Introduction Introduction Introduction Introduction

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Maximising efficiency of the procurement process

Towards the development of a purchase-to-pay channel framework

Maarten Beekman

IBM Nederland N.V. verleent toestemming dat deze scriptie ter inzage wordt gegeven middels plaatsing in bibliotheken. Voor publicatie, geheel of gedeeltelijk van deze scriptie dient vooraf toestemming door IBM Nederland N.V. te worden verleend.

Rijksuniversiteit Groningen

Faculty of Management and Organisation University of Groningen

P.O. Box 800 9700 AV Groningen The Netherlands

Author: Maarten Beekman Studentnumber: 1429973 maarten.beekman@gmail.com

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Acknowledgements Acknowledgements Acknowledgements Acknowledgements

Firstly, I would like to thank Erick Haag for the time he has spent with me.

Erick has been very patient and open with me. Moreover, he has put a lot of trust in me.

Secondly, I would like to thank Dick Schaap, you have helped me in the process although it was not always easy. Thank you for your personal approach and your willingness to help whenever possible.

Thirdly, Dirk Kamann, thank you for your clear suggestions and help.

Finally, I have spent much time talking with various people about their procurement profession and experience in the field. They have all been very open to me and they were most helpful in helping me to bring this thesis to a good end. Thank you all for your time.

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Management summary Management summary Management summary Management summary

In procurement practice and literature, a lot of emphasis is placed on strategic sourcing. This is a vital step in procurement and savings can be high. Lowering costs of the overall procurement process, from the initial purchase requisition up to the invoicing process can produce significant savings as well. Although most manufacturing companies have gained strong control over direct materials, only recently have they begun to focus on fragmented MRO / indirect spend categories (Porter, A.M. 2006).

Different IT solutions such as EDI and ERP systems have drastically changed the way in which goods and services are being purchased. Computer systems can automatically place orders when a forecast, such as a Material Requirement Planning (MRP) requires them to. This has primarily affected the purchasing of direct goods and services, while indirect goods and services are still bought quite randomly. Elec- tronic procurement solutions such as Ariba and modules in ERP systems such as SAP SRM have emerged, but implementing these solutions is not easy and requires an organisation to rethink its procurement processes. Moreover, there are commodity specific solutions that need to be assessed (Roberts & Mackay 1998).

IBM distinguishes three main activities in procurement, strongly linked to each other, namely sourcing, purchasing and paying. These three aspects come together in the procurement cycle. IBM recognises potential savings in the entire procurement process by focusing on the operational purchasing process, also called purchase-to-pay, procure to pay or P2P.Purchase-to-pay processes can be very different in nature. Buying coffee cups from a catalogue is a very different process from buying a piece of production equipment with unique specifications. While the coffee cup probably requires no buyer intervention at all, the production equipment requires some level of buyer or supplier interaction before it can be ordered.

IBM procurement consultants have distinguished 11 generic purchase-to-pay processes referred to as purchasing channels. By helping organisations to gain control over their purchasing processes and channels, IBM recognises potential savings for her clients to control their spending with maximum efficiency.

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IBM wants to know why organisations prefer one purchase- to-pay channel over another. Purchase-to-pay channels will probably not be recognised as such, but interviews have provided more insight in their decision-making. When IBM understands its client’s decisions, IBM can help organisations to organise their purchase-to-pay channels effectively.

The following research question has been defined:

Which criteria determine why IBM’s clients prefer one purchase-to-pay channel over another when purchasing indirect goods or services?

Sourcing is the most important differentiator in the purchase-to-pay channels. Different criteria related to a purchase determine when sourcing is necessary and determine the level of intervention from other people apart from the initial requestor. The criteria can be found at the buying organisation, the supplier and the product which is being purchased. Appendix three shows a theoretical framework in which the different criteria are pictured. These criteria determine for a specific group of products how much intervention is expected and could later be connected to channels in order to create a fit between the channels and products.

Conclusions

The theoretical framework has been an attempt to identify possible criteria in the decision to choose a purchase-to-pay channel. In practice, these criteria are very hard to find.

The criteria in the theoretical framework differ depending on the maturity of the purchasing organization.

