1 Fundamentals of Procurement

1.1 Introduction
There is no organization today that does not deal with procurement. Almost all things we use on a daily
basis are procured from some source. Consider the following:
• A house wife running a home
• A personal assistant to a headmaster of a primary/secondary school
All these deal with issues of procurement in nature. She must decide either monthly or of course daily
the requirements of the home. She must decide what to get, how much to get, and at how much. In
addition, she must decide where she gets the products (source) and when to get the goods or
foodstuffs. The same will happen with the PA of the headmaster to ensure that the headmaster’s office
is running smoothly. Should certain requisites be less than what is required, some activities may have to
be suspended. Should the products be of an inferior quality, they may not last long or may be rejected
by the users. This may mean getting back to replace or acquire other products. The same will be true of
timing and not knowing the right source or place to acquire the requisites.
This shows the importance of procurement in everyday life. This is equally true for organizations. They
need various inputs in their production processes to provide products or services to satisfy their
customers or clients.

1.2 Purchasing and Procurement

Purchasing primarily means acquiring the right quality of materials, at the right time, in the right
quantity, from the right source at the right place. It has come to be understood that such a statement is
too simplistic. Therefore, the term procurement has come to be embraced as it deals with the use of the
product as well after its acquisition as well as the planning that goes in to determine what to get.

1.3 Definition of Procurement

Procurement could be defined as:
“a process that involves the design, specification and acquisition of goods or services” or
“a critical business process that enables an organization to secure a wide range of externally
provided resources and value efficiently and effectively from need to disposal” or
“a process of securing supplies, materials and services of the right quality in the right quantity at
the right time from the right source at the right cost” or
“a systematic process of deciding what, when and how to purchase; the act of purchasing it; and
the process of ensuring what is required is received on time in the quality and quantity
required”.
From the definitions, it is clear that procurement involves more than purchasing. It includes the
following:
• Purchasing
• Consumption management
• Vendor selection
 • Contract negotiation
• Contract management

1.4 Objectives of Procurement

Several objectives of procurement have been cited by a number of researchers, e.g., Baily et al and
Carter and Kilby.
According to Baily et al, the objectives of procurement are:
• To supply the organization with a flow of materials and services to meet its needs
• To ensure continuity of supply by maintaining effective relationships with existing sources and
by developing other sources of supply either as alternatives or to meet emerging or planned
needs.
• To buy efficiently and wisely, obtaining by ethical means, the best value for money spent.
• To maintain sound cooperative relationships with other departments, providing information
and advice as necessary to ensure effective operation of the organization as a whole.
• To develop staff, policies, procedures and organization to ensure the achievement of these
objectives.

According to Cartes and Kilby, the procurement objectives are:

• To support and contribute to the successful fulfillment of the organization’s corporate
objectives
• To secure resources
• To understand and exploit the market place
• To cooperate, liaise and communicate with customer organizations
• To act as a conduit for innovation and added value
• To provide the discipline required to manage all costs

All of the above objectives are achieved by:

• Selecting the best suppliers in the market
• Helping in the development of new products (resources)
• Monitoring supply market trends
• Negotiating effectively with suppliers and customers
• Adopting environmentally responsible supply management

It can clearly be seen from the foregoing that procurement is of importance to an organization. In fact, it
would be to the organization’s detriment to disregard procurement. The people in procurement need to
have a proper understanding of the organization they are in. Research suggests that where procurement
personnel have specialist experience, they work better. This is because they have greater market
knowledge and better supplier relationships which ultimately result into more savings than with those
without specialist experience.
It is also noted that procurement is directly linked to a company’s business strategy. It is seen that
procurement affects the profitability of a company. This is so because companies need access to
competitive and productive supply markets to be profitable. This is done through procurement. This
may not be possible if procurement is merely a departmental function. It should be company-wide. It is
held that where this happens, the organization will be able to establish collaborative relationships with
suppliers and others and secure competitive advantage.

