Are you a financial executive at a small-to-midsize company? Are you wondering when it is time to build a procurement function? This is the right place. We also put together a list of what you should be watching in your business and signals to be seeing that indicate it’s an excellent time to implement procurement. These worries cover cost overruns, poorly performing data analysis, and inefficiencies that the centralized procurement team sidesteps.
With this guide, you will have everything you need to know about the procurement department. After finishing it, you will learn about what a procurement department is, its benefits, how to configure it properly, and its core roles. We will also touch on why it is critical to have a purchasing policy in place to help speed up your employees’ purchasing, as we have previously explained in this purchasing policy creation guide.
Table of Contents
What is the Procurement Department?
It is the function that sources the goods and services you need to keep the day-to-day wheels turning in your business. Whether it’s paper clips or machinery, you name it; we will provide it and save you the hassle of procuring the product your organization needs for the best price and quality. Internal shoppers—a corporate shopping service, however, handles the private shopping system inside your company.
These are some other procurement department functions:
- Identifying and sourcing the appropriate suppliers and service providers for goods and services
- Contracting with suppliers to secure favorable terms for pricing, delivery schedules, and payment terms
- Provision of procurement orders
- Monitoring orders and ensuring they arrive in a timely fashion and adhere to the purchase order terms
- Establishing and maintaining close relationships with suppliers
- Conception of procurement policies and procedures for your organization
- Analyzing purchase data to identify cost-saving opportunities
Why Does Your Organization Really Need a Procurement Department?
They save you time, and as an entrepreneur, you might wonder: why would you need a procurement team? The exact answer depends on what you are offering. If you make products from raw materials, you probably have had a procurement process from day one, possibly within inventory or production. However, for service-oriented firms, like software providers, purchasing activities tend to be more siloed within individual departments (such as IT for hardware and software purchases).
One of the most important functions is to expedite contracts and centralize purchasing operations for process enhancement and compliance. Some of the signs that show it is time to onboard a procurement professional to build your dream procurement team are:
- Sourcing Products & Services: The procurement department sources, evaluates, and selects suppliers to secure top-quality goods and services for reasonable prices.
- Compliance: Every procurement task adheres to internal policy, regulatory, and legal requirements.
- Supplier Negotiation: They sit at the table with suppliers to establish the best possible agreements, terms, prices, and conditions.
- Contract Management: They draw up, check, and manage contracts with suppliers to formalize agreements and set out the rights and obligations of both parties.
- Supplier Performance Tracking: They monitor and assess supplier performance based on quality, delivery, and service standards.
6 Indicators That Your Company Needs a Procurement Department
1. Your Company Is Expanding
A clear indicator that your company needs a procurement team is experiencing consistent year-on-year revenue growth. If your company is in growth mode, with double-digit annual increases, your spending is likely rising in tandem to support this growth.
This matters when you are making a good amount of money. The answer is no, not when you’re a start-up with $100,000 in revenue a year, and doubling that doesn’t justify hiring a specialized procurement function for such a minuscule sum of money.
We think that threshold should be $15 million in annual revenue. In any industry, procurement can control, on average, 43% of total spending. Or, for a $15 million annual revenue business, that equates to managing $6.45 million in purchases annually. To this hefty sum, the need for a procurement department comes, and that can help with the expenses and make a better procurement.
2. Growing Workforce and Additional Locations
In addition to revenue growth, another sign that you need a procurement team is the increase in the number of locations and employees. If your business requires multiple physical locations to expand, having a centralized procurement department is essential for managing these operations effectively.
Moreover, as your company surpasses 100 employees, employee-related expenses will also rise. At this point, it’s beneficial to review these expenses and negotiate better deals to manage costs efficiently.
3. Rising Operational Costs
If your spending is growing, there may be opportunities for you to look at your budget a little closer and find ways to save money. The same report showed that many of the targeted cuts are in payroll, which is a fast way to reduce costs but may result in longer-term operational pain.