The procurement cycle strongly recommends focusing on the transactional procurement process. When the procur- ment process is designed as an end-to-end process, this will allow organisations to have more transparency in the process, which will increase procurement control.

The maturity of a purchasing organisation is strongly linked to the level of attention to the operational purchasing process. There is no one size fits all solution. Different products require different approaches and different levels of intervention. It is a combination of processes and tools that will form a best fit. One electronic solution for purchasing does not seem realistic at the moment.

There might be other criteria in the theoretical framework, but these criteria were mentioned the most in all of the discussions.

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The purchasing process as an end-to-end cycle, as mentioned in chapter 2 is not a perspective that is being used often. This perspective is very important and helps organisations to allow them to focus more on strategic issues than operational ones.

Every organisation I have spoken with is struggling with finding the correct purchasing information. Focusing on purchase-to-pay will help them to deliver the right information on their spending and will create a more efficient procurement process.

The theoretical framework has been a first attempt at identifying criteria. No scientific data has yet been collected in order to prove its validity. Future research could expand the theoretical framework and test its validity empirically.

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Table of contents Table of contents Table of contents Table of contents

Chapter 1... 13

Introduction... 13

1.1 Context description ... 13

IBM ... 13

IBM Global Business Services... 14

Sectors ... 14

Service lines ... 15

Supply Chain Management ... 15

Procurement ... 16

1.2 Problem description ... 17

1.3 Problem statement ... 18

Research question... 18

Objectives... 19

Approach ... 19

Summary ... 19

Chapter 2... 21

Introduction... 21

2.1 What is procurement? ... 21

The process of managing external spend ... 23

Effective sourcing of goods and services ... 24

Supplier management ... 25

Internal demand management ... 26

Total cost of ownership... 26

2.2 What is the procurement process?... 27

Procurement from a systems perspective... 29

2.3 What are indirect goods and services?... 30

Implications related to direct or indirect purchasing ... 31

2.4 Procurement cycle: what is purchase-to-pay? ... 33

Strategic, tactical and operational sourcing ... 35

Summary ... 36

Chapter 3... 37

Introduction... 37

3.1 What are purchase-to-pay channels?... 37

Hands-on procurement process ... 38

Hands-free procurement process ... 40

3.2 Standardising procurement processes... 41

3.3 Which criteria determine the differences between these processes?... 42

Product related issues ... 42

Buyer related issues ... 44

Supplier related issues... 45

3.4 Theoretical framework... 47

3.5 Introducing cases ... 48

Chapter 4... 49

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Introduction ...49

4.1 Interviews ...49

4.2 Company A...49

Facts and figures...50

Interviewees...50

Reflections on the theoretical framework ...50

4.3 Company B...51

Interviewees...52

4.4 Company C...52

Interviewees...53

4.5 Company D...54

Interviewees...55

Chapter 5 ...56

Introduction ...56

5.1 Conclusions...56

5.2 Recommendations ...57

References...58

Articles...58

Books ...58

Miscellaneous ...59

Appendices...60

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Chapter 1

Introduction Introduction Introduction Introduction

This chapter forms an introduction to the research that has been conducted at IBM and forms an essential background to the problem statement.

Firstly, IBM will be introduced and procurement’s position within IBM’s Global Business Services will be described.

Secondly, the problem will be introduced and analysed further.

Thirdly, the problem statement will be presented and the approach to the research will be introduced.

1.1 1.1

1.1 1.1 Context description Context description Context description Context description

This paragraph describes IBM and the organisation in which the research has been conducted. It will start off with IBM’s service lines and sectors and will zoom in on the procurement consulting area. Definitions will be presented when necessary.

IBM

International Business Machines Corporation (IBM), incorpo- rated in June 1911, is an information technology company. IBM also provides business, technology and consulting services. The company's major operations comprise a Global Services segment, a Systems and Technology Group, a Software segment, a Global Fi- nancing segment and an Enterprise Investments segment.

IBM's business comprises three principal business segments:

Systems and Financing, Software and Services. The majority of the company's enterprise business, which excludes the company's original equipment manufacturer technology business, occurs in industries that are broadly grouped into six sectors: financial services, public, industrial, distribution, communications and small and medium business.

With a total revenue of 91.13 billion dollars in 2005 and about 330,000 employees working worldwide, IBM is one of the big- gest IT companies in the world.

