Procurement   by Alison Cole

The range of activities associated with the buying of goods and services to support business operations is called procurement. When talking about procurement, planning is the first and most important step in the whole process. Planning involves selecting missions and objectives and the actions to achieve them; it requires managers to choose among alternative future courses of action. Plans thus provide a rational approach to pre-selected objectives.

Planning bridges the gap from where we are to where we want to go. It makes it possible for things to occur which would not otherwise happen. Although we can never be sure what will happen in the future, and factors beyond our control may interfere with even the best-laid plans, if we don't plan we are leaving events to chance. And that is quite risky when talking about business operations. One wrong step and your business is history.

Today, most business enterprises engage in strategic planning, although the degree of sophistication and formality vary considerably. Conceptually, strategic planning is deceptively simple: analyze the current and expected future situation, determine the direction of the firm, and develop the means for achieving the mission. In reality, this is an extremely complex process which demands a systematic approach for identifying and analyzing factors outside of the organization and matching them with the firm's capabilities.

Planning is done in an environment of uncertainty. No one can be sure what the business environment will be even next week, let alone several years from now. Therefore, people make assumptions or forecasts about the anticipated environment. Some of the forecasts become assumptions for other plans.

To be effective, strategies and policies must be put into practice by means of plans, increasing in detail until they get down to the nuts-and-bolts details of operations. Tactics, then, are the actions through which strategies are executed. Strategies must be supported by effective tactics.

Procurement Management

Procurement management can be defined as the independent monitoring or tracking of manufacturing processes to purchase order requirements. An implicit assumption of Economic Order Quantity (EOQ) analysis is that the purchase price per unit is constant. In an inflationary period, this assumption is not valid. If the rate of inflation is predictable the EOQ formula can be applied.

The standard EOQ model assumes that materials can be procured instantaneously, and hence implies that the firm may place an order for replenishment when the inventory level drops to zero. In the real world, however, time is required for the procurement of materials, and hence the order level must be such that inventory at the time of ordering suffices to meet the needs of production during the procurement period.

If the usage rate of materials and the lead time for procurement are known with certainty then the ordering level would simply be lead time in days for procurement, multiplied by the average daily usage. When the usage rate and lead time are likely to vary, the reorder level should be higher than the normal consumption period requirement during the procurement period, to provide a measure of safety in face of variability of usage and lead time. Put differently, the reorder level should be equal to normal consumption, added by the safety stock.

When both the lead time and usage rate vary, which is often the case, and the range of variation is wide, complete protection against stockout may require an excessively large safety stock. Since inventory-carrying costs are proportional to the level of inventories carried, it rarely makes sense to seek total protection against stockout. In view of the trade-off between stockout cost and inventory carrying cost, the optimal level of safety stock is usually much less than the level of safety stock required to achieve total protection against stockout.

Procurement Budgeting

Procurement describes the acquisition of goods or services at the best possible cost, in the right quantity, time and place, for the direct benefit of the firm. The question now arises: how do you prioritize when you only have a limited amount of money to spend? That's where the role of budgeting comes in.

A budget is a quantitative expression of financial plans. How are budgets useful? Budgets induce management to think systematically about the future. They also serve as a device for coordinating the complex operations of the business, and provide a medium for communicating the financial goals of the firm.

In order to be useful, the budget must be drawn up for a specific time period. Usually, the budget is drawn up for a year. The operating budget for the firm may be constructed in terms of programs or responsibility areas. The program budget is developed in terms of products that are regarded as the principal programs of the business. Such a budget shows the expected costs and benefits of various products and services.

A cost center is responsible for keeping track of costs and expenses. To assess its performance, the actual costs are compared with the budgeted costs. The latter represent expenses that should have been incurred, given the actual activity level. The variance between actual costs and budgeted costs is analyzed for control purposes.

What is the base for preparing the budget? A commonly used base is the level of operations in the current year. Using this, the expected and planned changes in the forthcoming year are identified to develop the budget for that year. Under this approach, referred to as the incremental approach to budgeting, the focus of budgeting is on the operations during the budget period.

In every firm, there is a critical factor which sets a limit to its level of activity. Often, the expected demand is the limiting factor that defines the scope and level of operations. When the demand is fairly strong, the limiting factor may be the production capacity of the firm, which cannot be augmented in the short run. For firms that do not have easy access to the capital market, finances may be a limiting factor.

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