This approach might result in short-term savings, but costs tend to rise again as revenue grows. Instead, by strategically analyzing expenses, you can find better ways to allocate costs, leading to higher EBITDA margins and improved cash flow.
It’s not solely the responsibility of the procurement or finance teams to review expenses. Cultivating a cost-conscious culture where all budget owners regularly assess their spending ensures the best use of available capital.
4. Aggressive Cost Reduction Goals
Most companies have cost reduction goals of some sort, whether these are written down or just sort of in agreement. You can try to bundle effort on responsibility and accountability with cost savings via a procurement team. Your procurement department will be more competent in spending analysis, and they will see many other cost-saving opportunities. In addition to allowing companies to monitor trends and save, inductive spending analysis—a byproduct of collecting, cleaning, categorizing, and analyzing your purchasing data—can be conducted. For a more detailed walk-through of how to execute a spending analysis, see our step-by-step guide here.
If the spending data from the analytics process shows places for improvement when it comes to cost reductions, the procurement team, in most cases, can save money in several areas:
- Vendor Consolidation: Grouping purchases from multiple vendors to obtain better rates.
- Low-Cost Country Sourcing: Sourcing products from countries with lower costs so as to reduce expenses.
- Uniform Product Specifications: All locations shall buy the same functional product or service at the same price.
- Control spending behaviors: Identify and erase non-essential spending habits.
- Payment Terms: Cash Flow Management: Strengthening your cash flow by extending payment terms depends on your company’s high credit ratings.
- Purchasing Cards for DPO Extension: Extend payables by 30 days using purchasing cards as a payment method (with vendor consent).
5. Potential ROI from a Procurement Team
Most support functions are cost centers rather than profit centers, similar to departments like payroll and HR. These functions are essential for operations but do not directly increase revenue.
While procurement may not generate revenue, it can achieve something even more valuable: increasing EBITDA without requiring capital investment to generate additional revenue.
You can calculate the impact of procurement cost savings using a hypothetical income statement for a software company with an operating margin of 16.67%. Let’s assume this company currently does not have a procurement department.
| Income Statement: AAA Software Company | ||
| Year ended: 12/31/2019 | ||
| Revenue ($) | ||
| Professional service revenue | 200,000 | |
| Subscription revenue | 100,000 | |
| Total Revenue | 300,000 | |
| Cost of Goods Sold (COGS) | ||
| Subscription COGS | 50,000 | |
| Total COGS | 50,000 | |
| Operating Expense | ||
| General and Administration | 50,000 | |
| Sales and Marketing | 50,000 | |
| Research and Development | 100,000 | |
| Total Operating Expense | 200,000 | |
| Operating Income | 50,000 | |
| Operating Margin | 16.67% | |
We see the same income statement if the procurement department successfully gets a 10% cut in all costs, the world of COGS, Sales & Marketing, and General Administration. Now we compute the total savings:
COGS ($5,000) + Sales & Marketing ($5,000) + General & Administration ($5,000) = $15,000
Now, the new revised income statement is as follows:
| Income Statement: AAA Software Company | ||
| Year ended: 12/31/2019 | ||
| Revenue ($) | ||
| Professional service revenue | 200,000 | |
| Subscription revenue | 100,000 | |
| Total Revenue | 300,000 | |
| Cost of Goods Sold (COGS) | ||
| Subscription COGS | 45,000 | |
| Total COGS | 45,000 | |
| Operating Expense | ||
| General and Administration | 45,000 | |
| Sales and Marketing | 45,000 | |
| Research and Development | 100,000 | |
| Total Operating Expense | 190,000 | |
| Operating Income | 65,000 | |
| Operating Margin | 21.67% | |
Operating Margin from 16.67% to 21.67% = ~30% increase with no incremental sales. The tricky question is examining if the potential EBITDA uplift is enough to pay for a purchasing function.