IBM strives to lead in the invention, development and manufacture of the industry's most advanced information technologies,

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Context Context Context

Context description

including computer systems, software, storage systems and mi- croelectronics. They translate these advanced technologies into value for their customers through their professional solutions, services and consulting businesses worldwide (IBM intranet, 2006).

IBM Global Business Services

IBM Global Business Services Benelux delivers solutions from advice to implementation and business process outsourcing.

Global Services is an important component of the Company's focus of providing insight and solutions to clients. While solutions often include IBM software and hardware, other suppliers' products are also used if a client solution requires it. A sim- plified view of the organisation is depicted in a matrix in table 1.

Sectors

Different organisations face different challenges depending on the nature of the product or services they produce. A car manufacturing company faces other difficulties than a bank. IBM has expertise in different industries:

• Industrial - Aerospace & Defence, Automotive, Chemi- cal & Petroleum, Electronics and Metals

• Public - Government (Central, Social and Defence), Education and Healthcare

Table 1 - Organisation of IBM Global Business Services

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Context ContextContext

Context description

• Communications - Telecommunications, Media & Enter- tainment and Utilities & Energy

• Distribution - Retail, CPG/Wholesale, Travel &

Transportation and Life Sciences / Pharmaceutical

• Financial Services - Banking, Financial Markets and In- surance

Service lines

IBM offers services along the following service lines. Supply chain management will be discussed in the next paragraph.

• Financial Management - The Financial Management (FM) solutions help clients design and implement finance and accounting business transformation, process improvement, and technology solutions across the enterprise. The solutions help companies address the changing role of finance, better manage capital and profits, increase visibility of financial information, and maximize benefits of technology.

• CRM - The Customer Relationship Management (CRM) solutions help clients improve the efficiency and effectiveness of marketing, sales and customer service while im- proving customer loyalty, satisfaction, and profitability.

• Strategy & Change - Strategy and Change helps clients transform their enterprise and operations by framing industry opportunities and challenges into specific strategic options, formulating actionable strategies that intersect business and technology and accelerating implementation through tailored operations and change programs.

• Human Capital Management - The Human Capital Man- agement (HCM) solutions help clients create a responsive workplace and best-in-class HR function while aligning performance with strategic goals.

• Application Innovation - Application Innovation Services (AIS) helps IBM clients innovate and grow through cus- tom application development and integration services.

Supply Chain Management

Supply Chain Management is a multi-industry, global consulting practice. It combines IBM’s capabilities and experiences in supply chain planning, procurement, product lifecycle man-

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Context Context Context

Context description

agement, operations, ERP, and logistics. SCM has over 8,000 practitioners worldwide. The service offerings have been tailored to meet the unique business requirements of each sector.

Within the Supply Chain Management Service Area, IBM offers solutions in every phase of the supply chain, from design to source to plan to build to distribute. The main service areas within Supply Chain Management are:

• Supply Chain Strategy - Identifying, quantifying and as- sisting in planning supply chain transformation.

• Supply Chain Planning - Helping to plan and manage supply and demand across the supply chain.

• Supply Chain Enterprise Applications - Integrating the supply chain with existing or new Enterprise Resource Planning (ERP) solutions.

• Logistics - Helping to implement new technologies in warehousing, transportation and reverse logistics that can result in cost reduction and improved customer service.

• Product Lifecycle Management - Helping to design, build and maintain products, and improve design and product innovation processes, while potentially reducing costs, in- creasing quality and shortening development cycles.

• Procurement - Helping to improve procurement operations to achieve better prices, greater efficiency, tighter spend control and improved service levels.

• Supply Chain Operations - Helping to realise operational improvements across the supply chain to enable cost reduction, cash flow gains and greater efficiencies.

Procurement

Procurement leverages IBM's experience in procurement to enable their clients to better manage their enterprise spend

• Focuses on those business pressures that are driving companies to improve the effectiveness of their procurement operations to achieve better advantaged pricing, greater efficiency, tighter control of spend and improved service levels.

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Problem ProblemProblem

Problem description

• Leverages IBMs strength and experience in procurement to enable their clients to better manage their enterprise spend.

In the next chapter, the procurement service area will be further explored.

