a target group (e.g., minority) needs to be chosen, and 5. If there are multiple winning bid sets then we need to pick the set that arrived first. Identifying the cost minimizing bid set subject to these business rules is a hard optimization problem and difficult to do by hand (as is common practice today). We have developed a bid evaluation engine to provide the decision support required in this setting. Additionally, the engine can be coupled with an existing auction platform to conduct complex auctions (to implement iterative price negotiations) that allow for the above mentioned real-world business practices. This engine has been deployed at a large chocolate manufacturer and is being used by their traders (procurers) to evaluate such complex bids in an auction setting. It is estimated that the use of this decision support tool can reduce procurement cost (by identifying the cost minimizing bid set) by a few percent which could translate into large bottom line savings (in the tens of millions of dollars).