Home > Articles > Marketing

The Fundamentals of Procurement

  • Print
  • + Share This
One reason there is so much confusion surrounding the e-procurement marketplace today is that the press so often lumps all procurement into a single group. This is not the case; and there are several key distinctions that should be made when considering your company’s e-procurement strategy. Get a complete overview in this article, excerpted from e-Procurement: From Strategy to Implementation (Financial Times Prentice Hall, 2001, ISBN: 0130914118).
This article is excerpted from the author's book e-Procurement: From Strategy to Implementation (Financial Times Prentice Hall, 2001, ISBN: 0130914118).

Objective: One reason there is so much confusion surrounding the e-procurement marketplace today is that the press so often lumps all procurement into a single group, as if all purchasing techniques and all commodity groups required the same systems and same approach. This is not the case; and there are several key distinctions that should be made when considering your company's e-procurement strategy.

  • Procurement materials can be broken down into two major categories: indirect and direct.

  • Indirect procurement involves any commodity or service that a company buys that does not result directly in finished goods.

  • Indirect procurement can be divided into two groups: ORM (Operations Resource Management) materials such as office products and travel services, and MRO (Maintenance, Repair and Operations) materials such as replacement parts.

  • Direct procurement involves materials purchased for use in the manufacturing or distribution supply chain that are "directly" related to the production of finished goods.

  • With e-procurement, the traditional division between direct and indirect purchasing paths is beginning to blur.

Traditionally, procurement has been broken down into two major categories: indirect and direct. In general terms, indirect procurement describes all of the day-to-day necessities of the workplace—staplers, paper, furniture, laptop computers, pencils, travel services—those things that tend to be of low value per item, but are usually bought in high volumes.

In the typical company, indirect procurement accounts for 60% to 80% of all purchasing transactions.

Direct materials, obviously then, are those involved in the manufacturing supply chain that are directly related to the production of finished goods. These materials tend to be purchased in large volumes, and depending on the level of sophistication of a company's forecasting and planning capacity, are, at least to purchasing specialists, fairly predictable in name, if not in exact amounts. Purchasing officers in aluminum manufacturing companies know they need to procure certain quantities of bauxite and aluminum at certain times during the manufacturing process. High-technology manufacturers know that they will require microchips, wiring, and other components. Procurement of direct goods, then, is of concern only to manufacturing, distribution, or retail companies—those that create, assemble, or move large numbers or amounts of finished or perishable goods. Because of their predictability and high volume, procurement of direct materials accounts for far fewer purchasing transactions (between 20% and 40% in manufacturing companies), but can account for up to 60% of a manufacturing firm's total procurement expenditure. ("E-Procurement: Unleashing Corporate Purchasing Power," Time, Inc.).

Indirect Procurement: ORM Versus MRO

The term ORM (Operating Resource Management) is now used commonly to describe the many ordinary office products and services that organizations purchase day-to-day: office supplies, furniture, forms, travel services, computers, janitorial and maintenance services, light bulbs, extension cords, and the like. Usually thought of as high-volume and low-dollar items, they nonetheless amount to a significant portion of a company's total spending. To give some idea of the scale, in the U.S. alone in 2000, the overall market for ORM products and services reached $725 million.

Over the years, the abbreviation MRO—for Maintenance, Repair and Operati—has come into popular use, and today most software vendors selling solutions for indirect materials (and, therefore, the popular business press) have begun to mistakenly lump all indirect goods together under this heading. But there is an important distinction that should be made. Office products should not be confused with mission critical overhaul or maintenance items. In purchasing, the two groups of goods are often known as white collar ORM (staples and notepads) and blue collar MRO (replacement parts); and the respective purchasing processes in terms of the levels of complexity, cost, and volume, vary enormously. Many analysts believe that MRO is in fact the much more important of the two.

"In spite of the current hype about the ability to buy office products or janitorial supplies over the Web," contends Lisa Williams of the Yankee Group, "the real 'gating' factor to growing this B2B e-commerce market will be the use of the Internet to manage and procure mission critical items such as component parts, expensive plant spares, and outsourced manufactured items." ("E-Procurement: The Transformation of Corporate Purchasing," Time, Inc. in association with AMR Research, Inc., May 2, 2000).