1.2 1.2

1.2 1.2 Problem description Problem description Problem description Problem description

In procurement practice and literature, a lot of emphasis is placed on strategic sourcing. This is a vital step in procurement and savings can be high. Lowering costs of the overall procurement process, from the initial purchase requisition up to the invoicing process can produce significant savings as well.

Although most manufacturing companies have gained strong control over direct materials, only recently have they begun to focus on fragmented MRO / indirect spend categories (Porter, A.M. 2006).

Different IT solutions such as EDI and ERP systems have drastically changed the way in which goods and services are being purchased. Computer systems can automatically place orders when a forecast, such as a Material Requirement Planning (MRP) requires them to. This has primarily affected the purchasing of direct goods and services, while indirect goods and services are still bought quite randomly. Electronic procurement solutions such as Ariba and modules in ERP systems such as SAP SRM have emerged, but implementing these solutions is not easy and requires an organisation to rethink its procurement processes. Moreover, there are commodity specific solutions that need to be assessed (Roberts & Mackay 1998).

IBM distinguishes three main activities in procurement, strongly linked to each other, namely sourcing, purchasing and paying. These three aspects come together in the procurement cycle, which will be discussed in detail in paragraph 2.4.

IBM recognises potential savings in the entire procurement process by focusing on the operational purchasing process, also called purchase-to-pay, procure to pay or P2P. IBM defines purchase-to-pay as:

The entire process from requisition to fulfilment of purchase orders, settlement of invoices and measurement of total cost performance.

Purchase-to-pay processes can be very different in nature. Buy- ing coffee cups from a catalogue is a very different process from buying a piece of production equipment with unique specifica-

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Problem Problem Problem

Problem statement

tions. While the coffee cup probably requires no buyer intervention at all, the production equipment requires some level of buyer or supplier interaction before it can be ordered.

IBM procurement consultants have distinguished 11 generic purchase-to-pay processes referred to as purchasing channels.

By helping organisations to gain control over their purchasing processes and channels, IBM recognises potential savings for her clients to control their spending with maximum efficiency.

1.3 1.3 1.3

1.3 Problem statement Problem statement Problem statement Problem statement

IBM wants to know why organisations prefer one purchase-to- pay channel over another. Purchase-to-pay channels will probably not be recognised as such, but interviews should provide more insight in their decision-making. When IBM understands its client’s decisions, IBM can help organisations to organise their purchase-to-pay channels effectively.

Research question

The following research question has been defined:

Which criteria determine why IBM’s clients prefer one purchase-to- pay channel over another when purchasing indirect goods or services?

In order to answer the main question, the following sub questions have been identified and will be answered:

• What is procurement?

• What is the procurement process?

• What are indirect goods and services?

• What is purchase-to-pay?

• What are purchase-to-pay channels?

• Which criteria determine the differences between these processes?

• How do these criteria differ from the criteria IBM’s clients prefer?

These sub questions also form an outline for this thesis and the paragraphs are named accordingly. The first four questions will be answered in chapter 2. Moreover, purchase-to-pay will be explained by introducing the procurement cycle. The other

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Summary Summary Summary Summary

questions will be answered in chapter 3 and 4, while they require more discussion. Chapter 5 will present conclusions and recommendations on the research.

Objectives

The information should be obtained from IBM’s clients, consultants and competitors, completed with business theory.

The results of the research should be fed back to the people involved. People involved in the research should have a clear understanding of their roles and responsibilities and these will be communicated accordingly. The findings will be fed back to the people closely involved in the project in the form of a thesis.

Approach

The approach of this research is firstly to answer the sub questions and finally by introducing a theoretical framework. The framework has been the result of theory, conversations with consultants and the last chapter attempts to present some feedback on the framework.

Summary Summary Summary Summary

This chapter has introduced the environment in which the problem statement is placed and the problem statement itself.

IBM has been introduced, as well as IBM’s Global Business Ser- vices. Moreover, the service line Supply Chain Management has been introduced and the focus area of procurement has been discussed. This division of IBM consults businesses in their procurement activities. An analysis of the purchase-to-pay process and the criteria involved in the process will enable IBM to ad- vise clients in their procurement activities.

