One of the key elements for all of us to accomplish to insure a successful business is to have effective procurement procedures in place as we conduct our day-to-day business operations. Wikipedia offers this direct definition of procurement “the act of acquiring goods, services or works from an external service often via a tendering or bid process.”
Over the years, Tuchman Advisory Group has invited a variety of experts to share their knowledge of factors that impact our businesses. One of our most popular experts is Mike Glass, who for over 30 years has held positions in procurement for Nvidia, Hewlett-Packard and Flextronics. I asked Mike to answer a few critical questions relating to the art of making the procurement process work.
How do you relate operating expenses to cost?
“What you spend with your suppliers is likely the largest component of your OPEX (operating expenses) after your labor cost. It is important to have good discipline in place to ensure that what you buy meets your business needs at the lowest cost possible.”
What if you have less than or over $1000 to spend?
“Here are a few good tips to follow to ensure that you minimize what you spend with your vendors. For spending under a certain dollar threshold (say $1000), have all go through one resource (e.g. “buyer”). The buyer should validate that what needs to be purchased is a “must” need, and of course the buyer should source the need at the lowest cost possible. For spending over a certain dollar threshold (say $1000), employ a simple sourcing process. First and foremost, vet the potential suppliers to ensure which meet the business requirements for the expenditure. For example, business requirements could be a payroll software project that meets defined functionality, 24/7 customer support and references. Business requirements need to be met before negotiating on price. Once the suppliers have been vetted, go through a Competitive Bid Compliance (C.B.C.). Advising each of the potential suppliers you are talking to that you are conducting a C.B.C. will ensure aggressive pricing to win the business. Assigning one person to lead all of these sourcing projects will ensure better compliance with your policies, and will help build your employee’s needed negotiation skills.”
Should your employees be aware of your company’s procurement process?
“Even though you identify a resource in order to manage procurement, it is important for your entire company to be educated in the right procurement culture. Your employees should have the mindset that every cent saved with your suppliers is an extra cent to your bottom line.”
Cost analysis is critical to every business. How often should you produce spending reports?
“Providing reports on what you are spending on a quarterly basis will make your team more effective in finding ways of additional cost savings. For example, reporting could reveal that you are buying office supplies from two different vendors, with the conclusion that it would make sense to consolidate into one vendor.”
What should you be looking for to avoid pitfalls?
“Over specifying on what your company spends results in wasted dollars. Suppliers will always try to “upsell” you on additional features to gain themselves a better margin. Always be sure that what you buy is only what you need. Audit your procurement practices to ensure good compliance. Procurement is definitely a potential area for theft. Randomly audit some of your spends on a yearly basis. Make sure all of your employees are aware that these procurement audits will ensure better compliance.”
Are there specific steps to consider for the sourcing process?
“It is important to keep the sourcing process simple to ensure ease of compliance. The following are key steps to sourcing major spend projects:
• Define the need and validate the dollars budgeted for the year
• Identify the key sourcing criteria
• Decide on potential suppliers
• Reduce the number of suppliers who would meet the minimum sourcing criteria
• Send out a Request For Quote (R.F.Q.) to get responses and preliminary pricing
• Go through a ranking and decide on the top two to three suppliers
• Decide on negotiation strategy, then negotiate pricing and terms with these suppliers
• Award the business, and if needed, review and sign the contract.”
What have you learned during your years working in the area of procurement?
“You would think cost savings would be the priority #1. But where I have gotten burned is not on lack of cost savings, but sourcing with a vendor who did not meet the company’s minimum business criteria. A good personal example would be buying a new car on which you got a great deal, but ended up having numerous quality issues, and the gas mileage per gallon was a lot worse than expected.”
Any final observations based on your years of experience?
“Purchasing is a critical function for a small business because it affects performance at all levels. If supplies you purchase for consumption do not meet your needs they will reduce the efficiency of your operations. Material you buy for manufacturing or resale must be of acceptable quality at a competitive price or your customers will not be satisfied. You must develop appropriate purchasing procedures and closely monitor them.”
Mike observed that theft is a problem to be considered when dealing with procurement. That led me to include additional detailed information on the broader issue of fraud. A good definition of “procurement fraud” from an article by CPA firm Maxwell, Locke & Ritter is: “dishonestly obtaining an advantage, avoiding an obligation or stealing or redirecting funds during the acquisition, sale or management of goods or services.”
The article mentioned “the median loss to U.S. companies is $140,000 from occupational fraud, and the fraud takes an average of 18 months to be discovered, according to the most recent report of the Association of Certified Fraud Examiners, the 2012 Report to the Nations on Occupational Fraud and Abuse.”
One analyst has pointed out that small businesses are at the most risk for fraud because “they are typically lacking in anti-fraud controls.” In order to prevent fraud, owners must take responsibility by establishing an efficient system of internal controls. Maxwell, Locke & Ritter discovered that “organizations that perform surprise audits typically have less loss due to fraud, but surprise audits are one of the most under utilized fraud-detection methods.” By being alert to the procedures that help to prevent fraud, there will be a spill-over effect that will strengthen the methods of making your business work more efficiently and effectively.
In order to detect signs of a possible fraud problem, look for the following indicators in your company:
• Business records are missing or they don’t match
• Multiple copies of the same invoice or the same invoice number
• Management does not have a clear procurement process in place
• The choice of supplier appears questionable or doesn’t make sense
• A supplier is chosen without due diligence being done; favoritism
• Inferior, defective, or poor-quality goods are substituted at the last minute.
• Duplicate refunds are found from both petty cash and accounts payable
• Unauthorized or excessive use of the procurement process
• The procurement person is seen with new gifts or signs of increased wealth.
In the process of preparing this article I have been constantly advised that objectives and decisions have a direct impact on the overall success of the business, both of which involve procurement, an aspect critical to the growth and development of businesses of all sizes.