Certainly, procurement of white collar indirect supplies tends to be less complex than procurement of blue collar, or industrial, MRO, for obvious reasons. Indirect goods are seldom time or mission critical, and as important as pencils or notepads are, items like these can be purchased from any number of wholesale—or retail—vendors, each selling similar, if not identical, brands. These items can easily be described and cataloged—black ball-point pens or bond white liquid paper—and therefore do not require the specialist expertise necessary when purchasing complex electrical repair components or highly-engineered machine parts necessary for maintenance of complex manufacturing equipment. After all, it is much easier to quickly look up in a catalog—or run down to the local retail outlet—to purchase paper clips than it is to search for and procure a specially tempered, metal valve stem.

The consequences of misordering are also obviously different. Getting the wrong color ball point pen is bad, but buying the wrong shear pin or gasket for a critical assembly-line component can be catastrophic. Also blue collar MRO orders are often single-sourced, purchased in limited quantities, and are necessary to prevent the shut-down of the production lines. Blue collar MRO orders can easily amount to several hundreds of thousands of dollars, and require special service contracts. Blue collar items are often listed as inventory, tied into the company's inventory system, and accompanied with critical and complex design and performance regulations. Purchasing and maintenance employees often need to do a good deal of time-consuming prescreening of suppliers in order to understand which vendors will be trustworthy. MRO buyers are usually looking for high levels of quality control and technical support from their suppliers, so that replacement parts are delivered quickly, often at a few hours' notice. As a result, the average company uses up to 50 different MRO suppliers, and over a third of U.S. companies use 50 or more. (Miklovic, D., "The MRO E-Procurement Civil War: Blue vs White," Gartner Advisory Research Note, Tactical Guidelines, The Gartner Group, February, 2000, pp. 2–3; "Survey: How Companies Order MRO Supplies," Modern Distribution Management, February 25, 2000, p. 6.)

Table 1 A comparison of white collar ORM and blue collar MRO. (Source: The Gartner Group)

Issues

"White Collar" ORM

"Blue Collar" MRO

Number of Orders

Moderate

Often hundreds of thousands

Quantity per Order

Few to moderate

Varies from one to thousands

Delivery Criticality

Generally low

Routine to critical to the point of work stoppage for delivery failures

Ratio of Single Source

Low

High percentage (up to 30% by count, more by value); may be single/very limited sourced

Services/Contracts

Some

Almost always required—performance is critical in many cases

Accounting Tie Back

Generally only to a GL account

May be multiple—to work order, equipment, GL and other accounts, capital tie back as well

Controlled Inventory

Rarely

Always

Internal Item Master

None

Frequently—usually critical functionality

Vendor Performance Measurement

Minimal—usually by contract

Almost always—variable measurement criteria


There are two key cost areas in indirect procurement. The first is simply the straightforward inefficiency and labor-intensity of the process itself. For most companies, the centralized purchasing function has traditionally been responsible for buying a good portion of all indirect, non-production goods—whether blue or white collar—with around half of the workload of a typical purchasing department dedicated to these low-value, repetitive orders. The average level of productivity for this area is appalling, and it is one of the most labor-intensive areas of modern business.

Part of the problem is that indirect procurement policies are seldom standardized in large or multisite companies, varying greatly between departments and between branch and corporate office. The accompanying approval policies are usually cumbersome, sometimes requiring multiple levels of sign-off, which causes delays and internal inconvenience when employees wait for needed items and middle management staff members put off signing burdensome paperwork. In exasperation, approval thresholds are raised, and spending anarchy ensues, with only the larger ticket items falling into an even more stringent and extended approval process.

There is a second area of cost. For most companies, this cumbersome, centralized process is augmented by independent, or maverick, buying by employees throughout the organization who buy items—paper, scissors, light bulbs—when needed independently, often at nondiscounted and even retail prices. This maverick buying—that tendency for individuals, or often entire departments, to buy "off-contract" without taking advantage of negotiated company discounts—is often rampant, particularly among larger companies, and typically can account for a staggering average of between 30% and 45% of all indirect procurement spending. To put the effect of this maverick buying phenomenon into perspective, consider that at these rates a typical billion-dollar company would be losing up to $10 million each year just in lost discounts alone. The smaller the company, the less formal the process, as a rule, and for those non-manufacturing companies that do not see purchasing as a core competency, a frightening 84% of indirect materials are purchased simply by employees visiting their local retail outlet. ("Survey: How Companies Order MRO Supplies," Modern Distribution Management, February 25, 2000, p. 1–2.) This "rogue buying" can be a significant cost to companies, and even a modest reduction in maverick purchasing can significantly cut procurement costs.

  • + Share This
  • 🔖 Save To Your Account