When do small and medium businesses start benefiting from having procurement processes?

Procurement is often viewed as a function reserved for larger organizations. However, businesses of any size can reap significant benefits from effective procurement practices whether that is by establishing an in-house procurement function or hiring temporary support to ensure the company’s success.

This article explores the value procurement can deliver to small/medium businesses and scenario where companies start benefiting from procurement processes and answer the following questions :

• How is procurement a key vector for profitability and efficiency ?
• When Does a Business Really Benefit from applying procurement processes in terms of Sourcing? Procure to Pay?
• And what type of benefits can be expected ?

As this article studies the benefits for small to medium businesses, it will focus on the sourcing value since it benefits appear earlier than the Procure to Pay value which requires a certain “mass”.

I. How is procurement a key factor for profitability and efficiency?

Overview of procurement value

Procurement is much more than a cost-cutting tool. It brings a multitude of values to a business, impacting both the sourcing process and the procure-to-pay (P2P) process. Let’s quickly review the value that procurement can deliver :

Sourcing Process

1. Cost Savings: Procurement helps in achieving significant savings, directly impacting the bottom line.
2. Supplier Management: It aids in building and maintaining strategic supplier relationships, essential for long-term success.
3. Market Analysis: Procurement teams provide valuable market insights, guiding strategic decisions.
4. Risk Management: The process helps mitigate risks related to supply chain disruptions and compliance breaches.
5. Innovation: Procurement encourages innovation by fostering supplier collaborations.

Procure-to-Pay (P2P) Process

1. Efficiency: Streamlining P2P processes reduces costs and errors, speeding up operations.
2. Compliance: It ensures adherence to internal policies and external regulations.
3. Data Analysis: Procurement offers data analytics to enhance spending patterns and forecasting.
4. Supplier Performance: Regular assessment of suppliers ensures they meet their obligations.
5. Technology Integration: Using e-procurement tools enhances control and efficiency.

The material impact of procurement sourcing

Sourcing :

Procuring products and services at the right price can help your business thrive. A decrease in cost impacts more than proportionally the profit compared to sales so if executing a procurement process can cut cost by 5%, this is equivalent to increasing sales by 12% to achieve the same profit levels; which is a lot harder to attain.

Sales of $ 50 million with 15% profit =7.5 million profit
Purchase of Goods and Services : 40% or 20M€
5% savings on PCOGS: 1M€ in additional profit (8,5 total)
To reach the same level of profit, you need to increase sales to: 56M€ which is a 12% increase in sales.

Also, since procurement tends to look at the picture from a holistic point of view with the Total Cost of Ownership, it helps businesses make the best decision for them, and not one just based on the “price tag”. Procurement typically will look at all other costs (maintenance, spare parts, energy consumption etc…) to compare solutions and identify the lowest total cost.

And this is just the price aspect, as we have seen, the procurement process can leverage a number of other benefits regarding risk mitigation (on-time delivery, price increase, reputational risks etc..) and bringing innovation in.

Procure to Pay (P2P) :

The act of procuring goods and services costs businesses a lot of money, and this can become a major burden for companies as they grow. With low levels of digitalization, the cost of a Purchase Order can easily reach 100€/PO and the time your teams spend raising these is time they won’t spend adding value to your business. So having a procurement team can ensure that this process is as efficient (and digitalized) as possible, and ensure your costs stay down while your teams remain focused on what they are hired for.

According to a study from Opstream, a company of 1,000 employees emits 3000 Purchase Orders annually (300k€ spent !), each of these PO involves 7 to 9 people to approve and review and sometimes takes weeks to be issued, slowing down the whole business. Optimizing this is therefore a key opportunity, that only grows as much as your business.

II. When Does a Business Really Benefit from applying procurement processes

In short, it is best to follow practices from any size, but having a dedicated resource to work on procurement is particularly relevant in certain cases. We will cover the general spend level required and use cases where procurement can leverage value through sourcing, and then Procure to Pay activities.

Sourcing

General spend level: from what level of spending is procurement more or less guaranteed to bring in money?

As seen previously, any price reduction impacts profit at a higher rate than an increase in sales does. Therefore, procurement processes and tools (e-auction, negotiations etc) can be really decisive for your future and your organization’s efficiency. Yet, procurement resources come at a cost so at what point is it really worth it?