Although purchase-to-pay has been introduced in this chapter and the problem statement has been defined as well, the purchase-to-pay concept requires much more background and explanation. The following two chapters will provide background for this concept and attempts to create a theoretical framework, based on discussions with consultants, clients and business theory.

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Introduction Introduction Introduction Introduction

Chapter 2

Introduction Introduction Introduction Introduction

This chapter provides background for purchase-to-pay and will introduce several concepts in this field of study. The chapter will start off with a procurement definition and will zoom in on the different aspects of this definition. Related subjects will be discussed, resulting in an explanation of the procurement cycle.

This procurement cycle plays an important role in procurement.

Although it might seem a simple concept, the implications are essential for a business.

This chapter will answer the following sub questions from the research question:

• What is procurement?

• What is the procurement process?

• What are indirect goods and services?

• What is purchase-to-pay?

Related to both questions, several other concepts will also be discussed. The concept of procurement as a cycle will be presented as well. Strategic, tactical and operational procurement will also be discussed.

The answer to “what is procurement” and the related concepts in this definition have been formulated using existing business theory. The procurement cycle is a result of discussions I have had with several of IBMs consultants. Finally, “what are purchase-to-pay channels” is an elaboration on the concept introduced in the problem description in chapter 1. This will form the basis of the next chapter, which will zoom in on the essential differences between purchase-to-pay channels.

2.1 2.1

2.1 2.1 What is procurement? What is procurement? What is procurement? What is procurement?

In order to build a theoretical framework and to understand what purchase-to-pay is about, first the different concepts related to procurement will be discussed.

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What What What

What is procurement?

Purchasing is a term which is often used in relation to procurement. Purchasing can be viewed from different perspectives, such as purchasing as a function, a department, a process or a profession. The exploration of the purchasing concept is necessary in order to put IBM`s vision on procurement in perspective. In order to do so, the purchasing function and the purchasing process will be described.

The purchasing function is the role purchasing plays in an organisation. Porter’s value chain (1985) describes how primary and support activities produce margin in industrial organisations. Procurement is one of the four support activities and is described as the procurement of raw materials, servicing, spare parts, buildings, machines, etc. Procurement is a wider term than purchasing; however both concepts are often used in practice.

Van Weele (2001) defines purchasing as:

Obtaining from external sources all goods and services which are necessary for running, maintaining and managing the company’s pri-

mary and support activities at the most favourable conditions.

This definition is very much focused on resource management.

While this thesis focuses on indirect purchasing, it is also necessary to illustrate the most important differences between procurement for primary and procurement for support activities.

Van Weele (2001) describes differences between product-related and non-product related procurement. The differences can be found in table 2.

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What What What

Purchasing function in primary activities

Purchasing function in support activities

Assortment Limited Very large

Number of suppliers Limited Very large

Turnover Quite large Limited

Number of orders, etc.

Quite large Very large

Average order price High Modest

Control Depends on pro-

duction planning

Limited (often works with esti- mates)

Decision Making Unit

Often engineering, production

Composition varies

Table 2 - Purchasing function in primary and support activities IBM provides the following definition of procurement:

The process of managing external spend through effective sourcing of goods and services, supplier management and internal demand man-

agement. Effective procurement results in acquiring products at a minimal total cost of ownership.

This definition introduces several concepts and raises new questions. The definition will be broken up into several elements and these will be discussed in the following paragraphs.

The process of managing external spend through effective sourcing of goods and services, supplier management and internal demand management. Effective procurement results in acquiring products at a minimal total cost of ownership.

The process of managing external spend

The key issue in procurement seems to be the process of managing external spend. The definition presents several ways to accomplish this.

Telgen’s (1994) explanation of procurement is “everything op- posing an invoice”. This means for example that raw materials, semifinished products, but also energy and labour can be con-

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What What What

sidered as a part of procurement. This thesis will focus on indirect purchasing. Non-production materials often account for 30 to 60 percent of a company’s total expenditures, yet they remain poorly controlled and costly to process in most organisations (Aberdeen Group 2001).

The distinction between indirect and direct spend will be discussed further in the paragraph on effective sourcing of goods and services.

