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Five-stage model of procurement. What stage are you at?

Enterprises are the main body of large-scale commodity production. In order to achieve large-scale product production, large-scale commodity procurement is also needed. The production of production enterprises is based on procurement as a prerequisite. Without procurement, production cannot be carried out. The procurement of enterprises not only purchases a large quantity and a wide range of procurement markets, but also has particularly strict requirements for procurement activities. They need to conduct in-depth research on the variety, quantity, and law of demand of the entire factory, analyze and study numerous domestic and foreign suppliers, and conduct in-depth research and scientific operation on each link of the procurement process in order to complete the procurement task and ensure the timely and appropriate supply of various materials needed for enterprise production.



In the field of enterprise procurement management, there is a famous five-stage model, which divides procurement into five development stages: supply, price, total cost, request management, and comprehensive value-added.


The first stage of enterprise procurement management: material supply is to ensure that there is material


Supply is to ensure that there is material. The role of procurement is to be a purchaser and planner, doing typical secretarial work. For example, in the early days of a high-tech company, engineers determine requirements, and purchasers place orders, follow up orders, receive materials, and make payments. In some small companies, with small procurement volumes and little room for negotiation, it is good enough if procurement can ensure timely supply. Procurement also negotiates prices, but the impact on prices is minimal. There are many reasons for this, such as strong internal customer strength, where engineers have the final say in setting specifications, finding suppliers, and negotiating prices. The company is too small and the division of labor is not detailed, and procurement is only a supporting function for minor details. In the supplier market, market transparency is high, and there is little room for negotiation (such as raw materials). The strength of internal customers and supplier markets, coupled with the low quality and status of procurement personnel, determines that procurement is a rough operation, and its value can only be to ensure that there is material. However, this does not mean that the on-time delivery rate is high, and the reasons are the same.


The second stage of enterprise procurement management: cost savings are the main indicators of procurement


In the price stage, the role of procurement shifts to negotiator, and cost savings are the main indicators of procurement (but this does not mean that delivery rate and quality are not important, these indicators are natural). Compared with the supply stage, companies in the price stage systematically track and compare prices, and calculate procurement cost savings. There are mainly two ways to compare prices: comparing with market prices, that is, comparing with the main price index, such as the US Producer Price Index (PPI); comparing with historical procurement prices, that is, calculating the purchase price difference (PPV).

In large and well-established Western companies, these two systems are mostly complex (but not necessarily perfect) and are the main criteria for measuring the procurement department. How complex are they? The US Advanced Procurement Research Center (CAPS Research) has held several rounds of roundtable meetings worldwide, attended by Chief Procurement Officers, Vice Presidents, and Senior Directors of Fortune 500 companies, with the theme of how to calculate cost savings (note that it is not how to reduce costs). Within the company, how to set the standard price, how to track the actual purchase price, and how to predict the purchase price difference often make procurement and accounting personnel headache. Many bureaucratic mechanisms in the procurement system, process, and policy are built around these two aspects.


In practical operation, some large companies use their scale advantages to systematically obtain the best procurement price, and even help other companies purchase, making procurement the profit center of the company. For example, HP purchases some products, sells them to its own suppliers at a higher price, and then integrates them into the final product and sells them to HP because HP can obtain better prices. IBM also has a similar approach.


Stage 3 of Enterprise Procurement Management: Total Procurement Cost


Purchasing cost savings is an important indicator of procurement performance because it is direct, clear, and easy to quantify. However, the procurement price is only a part of the cost, and its optimization often leads to the non-optimization of other costs. For example, if you buy a piece of equipment very cheaply, the procurement department will be rewarded, but the user department will pay the bill because the usage and maintenance costs are too high. This requires considering the total cost, which is the third stage of procurement. Correspondingly, the role of procurement is also transformed into supply chain management, taking into account transportation, warehousing, tariffs, exchange rates, usage, recycling, etc.


The concept of total cost seems simple, but why are there not many companies that can achieve it? There is a problem of professional division of labor. One of the characteristics of industrialization is specialization. For example, procurement, logistics, production, design, and sales are mostly done by different departments, with clear division of labor and high degree of specialization. In some companies, departments are even tightly guarded, and it is difficult for anyone to be proficient in multiple functions. Generalists who are familiar with multiple functions often cannot do it deeply and only know the surface without truly optimizing the overall situation. For example, if the purchaser knows that the more purchases, the higher the procurement cost; but if the purchase volume is large and the inventory backlog is too large, the inventory cost will be high. This is easy to solve, and the economic order quantity model can solve the problem. However, if the purchase price also changes with the purchase volume, how do you optimize the purchase volume? Adding transportation mode, sea freight is cheap but has a long shipping period and high inventory, while air freight is fast but has high costs. In terms of freight, there are fixed and floating parts. How do you optimize? This is only the purchase cost If factors such as Cost of Quality and opportunity cost are added, optimization is basically impossible.


