Procurement always tries to have the complete spend under control. And so, after a while, for everything procured, an LPO needs to be created. Great, isn’t it? All is under control. But, then, suddenly, you figure out that your team is flooded with many small value requests. Instead of negotiating, they are just crunching orders out.
I have done the following exercise in one of the companies I worked for. We have pulled out the number and value of purchasing orders and divided them as:
Very small value: usually the ones that require only one quote and one level of approval
Small value: Two or three quotes are mandatory, and the approval goes to at least two more persons
Medium value: Three quotes are mandatory, three persons need to review and approve the order
Large value: either a full competitive bidding exercise or formal tender must be executed. The results go to a procurement committee or management board for approval. And usually, a contract is signed before the official order is placed.
Guess what happened?
Our good friend Pareto was right once more!
Eighty per cent of orders were of small value, accounting for twenty per cent of the total purchases. My team was overwhelmed because they had to crunch out every day about 30 LPOs. Of which 24 were for a couple of hundred dollars in value.
There is a solution. Hire a couple more guys for those orders. They do not need to be highly qualified to do this part of procurement. Right? Well, we are forgetting the hidden costs. Let’s do some math
Buyer; salary per hour 10 USD
Manager; salary per hour 25 USD
A good buyer needs about an hour to send out three RFQs and analyze the two he got back. Then he requires another 30 minutes to enter the order in the system, assures the vendor got it and eventually place a follow-up call for delivery.
The manager requires about a minute to review the order and approve it. Since we have at least two approval levels, let’s presume that they can together review about 50 orders in an hour
LPO value: 1000 USD
Buyer cost: 15 USD
Manager cost: 1 USD
The TOTAL cost of placing the LPO: 16 USD or 1.6%
Not too much? If your annual procurement is 10 million USD, which is a mid-size company spend, we are talking about (20% of the spend * 1.6%) = 32,000 USD! Of plainly administrative, no value-adding cost.
What can we do about it?
Clap into larger orders
I many cases the items in the order will repeat. If you do a detailed analysis, you may see as well ordering patterns. Wherever possible, join those requests into large ones. Not only you will spend less time on the paperwork. The vendor will as well be happier, as his value per delivery increases. Which may result in price reduction as well.
You (and your manager) may wonder, does it make sense to contract an annual spend of 10,000 USD? Yes, it does!
Maybe not from a saving and compliance perspective, but to increase team efficiency. The RFQ for this purchase is no longer needed. Price is fixed so even the ordering process can be automatized. Make a couple of those “small” contracts and suddenly your team has a couple of hours available every week.
Some vendors will offer you VMI service – Vendor Managed inventory. In short, they will access your system and monitor stock levels. Once the stock reaches reorder levels, they will replenish it themselves. Hence, there is no involvement required from your side.
The second way of outsourcing would be to contract a company that will take care of all those small orders. Your orders go to them, and they are the one’s sourcing, storing and delivering when needed. You will, of course, have to pay something for this service. As long as it is less than the cost of administrative costs associated with this spend, you are effectively saving money. Plus, creating free time for your team. So, they can save some more money.
There is no such thing as small and big orders if you want to manage the spending properly. Ignoring costs you, directly or indirectly, as we could see from this example.
Either work on savings or work on efficiencies.