1.5 Strategic Importance of Procurement

Since procurement is of such importance, it is reasonable to have its involvement or representation at
board level in a company rather than at departmental level. Most successful organizations that are
successful have used procurement as a major contributor to their success (…). They have used
procurement to drive market penetration, to grow revenue and maximize profit. There is a shift in the
understanding of the importance of procurement today. Some of the reasons are:
• Organizations today are employing what are called cutting-edge approaches to management
based on strategic and integrated procurement like supply chain management, relationship
management and customer focus. To achieve these objectives, procurement needs to be well
developed and proactive.
• There are fewer but larger suppliers (effects of globalization). We now have global players in
many areas of life who work on a large scale. This requires the procurement that works on a
higher profile than departmental.
• Increasing environmental awareness. Increased concerns to be ‘green’ are impacting a lot on
procurement, e.g. returnable, reuse, recycling, etc.
• Customer demands. It has been realized by many organizations the importance of satisfying
the customer. In fact, we need to exceed his/her expectations. Such drives for customer
satisfaction impact on procurement
• Advancing technologies and innovation. There are a lot of changes going on in business today.
New products are being launched with new players coming on the scene every time leading
increase in competition. This requires a lot of improvement in the interface between one
organization and another as well as within an organization. To develop new products as well
as take advantage of new products on the market requires a proactive procurement function.

1.6 Proactive Procurement

With the various changes in the world today, there is a move from reactive procurement to proactive
procurement. Procurement is moving away from the “traditional relationship” to the “mutual
relationship”. Organizations are concentrating on negotiating long-term relationships, supplies
development and total cost reduction rather than simply ordering and replenishing routines. Instead of
reacting to the needs of users as and when the need arises, there is a move to forward-looking proactive
approaches.
To understand proactive procurement, reactive procurement must be considered. One way to view
reactive procurement management is to think of the procurement function as only reacting to internal
customers. This is the traditional approach in which the procurement department receives a purchase
order from some other department and proceeds to place that order with a supplier. The procurement
department then follows the procurement process to assure that the order is placed and that the goods
are received in a timely manner. If goods are not received on time, a crisis may develop to which
purchasing must react. In this situation, the procurement department is largely a transaction-oriented,
clerical function that services other functions within the company and generally has low status in the
firm. More time is spent expediting than planning.
The reactive procurement function is largely evaluated on two criteria: administrative costs and savings
on material expenditures. Typical metrics are requisitions filled per employee, cost per requisition or
total number of employees per kwacha spent, and cost reductions accomplished by the purchasing
group. The focus is on controlling administration costs and on negotiation skills that result in reduced
contract costs. Adversarial relationships with suppliers may be encouraged

Table 1.1 Comparison of reactive and proactive procurement

Reactive Proactive
Buying is a cost centre Buying can add value
Buyer receives specifications Buyers (and Sellers) contribute to specification
Rejects defective materials Avoids defective materials
Responds to market conditions Contributes to market conditions
Problems are supplier’s responsibility Problems are shared responsibility
Price is the key variable Total cost and value are key variables
Emphasis is on today (now) Emphasis is on strategy
Buyer’s system is independent of supplier’s Buyer’s system is integrated with supplier’s
Users or designers specify Buyers and suppliers contribute to specification
Negotiations are a win or lose situation Negotiations are a win-win situation or better

The proactive approach moves away from regarding procurement as merely buying, i.e. finding a
supplier who gets paid a certain sum for delivery of a product at an “arms-length” as in Figure 1 (a) to a
mutually interactive relationship as in Figure 1.1 (b).

Confidence
Technology
Commitment
Buyer Buyer Seller
Seller Efficiency
Information
Support

(a) Reactive Approach (b) Proactive Approach

Figure 1.1: Comparison of the reactive approach (a) and the proactive approach (b)
Looking closely at the definition, objectives and importance of procurement, we can identify the five (5)
key procurement questions regardless of the field or type of profession we are dealing with:
(i) What are we trying to secure?
(ii) What is really fit for our purpose?
(iii) Who should provide the resources?
(iv) What are the risks and/or rewards?
(v) What is the correct procurement methodology?
In many respects, how these questions are addressed has a significant impact on the subsequent
success of any procurement project or activity.