So why do so many companies implement total cost? The reason is simple: sub-optimization of total cost is better than no optimization. Like many business problems, you may never achieve optimization, but pursuing optimization, even if sub-optimization is achieved, can add value or save a lot for the company. Of course, the ability of procurement to approach total cost optimization is also related to the level of procurement practitioners and the improvement of the procurement department's position in the company. Imagine if procurement revolves around orders all day long, and only revolves around orders, who would believe in their promotion of total cost?



The above three stages focus on the supply side. Simply put, after the demand is determined, procurement meets the requirements in the most economical way, but the impact on how the demand is determined is limited. In this way, procurement is managed afterwards. In fact, 70-80% of the cost is decided in advance during the design stage. If procurement wants to demonstrate its contribution to the company, it must effectively intervene in the demand determination stage, help with design and planning work, and this is also the fourth step that procurement needs to take, request management.


Stage 4 of enterprise procurement management: request management


Early involvement of suppliers is one aspect, that is, incorporating good ideas from suppliers into the design as early as possible to make the design more reasonable and reduce costs from a design perspective. Customer management is the second aspect, ensuring the use of suppliers with the best comprehensive performance, minimizing demand changes, controlling bullwhip effects, etc., all of which fundamentally reduce the total cost of the supply chain. Some may say that procurement is a support department and should be service-oriented, and managing customers seems inappropriate. In fact, customer orientation is not blind obedience. Managing internal and external customers from a professional perspective is actually for the good of internal customers and the company.

For example, by helping customers make plans, suppliers do not need to rush or pay for rush work; persuading internal customers to change unreasonable requirements, because although these requirements do not increase company costs, they will increase supplier costs. "You get what you pay for", and ultimately the company has to pay for it.


These have new requirements for procurement skills. It should be noted that compared to "external competition" and "internal competition", "internal competition" is often more difficult, requiring procurement to be familiar with the business of internal and external customers, have better leadership skills, and be able to understand the impact of specific decisions from the perspective of the supply chain.


For example, under the consignment model, suppliers bear the burden of inventory, and the company's production department naturally wants to raise the inventory level very high to avoid the risk of running out of materials. However, procurement needs to recognize that if the final product goes offline or cannot develop the market as expected, there will be a large amount of consignment inventory stagnant. If the inventory is too high, the supplier's funds will accumulate too much, and the cost of capital will be high.


If the supplier is small in scale, the cost of capital will be higher (large companies often earn better interest rates on loans than small companies, that's the reason). These costs have to be passed on to the purchaser directly or indirectly. Here, the purchaser needs to understand production, planning, forecasting, and transforming forecasts into inventory levels, as well as understanding inventory costs and the time value of money. And that's not all, you also need to persuade the management personnel on the production line. What the production personnel see is mostly supply shortage, and demand is always continuous. The market is constantly changing, and the sharp decline in demand seems unattainable or not their problem. To explain these explanations clearly, you also need to understand the market. In short, procurement needs to be transformed into supply chain management, which requires persuasion rather than coercion, and influence through support and assistance rather than relying solely on administrative orders.


Stage 5 of Enterprise Procurement Management: Comprehensive Value-Added


Selling well is not as good as buying well. In many industries, procurement has become the core competitiveness of a company. For example, in the automobile manufacturing industry, about 80 yuan of every 100 yuan of sales revenue from the original factory must be paid to the supplier. Procurement is the lifeblood of the company, not only in cost savings, but also in ensuring the quality and technical content of the purchased products. In the contract processing industry, labor costs are almost the same, and the material price obtained by procurement is crucial to whether orders can be received. Due to the increased dependence on suppliers, procurement has risen to the strategic level. Correspondingly, procurement indicators have also increased a lot of financial and operational content, such as cash flow, asset management, and other indicators previously responsible for operations and finance departments.


The problem at this stage is that procurement is related to the survival of the company, but its means are often price negotiations in the second stage, in other words, profit transfer. This is like carrying a local gun to fight a nuclear war. The US automobile industry can be said to be representative. The result of squeezing the last silver dollar from the supplier is that the relationship between the two sides deteriorates, and the situation is like water and fire. In the long run, the industry is facing collapse. The reason is simple: the comprehensive value-added of procurement is not to reduce supply chain costs by optimizing the supply chain and solving problems, but to transfer costs to suppliers through strong practices. The failure of procurement lies in the inability to build a first-class supply chain, and the company naturally cannot stand out in the competition between supply chains.


No matter how many stages we divide enterprise procurement management into, as a qualified procurement manager, we need to know ourselves and our enemies. Only by understanding our own enterprise and the market trend can we seek development in the fiercely competitive business wave.


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