Assuming a meager 3% savings (It’s meant to be very conservative and I don’t think I’ve ever delivered a project with less than two digits savings), you need :

Cost of an in-house procurement professional: About 150k€ per annum
Number of sourcing projects handled: 2 (also conservative)
Cost per project: 75k€
Minimum spend per project: 2,500k€ (75k€ per project as 3% of total spend)

So if you have 2 sourcing contracts per year with a minimum spend of 2,500k€; or one 5M€ spend opportunity, having an in-house procurement resource will pay itself off, on top of all the other additional benefits that a solid procurement approach brings: better contracting and SLA, risk identification and benchmark, innovation etc… Below these amounts, it is hard for procurement to justify a clear ROI.

Sourcing for new or existing spend: How can procurement deliver value?

With these amounts in mind, the procurement process can really make a difference on both existing spend (typically an existing relationship that is contracted or not) or new spend (Sourcing of goods or services that were not acquired before).

Existing spend :

As seen, the financial benefits of procurement on existing spend are straightfoward : cost reduction, TCO consideration etc.. but procurement can also leverage a number of benefits that are maybe harder to quantify but are nonetheless critical.

• Value delivery: Procurement, through RFx, negotiation and contracting, can help mitigate supply chain risks and protect against poor supplier’ delivery. Everyone in the business can negotiate deals but often, KPI and SLA are omitted and the negotiated value is never delivered as contracts do not permit enforcement of this “negotiated value”. Procurement can help by framing good contracts (and executing contract management) and ensure your business is protected against poor performance, and value delivered.
• Risks (financial, data, public relations, etc..) and sustainability: Procurement can also add value with its vetting process, which brings impartiality, and looks at the wider picture. Through RFI, and proper RFx; the risks are usually identified and discussed through the process, guaranteeing the best outcome for the company and the planet.

As businesses mature, the management of existing spend moves away from tactical sourcing and move to more advanced models of category management.

New spend :

While procurement activities are often centered on existing spend categories, they can help with new spend and ensure :

• a good benchmark is run, ensuring that the best total cost is achieved from the start instead of starting “quickly with the historical supplier and see later”. A procurement approach will also ensure a contract is made protecting you against future risks (quality, delay etc..)
• and that competition will not undermine you immediately after by negotiating a better deal, because they took this extra step. (in some cases, negotiating some exclusivity in the contract will also delay your competition)
• the company is protected against value leakage and reputation risks, as discussed previously.

Eventually, a good procurement process can lead to a durable competitive advantage (think of IKEA) as you are able to go to market with the best terms. I’ve seen many companies not caring about negotiating or even contracting their new initiatives’ spend under the excuse of speed, but the whole approach can fail without this extra step. However, it remains critical to execute procurement with agility and pragmatism: delaying a new product or service by 6 months is often not acceptable.

Procure to pay efficiency :

The second aspect of a procurement job is about bringing efficiency – and compliance to the company buying process: the Purchase Requisition (PR) to Purchase Order (PO) and Payment processes. With over 100€ per Purchase order, digitalising and automatising the P2P process becomes a priority for businesses. Note that this number can be doubled if your invoice processing is manual (200€ for the end-to-end process), but let’s leave this outside of the argument for now, even tough procurement can influence the Account Payable process significantly and fairly easily.

Assuming again the same salary of 150k€ per annum and a reduction in cost per PO of 20% (20€ per PO of savings), a business needs to emit about 7,500 PO per year to make a dedicated procurement resource profitable – this is about 35 PO per day so again, not this much. If we consider the previously mentioned study, and assume linearity, it means a company needs to reach about 2,000 employees before it gets beneficial (from a simple economic point of view).

When businesses grow, the amount of purchases increases, and it can start to take a lot of time for your employees to buy compliantly. Usually, the first purchaser a company hires is hired to place these orders on behalf of the business.

• The levers for optimization are usually the following :
  • Digitalise the P2P process
  • Reduce the number of POs and invoices through consolidations

I will cover this in more detail in another article, as this aspect of procurement tends to affect companies that are maybe more mature, or simply bigger since they require a critical mass that is higher than the spend amount (yet they represent a key opportunity !)

So in summary, procurement can always add value to your organization, whether you need to negotiate one critical deal or just make sure your organization remains agile.