Our previous article introduced the concept of Purchasing operations and an understanding that the function need not be viewed as a low value-add transactional practice only. Having stated that, it bears to remember that such a concept may not be suitable for all organisations. Smaller organisations which operate from a single location may have adopted a centralised ordering approach operated by a handful of personnel only, and such an approach may be appropriate and optimised for efficiency until the organisation outgrows it.
To address the challenges faced by larger and multi-tiered organisations, this article (and the next) presents some essential building blocks for an efficient Purchasing operation in a de-centralised environment. Many of the topics are phrased around e-Purchasing systems, which are commonly implemented in larger organisations to enable the process. The topics are not predisposed to any brand of solutions or service provider in the market, but are concepts which can be setup or adapted to most e-Purchasing solutions.
As organisations grow in size, it is common that resources are separated into operating units to optimise the decisions made for business operations. Some form of hierarchy is created to control and manage the operating units, giving rise to structural views which are synonymous with today’s business organisations.
A key consideration to efficient Purchasing is the strict implementation of Authorisation Limits for the organisation to control its purchases. Taking a sample organisation structure (above), it is easy to follow the logic that the Managing Director, being the leader of the organisation, is authorised to make all purchases for the organisation. For this organisation, the following Authorisation Limits may be established for the resources:
- Operations Director: up to $ 100,000
- Managers: up to $ 50,000
- Warehouse Supervisor: up to $ 2,000
As an example, purchase requisitions raised by Warehouse Staff that are below $ 2,000 will be evaluated by the Warehouse Supervisor. If the purchase requisitions are justified, the Warehouse Supervisor will approve the requisition and orders will be placed for the purchases. This form of control is widely implemented in organisations, with the Approval Limits varying together with the hierarchical form.
The setting of Approval Limits is a fine balance between the need to exercise financial control and the ease (and speed) of operating the business, and is determined by the organisation’s risk profile. An organisation with a high aversion to financial risks may set zero limits to all levels of the organisation, requiring the Managing Director to exercise control and approve all purchases. This approach may work for smaller organisations, but will be extremely cumbersome and inefficient for larger organisations. Here is where the actions of ‘approving’ (and rejecting in case of questionable requisitions) and to ‘be informed’ need to be distinguished. If a Managing Director has a need to be informed of purchases made, a regular report on the purchase orders or requisitions will suffice and without channelling all purchase requisitions to the position. Likewise, a setup where a Financial Controller approves all requisitions before routing to the Managing Director for final approval is a wasteful practice, as the real control and the right of rejection lies with the Financial Controller, and the Managing Director is simply being informed of the requisition. Organisations need to be aware of such pitfalls when an extremely prudent approach is adopted for managing financial risks.
In setting the Authorisation Limits, it is useful to analyse and consider the historical purchases and requisition records. Use the Pareto Analysis on the proportion of requisitions and their purchasing values, and set the appropriate Authorisation Levels for the organisational levels. In the example above, the $ 2,000 level for the Warehouse Supervisor may be established so that not more than 2% of requisitions (by value or occurrence) are approved at that level of the organisation. In the event of malicious acts committed by the Warehouse Supervisor, the organisation will likely face a financial loss of not more than the 2% of the overall purchasing volume and deemed to be within the organisation’s risk appetite.
An e-Purchasing solution is a popular IT system implemented to enable the P2P process, ensuring that process steps and business rules such as Authorisation Limits are applied consistently and diligently. An e-Purchasing solution with an integrated material catalogue will provide all these benefits and more, and it replicates the buying experience of online e-Commerce services made famous by Amazon.com. What are the benefits which the material catalogues bring to the e-Purchasing solution? Here are some of them:
- Avoids the repetitive entry of data and information (and associated errors due to re-entry of data) such as material descriptions and service specifications required on purchase requisitions, purchase orders and accounting entries.
- Provides rich information and descriptions of the materials and commodities, including images where applicable, to support users in making their purchasing decisions.
- Implements the sourcing strategies effectively by offering the preferred or standardised commodities for purchase only.
- Implements negotiated contracts in timely manner, especially when price changes are involved in re-negotiated contracts.
- Offers a solution that requires minimal user training and support, as most users would be able to relate their experience with online e-Commerce websites such as Amazon or eBay.
Material catalogues may be easy to use but require some effort to prepare and compile. A common practice among matured Procurement organisations is to request the catalogues to be compiled and submitted by contracted suppliers, for the assumption is that suppliers should know their products better than the buying organisations. There are marketplace service providers who take up this responsibility of working with suppliers and sellers to ensure that material catalogues are prepared to a minimum standard in terms of information clarity, and in an electronic format that can be integrated into the buying organisation’s e-Purchasing system.
In conjunction with material catalogues, the ability to view, search and select the required products from catalogues is just as important. The objective here is for users to use the minimum number of clicks or navigation steps to identify and select the desired product. This may require more than just a generic search engine to do the job. In the author’s opinion, the gold standard for cataloguing products and commodities is Amazon.com, which provide catalogues for thousands of products that are labelled, tagged and categorised in a structured and logical manner. The structured catalogue data enables users to rapidly identify the products of interest instead of relying on the results of search engines only.
Other more advanced functions such as ranking the products by specific preferences (from lowest to highest cost, or products that carry an energy efficient certification compared to those with none) are useful to promote specific corporate objectives of the organisation.
It is a foregone conclusion that e-Purchasing systems are highly effective in implementing Authorisation Limits of an organisation. The systems operate without prejudices and are programmed to follow the Authorisation Limits without missing a step required from it. To enhance the effectiveness of such a rigid implementation of a business rule, Commodity Approvals can be introduced to the solution.
Consider the situation where an organisation’s IT department is entrusted with the assurance of all IT equipment and solutions (software) are complying with a defined standard. This may require an IT resource to evaluate equipment as capable of operating within the network environment without conflicts and interruptions with other equipment, or ensuring that security protocols of new equipment can be adhered. In such a scenario, the organisation’s e-Purchasing solution can be setup to add an appointed authority from the IT department to approve all purchase requisitions relating to IT equipment and software, regardless of the party requesting for the purchase. Likewise, all purchase requests for services carried out to building facilities can be channelled to the Real Estate department for consideration and approval prior to the finalisation of order for building services. Such a Commodity Approval function extends the reach and control of the Purchasing process to more indirect commodities used by an organisation.
In our next article, we will highlight a key component of e-Purchasing and how it effectively supports the automation of the payables process. Stay tuned.