According to IBM’s definition, three elements lead to managing external spend: effective sourcing of goods and services, supplier management and internal demand management. This elaboration of the definition introduces the key players in procurement, namely a buyer and a seller. While economically, an organisation needs to act in both roles in order to survive, this can lead to complex situations. Especially in larger organisations, chances are big that an organisation’s supplier is also an organisation’s client. Needless to say, this means that management involvement can be necessary in procurement negotia- tions.

Effective sourcing of goods and services

Before IBM’s view on sourcing will be introduced, first we look at several other definitions.

Vollman, Berry and Whybark (1984) describe sourcing as:

…researching the market for potential input sources, securing the continuity of these sources, searching for alternative sources and keep-

ing the relevant knowledge up to date.

This definition does not vary much from IBM’s definition. In their Principles of Supply Chain Management, sourcing is explained as:

Where, and how, do we get our finished goods for onward sale or raw material products for manufacture, and what are the best and most appropriate prices, lead times and quality we should elect for them.

This definition will be used throughout the thesis, although this description seems to focus more on direct in stead of indirect goods and services.

Sourcing can be viewed from different perspectives. Sourcing is often viewed as strategic, tactical and operational. Sourcing is also described as local versus global and single versus multiple sourcing. These last perspectives are actually different sourcing

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What What What

strategies. First, the distinction between strategic, tactical and operational sourcing will be presented.

Strategic sourcing is concerned with top-level, longer-term decisions relating to high profit/high supply risk strategic items and low profit/high supply risk bottleneck items. Strategic sourcing is also concerned with the formulation of long-term purchasing policies relating to core competencies, strategic make-or-buy decisions, thin supplier base, partnership sourcing, reciprocal and intra-company trading, globalisation and counter trade, the purchase of capital equipment and ethical issues (Lysons & Gillingham 2003). Killen and Kamauff (1995) define strategic sourcing as:

The process of creating a value adding (or optional mix) of supply relationships to provide a competitive advantage.

This is a very high-level description of strategic sourcing. IBM has a different approach to the different levels of sourcing and this approach will be discussed in paragraph 2.3 (Procurement cycle: what is purchase-to-pay?)

Tactical and operational sourcing is concerned with lower level decisions relating to high profit/low risk non-critical items. It also concerns short-term adaptive decisions as to how and from where specific supplier requirements are to be met (Lysons &

Gillingham 1995).

This research focuses mostly on the internal customer’s experience and the management’s perspective and will not focus specifically on demand management and supplier (relationship) management. The focus will be on operational procurement:

ordering, delivering and invoicing and payment.

Supplier management

Many organisations have recognised the fact that supplier relationships are very important. Recognising that you need a portfolio for relationships with suppliers and that they need different management approaches is key to this operation. This is supplier management or Supplier Relationship Management (SRM).

SRM aims to establish long term relationships with suppliers, such as partnerships or alliances.

While this is an important aspect of procurement, this will be beyond the scope of this document.

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What What What

Internal demand management

Internal demand management focuses on standardising parts or services across departments or divisions to increase volume by requiring usage of only one type of service or product. For instance how a company can standardise a single type of copier paper across all departments. While this might seem an oversimplification of the issues in demand management, they will not be discussed any further within the scope of this thesis.

Total cost of ownership

The procurement definition ends with:

…effective procurement results in acquiring products at a minimal total cost of ownership.

The Total Cost of Ownership (TCO) perspective stresses the fact that purchase price is an obvious but still just a single element of the total cost of a good or service. TCO is a purchasing tool and philosophy aimed at understanding the relevant cost of buying a particular good or service from a supplier (Ellram, 1998). There are a number of additional costs which are in- curred through the life of the product, which aren’t always clear at the start of the buying process. Understanding these costs highlights significant sourcing opportunities.

Acquisition - Sometimes the very process of buying can match or exceed the value of the item…this doesn’t make much sense if the process is long and complicated for inexpensive products, acquisition costs can be high if the buying company must produce an Invitation to Tender or Request for Proposal document, vendors must reply in a set format and then the buyers have to review all returns and check references – although this is appropriate for certain buys.

Installation - How much it costs to get the item to its place of use and get it working. So for our IT example, once equipment has arrived on site, it must be matched to appropriate paper- work and then internally transported to the correct location, in the case of a desktop PC this could be a specific office location, there is then the process of setting it up, completing data trans- fers and making sure it functions correctly, and removing any old equipment that it may be replacing – this all takes up time for both the installation team and the user.

