TRANSPARENCY & COST EFFICIENCY IS THE KEY IN MANAGING YOUR PROCUREMENT VALUE CHAIN

This document outlines procurement related good governance practices to help you achieve the twin objectives of transparency and cost efficiency

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ANALYSING THE PROCUREMENT SPEND

Effective and transparent procurement process is gaining importance after the recent economic slowdown. Worldwide, transparency in procurement management is being increasingly promoted by the organisations and regulatory bodies as procurement is the largest spend area for any manufacturing organisation. The decision to select and arrive at an optimum vendor mix is a complex affair thereby making the buying process highly opaque. Typically in a manufacturing company, on an average, the procurement spend ranges between 45% - 85% of revenue. Out of this, the spend on A category (the items that highly influence the cost of final products) ranges between 60% - 75%. Lack of detailed analysis and transparent practices lead to potential increase in input costs, which is not visible to the organisation. Effective procurement supports delivering value for money and savings. On an 80:20 principle, business focuses on the A Category items which normally consists of 5 to 50 key raw materials, whereas B & C categories consisting of 25%-40% of the total spend involving thousands of items remain out of focus/unattended. This means:

CATEGORY A B&C

TRANSACTIONAL VALUE High Transactional Value Low Transactional Value

TRANSACTIONS Low number of Transactions High number of Transactions

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In simple terms, for the A category, the transactional activities are very low, whereas the transactional activities are generally on a higher side for B & C categories of items procured. Since the attention span is directly proportionate to the value of a transaction, B & C categories run a high risk of insufficient controls, visibility and non-transparent negotiation efforts leading to cost leakages which may go up to 25%-50%. What could be the total value of B & C categories of Spend?

Annual Procurement INR 1000 crores

Spent

INR 250-400 crores

This indicates that the cumulative value of the spend of low value transactions is still very high. Identification of low value B & C category items and developing an annual procurement budget with stringent monitoring controls can play a vital role in managing the procurement cost.

THE PROCUREMENT VALUE CHAIN HOW MUCH IS VISIBLE?

The below mentioned process flow reflects generic process followed by any organisation to plan, manage and administer the procurement processes.

Procurement Planning

Solicitation Planning

Solicitation

Negotiation

Source Selection

Contract Administration

Contract Close-out

Make-orBuy Decision

Issue Request For Proposal

Receive Proposal

Discussion and comparison

Award Contract

Complete Substantial amount of Work

Formally close contract

PROCUREMENT PROCESS
The above processes may be partially supported by Enterprise Resource Planning (ERP) and other legacy systems. Any inefficiency or lack of effective checks and balances in the procurement value chain can significantly impact the bottom line of an organisation. Many organisations with support of ERP's and analytical tools have been able to optimize controls and achieve efficiency within procurement function. However there are some inherent challenges within procurement value chain which need to be appropriately addressed. Considering procurement as a major spend it is necessary to adopt certain good practices within the procurement value chain. One of the good governance practices would be to establish a balance between transparency and accountability. These must be further balanced with other good imperatives such as providing guarantees for fair competition. If the level of transparency is adequately defined, the benefits will outweigh the cost, especially when comparing the initial cost of transparency with the potential negative consequences of fraud. As a good governance practice, many organisations are developing robust procurement policies/practices which are effectively implemented through an appropriate web application to bring agility in the process of buying, thereby ensuring complete transparency in this highly sensitive decision-making process.

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THE PROCUREMENT RISK GRID

Within the procurement value chain, there are certain few risks which may remain partially addressed or unaddressed. An illustrative matrix is produced below:

Identified Risk Absence of a defined procurement policy encapsulating roles and responsibilities for various activities Absence of accountability for every decision involving negotiation with vendors Absence of KPIs for the procurement function Absence of market information or market information not being appropriately leveraged Lower transparency in supplier selection process

Risk Classification Critical

Risk Treatment through ERPs & Process Elements Addressed

High Medium High High

Partially addressed Unaddressed Partially addressed Partially addressed

A critical analysis of the procurement risks can help in identifying the right strategy to address various risks that will also facilitate the optimum utilization of available resources for overall control and efficiency. One can conclude that there is Low or No visibility within the Decision-making process leading to accountability and transparency risks.

PROCUREMENT: Fraud Risks

Of all the forms of white-collar crimes, so-called procurement, or contract fraud is probably the least visible and most costly. That's largely because it's frequently a hidden by-product of seemingly legitimate transactions, often involving millions of rupees. Procurement fraud includes, though not limited to, cost/labour mischarging, defective pricing, defective parts, price fixing, bid rigging and product substitution. Of all the areas mentioned, bid rigging is an area where due to least visibility, controls are at a minimum level. There are several other areas of risks within procurement function where there is a potential for fraud and corruption: Gifts and benefits, collusion between staffers/organisation personnel function with suppliers, a non genuine competition, unfair advantage to suppliers, circumventing thresholds, inadequate knowledge of market or nature of goods/services being procured, inappropriately issuing expressions of interest or requests to quote etc.

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BDOs SUGGESTED APPROACH TO MEET THE PROCUREMENT CHALLENGES

The prime most key challenge faced in maintaining internal controls within the procurement function pertains to the buying decision. ERPs fail to address the complete decision-making process post release of Purchase Requisition to finally arriving on a decision to raise order on a particular vendor. What is currently being audited is the order which is the outcome of the final decision, but is there a trail available for actions taken by purchasers? If no, then how do you determine whether the decision is the most optimum decision under the given circumstances? To justify the buying decision, hard/soft copy of negotiations process like quotes etc retained by the purchase department. Unfortunately it lacks credibility due to manual handling of supplier data and absence of visibility on actions of the buying officers. To bring desired transparency and dynamic transaction capability in the decision-making process, an organisation needs real time access to supplier/ supplier base located across the world to facilitate exchange of information with the suppliers. Considering this, it is strongly recommended for organisations to adopt an appropriate balance of process and technology to bring transparency and visibility in procurement function. There is an urgent need to re-rate the sourcing risks, implement processes and new age systems which establish desired visibility and transparency for all buying decisions to support your buying offers in arriving at an optimum buying decision. We follow a 4-step approach to perform a specialised review of procurement spend:

1
Process understanding
Understand business Interview key process owners Review authorisation and approvals configured in ERP Review procurement manuals Identify risks using BDO normative process models

2
Control assessment
Map controls to identified risk with an objective to: Identify controls not adequately designed Control activities which may be eliminated Identify control activities with automation potential

3
Transaction analysis
Perform data analytics to assess: Impact of operational failures of controls designed Efficiency opportunities Recommend leading practices

4
Reporting
Submit procurement control assessment summary report with observations and suggested recommendations

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To read more about our latest publications around the world on manufacturing, visit our website www.bdoindia.co.in

BDO INTERNATIONAL OUR OTHER RELATED PUBLICATIONS

BDO: Manufacturing Outlook December 2010

BDO: Manufacturing: 60 second Survey March 2010

BDO: Changing shape of UK Manufacturing April 2010

For other useful procurement practices visit www.vend-x.com

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May 2011