1.7 Total Cost of Ownership versus Price

It has been established that many buyers and other procurement people including clients take the view
that in procurement what is most important is to get the lowest possible price for the items they
purchase. These people take the view that when they pay the lowest price, they are obtaining the best
value. This view has been found to be defective because price is just a component of the total cost of
acquiring an item. Nowadays, many researchers, and practitioners, argue that obtaining the lowest total
cost of ownership (TCO) instead of the lowest price is the best.
Total Cost of Ownership is a calculation designed to help people make more informed financial
decisions. Rather than just looking at the purchase price of an object, TCO looks at the complete cost
from purchase to disposal. It adds to the initial purchase price other costs expected to be incurred
during the life of the product, such as service, repair, and insurance.
Some of the reasons cited for the above argument are that:
• Price is a poor measure of value
• Procurement involves more than the price of buying
• There is the concept of added value
• There is the concept of cost plus time
• There is the concept of cost in use

1.7.1 TCO In Different Industries

The additional costs that must be added to the initial purchase price to calculate the total cost of
ownership (TCO) vary by industry (and often by the point an analyst is trying to prove):

Information Technology industry - TCO is used heavily in the IT industry. When used in evaluating the
purchase of a computer or system, usually includes purchase, repairs, maintenance, upgrades, service
and support, networking, security, training, and software licensing. However, the costs included in a TCO
evaluation can get complex as shown in this TCO concept map.
Financial industry – Many mutual funds and similar products charge quarterly management fees and/or
have withdrawal charges. These indirect costs must be considered when calculating the true cost of
these investments.
Construction Industry - There is the concept of initial costs (price) as well as the cost-in-use. All these
need to be considered in procurement. A lower initial cost may not provide the best value for the
product as there could be other hidden costs. A lower cost may have come from lower inspection costs
by the supplier, lower adherence to quality matters resulting in lower prices. Such could lead to higher
rectification costs, lost production time, etc. it could also lead to higher maintenance costs or shortened
product lives or simply poorer quality of products bought with a short life-span.
It is therefore, necessary that the TCO is thoroughly considered when undertaking purchasing or
procurement of goods and/or services. This is the total cost that one actually pays for the goods and/or
services including things like duty, inspection, rectification, cost-in-use, etc. it must be noted here that
price is the most visible of the various elements of the TCO. This is sometimes referred to as the “price
cost” iceberg (See Figure 1.2)

Figure 1.2: The elements of a Total Cost of Ownership

It has been observed that when the production and marketing departments or procurement section
work together, the TCO could easily be identified and the best project or product conceived. Value
analysis studies have shown that there is much potential to be gained in procurement function in the
search for optimum specification or product.
TCO includes the following:
• The initial price (purchase) or capital
• Inspection costs
• Rectification costs
• Lost production time
• Missed innovation opportunities
• Communication costs

1.7.2 TCO and Purchasing a Good or Service

When purchasing goods or a product and quotations from various suppliers are being scrutinized,
consideration of the relative TCOs could help the buyer to decide which supplier to use. The following
criterion has been found to be helpful in selecting a supplier with lowest TCO:
• Business need
Item must meet the organization’s business need

• Design
The ability of the item to perform in a way that the purchasing organization wants

• Specification
Particular features that one supplier may have that another one does not have

• Acquisition
What are the relative costs of acquiring what the organization needs?

• Commission
What are the commissioning costs? Comparisons need to be made between potential
suppliers.

• Storage
Cost of items requiring to be stored prior to use

• Use
How much is the item likely to cost in terms of consumables e.g. energy. Comparisons need to
be made between potential suppliers

• Maintenance
This involves looking at the cost of servicing and repairs as well as potential costs of spare
parts. Service intervals can be compared between potential suppliers.

• Disposal
How much is it likely to cost to dispose of the items at the end of their projected life?
1.8 The Procurement Cycle
This is the totality of events in sequence that make up the main parts of the activity of procurement
from identification of the need to payment of the invoice in respect of the good or service purchased to
satisfy the need. Generally, the cycle flows according to the following pertain:
• Need identification
• Business case development
• Specification and quality assurance
• Sourcing
• Cost and price analysis
• Supplier selection
• Negotiation and bid evaluation
• Contract award
• Payment to vendor
Cross-referencing of the various stages from the purchase order to delivery is important as it forms what
one would call the audit trait so that we could follow up all that happens. This could also help in supply
chain management.