What is Procurement, Purchasing & Everything in Between?

What is Procurement? In this article, we will explain the meaning of procurement and the difference between procurement, purchasing and other related terms.

1. What is Procurement?

Procurement has become a very effective tool for company of all sizes to cut costs and improve customer's satisfaction. However, this term has different meaning to different people. 

Anyway, procurement can be defined as below:
“Procurement refers to the participation in the development of requirements and their specifications; managing value analysis activities; conducting supply market research; managing supplier negotiations; conducting traditional buying activities; administering purchase contracts; managing supplier quality; buying inbound transportation” - from Purchasing and Materials Management Text and Cases by Donald Dobler

2. What is Purchasing?

Another confusing term is “Purchasing”. People often use the term “Purchasing” and “Procurement” interchangeably. Anyway, we would like to talk a little bit about the definition from Purchasing and Supply Chain Management: Strategies and Realities by Michael Quayle as below,

"Purchasing refers to the process by which a company contracts with third parties to obtain goods and services required to fulfill its business objectives in the most timely and cost-effective manner"

3. What is the difference between Procurement and Purchasing?

We are totally OK when people use the term Procurement and Purchasing the same way. The most important point to remember is that, Purchasing focuses on day-to-day or short term planning while Procurement focuses on long term planning or strategic planning.

4. What is Outsourcing?

Outsourcing is basically how a company asks external parties to perform some tasks that originally done in-house. Outsourcing is considered the fast way to cut costs if executed properly. However, there are some golden rules you should follow as below,

- Don't outsourcing core competencies: don't outsource your activities that are rare, difficult to imitate or difficult to substitute

- Don't selecting wrong vendors: vendor with lowest price is not always the best case, revenue increase from the value added services can be a good alternative

- Avoid drafting poor contract: create a clear and concise contract in stead of a loose contract

- Don't overlooking personal issues: employees see outsourcing as an underestimation of their skills and they can be counter-productive,then, open communication is the key

- Take helm of outsourced activities: retain a small group of people with appropriate skills to manage and control vendors

- Do plan the exit strategy: avoid sole outsourcing and always have some backup vendors

5. What is Offshoring?

Obtaining products or services from outside the country to achieve cost effectiveness is one of the most widely used strategy. Offshoring encompasses two meaning,

- Moving your OWN factory out of the country (insourcing) 

- Asking vendors in foreign countries to make products and services for you (outsourcing) 

Why a company chooses to do offshoring in the first place? The biggest motivation to do offshoring is to cut cost. However, a company should also consider these offshoring costs below,

- Cost of facilities and utilities
- Landed material cost
- Labor cost
- Outbound logistics cost
- Interest rate and insurance
- Tax and duty

Some hidden costs of offshoring should also be identified as below,

- Shortage cost
- Loss from poor quality
- Loss from lower utilization 
- Payment of bribes
- Loss from exchange rate
- Cost of control

6. What is Reshoring?

Reshoring is how to bring insourcing or outsourcing activities back to your own country. In the past couple of years, there are the increasing interest to bring manufacturing back to home country. Other than the government policy in the U.S., people are considering reshoring because,

- Expected benefits of offshoring can't be reached 
- Cost is higher than expected 
- Rising labor cost 
- Currency risk 
- Quality problem
- Problem with trading partners abroad
- Infrastructure is not reliable
- Difficult to control
- Need to be near market/R&D

7. What is Supplier Relation?

Supplier relation is the way trading partners interact with each other. Based on theoretical background, there are 4 types of supplier relation as below,

- Transactional Relationship or Arms Length Relationship (no formal relationship)

- Basic Alliance (some level of trust and open communication)

- Operational Alliance (constant communication about capacity and demand/supply issues)

- Business Alliance (each party depends of specialized products / services from each other)

- Strategic Alliance (long-term commitment, resources sharing)

8. What is Supplier Relationship Management?

Supplier relation is a strategic decision, but it's usually formed by the top management or formed with the existing customers or suppliers. Anyway, supplier relation seems to start naturally the same way as human relationship.

To management supplier relation properly, supplier relationship management practice should be in place. There are some guiding principles for supplier relationship management as below,

- Avoid knee jerk reaction: don't form alliances based on actions of your competitors. Alliance should be formed based on the mutual interests, benefits or common goals, not just because your competitors has formed the alliances with someone else.

- Focus more on how to work together: because a strict contract terms kill relationship.

- Track alliance progress: when a company needs to make an investment in certain resources, they tend to focus on a financial goal or a return of investment. In order to achieve fullest potential of the alliances, company should instead track the alliance progress such as quantity and quality of information sharing, business ideas, speed of decision making of each party and feedback from the team members.

- Embrace differences: if you look at "differences" on the bright side, you will find that it provides a very good opportunity for your company to benchmark certain business practices against your partners.

- Encourage non-formal interaction: as mentioned earlier, alliance grows the same way human relationship does. So, non-formal interaction may be the opportunity to know personal side which will lead to the openmindedness.

- Manage your internal stakeholders: don't show the internal disagreements in front of your partners ever.

- Plan your exit strategy: some type of alliances are a project based, for example, the new product development or technology exchange. The exit, in this case, means the objective of alliance is achieved. In case certain alliances don't render the mutual benefits, ending it on good terms is the way to do.

9. What is Supplier Risk Management?

Supplier risk management is the important element of supplier evaluation. However, assessment of supplier risk is not quite easy to carry out because of the availability of financial statement.

Anyway, suppliers who are in bad shape will show some signs as below,

- Request shorter payment terms 
- Make generous price discount or increase discount for cash payment
- Loss of key customers 
- Key customers are in financial trouble 
- Delivery performance drops drastically 
- Higher level of defects 
- Change raw materials or manufacturing processes without permission
- High turnover of important positions or long-time staffs 
- Supplier's personnel shows poor morale 
- There are issues with labor unions often 

In order to collect these data, you need to maintain close relationship with suppliers and monitor news related them on regular basis.

10. Further Reading for Procurement

In order to show what purchasing/procurement people can do for the company, we need to acquire more knowledge about procurement and related areas. We would like to recommend further readings as below,

Posted by , the editor of SupplyChainOpz.com