6. Unplanned Contract Renewals Cause Financial Losses
A sign that you need a procurement department is if you are incurring financial losses due to automatic contract renewals. Your company makes purchases whether you have a procurement department or not. For instance, an IT manager might have negotiated an agreement for a $100,000 annual renewal on software, but it is not centrally tracked. Alternatively, it may be under the contract of a former employee, so you may not have even heard about it.
This often results in untracked software renewals, where you only receive the invoice from the vendor for the annual subscription. The written agreement can typically be renewed or canceled with 30 to 60 days’ notice. Once the invoice appears, it can be too late to cancel, collecting a fee for a service that is not being used.
No one wants to see that happen, and that is why we set up a centralized procurement department. Such a department keeps schedules of contracts and provides precise notification times for termination well in advance, helping you decide if you need to renew the contract or not.
5 Core Roles in a Procurement Department
An organized procurement department is an indispensable factor in effectively handling the procurement of goods and services. Here are five key positions in that department:
- Chief Procurement Officer (CPO)
The leader of the pack defines where the department is going, reports to the C-suite, innovates, and keeps the department informed about trends in procurement.
Creating the Future — the CPO sets the long-term course, directs the product line to meet the corporate objectives, and ensures a culture of continuous improvement is alive and well. Moreover, CPOs study market dynamics to inform strategic sourcing and deploy innovative procurement technologies to improve operational efficiency.
- Head of Procurement
The Head of Procurement is responsible for day-to-day operations, staff, relationships with stakeholders, and ensuring the efficiency of the budget. This entails working with other departments to determine their procurement needs and making their needs a part of a unified procurement plan. The Director also formulates performance measures to assess the efficiency of procurement functions and makes sure that procurement functions comply with regulatory requirements and internal policies.
- The Procurement Manager
The Procurement Manager is a Category Leader who does this in his category and is also a Team Leader for Procurement. He manages specific categories and does risk assessments on his categories. Observe supplier performance to improve continually. Supplier relationship development and management, supplier quality and delivery compliance, and all opportunities for cost savings are directed by the Procurement Manager. Procurement teams are vital to problem-solving in the supply chain and determining the terms for operational contracts that yield the best possible outcomes for the company.
- Procurement Specialist
As an operational life force, the Procurement Specialist carries out sourcing functions, compiles vendor research, makes cost comparisons, and adjusts supplier contracts. Duties include bid evaluations, issuance of purchase orders, and follow-through to ensure timely delivery of goods and services. Additionally, this procurement partners with other team members to create and execute sourcing strategies and maintain comprehensive procurement activity documentation to assist in audit and compliance needs.
- Contract Specialist
With legal knowledge, the Contract Specialist ensures contract accuracy and compliance, assists with negotiations, facilitates contract amendments or modifications, helps resolve disputes, and influences contract terminations. Reviewing contract terms to minimize risk and ensure the company is protected, advising on the legal consequences of contract clauses, ensuring all contracts are in line with organizational goals & regulatory guidelines, and providing a seamless and legally compliant procurement process in collaboration with the procurement team and other departments.
Frequently Asked Questions
What are the crucial duties of procurement?
Acquiring goods and services is vital for controlling costs, minimizing financial hazards, and enhancing overall fiscal well-being. It guarantees that the company obtains the required goods and services at the most favorable cost and standard.
Where does procurement belong within the organization?
Procurement is traditionally housed within the corporate finance area. This cooperates with supervision to ensure that the spending is productive and profitable by providing services that challenge the best prices and, above all, serve the life of the company.
What are the Key traits of the procurement department?
The procurement or buying department deals with the entire buying process, which includes bargaining with suppliers for prices, creating procurement agreements or contracts, as well as authorizing acquisition orders to meet the internal needs of the firm in a timely manner.
So, what does a procurement team do?
The procurement team consists of the professionals responsible for getting the goods and services you desire, including buyers, planners, analysts, and coordinators. In the simplest terms possible, what they are driven to do is find the right things to buy at the correct prices.
What is the primary goal of the procurement department?
The primary objective of the procurement department is to lower expenses while effectively meeting the business’s needs, ensuring smooth and efficient operations