Maintenance – These are the costs to fix, and use, in our desktop PC example, this might include software or operating system upgrades, or replacement of faulty parts, say a CD drive or

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What What What

What is the procurement process?

network connector – once again this includes the time for maintenance team and user and also the cost of any parts.

Disposal – Finally there are actual disposal costs, which may also include some requirement for recycling. There are also

‘negative costs” of remaining value, for instance writing an as- set off, from the company balance sheet.

There are a number of challenges around how we can measure and attribute TCO, for example:

• How to collect data

• How costs are attributed to departments’ budgets

• And measuring costs that could happen far in the future A framework for TCO must be developed in conjunction uniquely with each client. While TCO is currently a very interesting aspect of procurement, this will not form a part of this research. Nevertheless, it forms a vital part of procurement and in light of this study, it would be interesting to analyse in a particular situation what the TCO would mean for example in maintaining an internal or external catalogue. While this research focuses on more than one organisation, it would have been very time consuming to do so.

2.2 2.2 2.2

2.2 What is the procurement process? What is the procurement process? What is the procurement process? What is the procurement process?

Harmon (2003) describes a business process as:

At its most generic, any set of activities performed by a business that is initiated by an event, transforms information, materials, or business

commitments, and produces an output. Value chains and large-scale business processes produce outputs that are valued by customers.

Other processes generate outputs that are valued by other processes.

The procurement process can be best described by the buygrid framework (Robinson et al, 1967). They describe the procurement process as:

…the sequence of activities which must be performed in the resolution of a buying situation.

Robinson et al view industrial purchasing as a problem-solving process, namely a problem exists and the problem might be re- solved through a purchase. They identify three types of buying situations or buyclasses: the New Task, the Modified Rebuy

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What What What

and the Straight Rebuy. The activities are eight distinct activities or buyphases. These can be found in table 3.

1. Anticipation or recognition of a problem (need)

2. Determination of the characteristics and quantity of the needed item

3. Description of the characteristics and quantity of the needed item

4. Search for and qualification of potential sources 5. Acquisition and analysis of proposals

6. Evaluation of proposals and selection of suppliers 7. Selection of an order routine

8. Performance feedback and evaluation

BUYCLASSES New

Task

Modified Rebuy

Straight Rebuy

BUYPHASES

1. Anticipation or recognition of a problem (need)

2: Determination of the characteristics and quantity of the needed item

3. Description of the characteristics and quantity of the needed item

4. Search for and qualification of potential sources

5. Acquisition and analysis of proposals

6. Evaluation of proposals and selection of suppliers

7. Selection of an order routine 8. Performance feedback and evaluation

Table 3 - Organisational Buying Grid

The phases are closely interrelated and while there is a sequen- tial flow in these activities in a logical sense, two or more may

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What What What

take place concurrently. The eight phases represent the critical decision points.

Procurement from a systems perspective

The systems perspective emphasises that everything is connected to everything else and that it is often useful to model businesses and processes in terms of flows and feedback loops (Harmon 2003). Figure 1 shows the business process, inputs, outputs and feedback

The problem-solving approach from the buying grid can be applied to this approach. When the systems perspective is applied to procurement, the following high-level picture can be made (figure 2).

This picture shows that a problem is input and a solution to the problem in the form a purchased good or service is the output.

Business process

Inputs Outputs

Feedback

Figure 1 - Business process from a systems perspective

Figure 2 - Procurement from a systems perspective

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What What What

What are indirect goods and services?

The main procurement process can be described as transform- ing the problem into supply; however this view might overlook the managerial aspect of procurement. Management for example will need to know whether this transformation is performed efficiently and effectively. A procurement organisation needs to know whether the goods and services have actually been delivered as promised, whether employees have ordered complying with a contract, or perhaps if it was below or above budget.

Procurement needs to co-operate closely with Accounts Payable.

In this way, an organisation is able to control the process and check if the received products and services have actually been ordered and paid for. While this process repeats itself, procurement can be considered a cycle.

2.3 2.3

2.3 2.3 What are indirect goods and services? What are indirect goods and services? What are indirect goods and services? What are indirect goods and services?

The distinction between direct and indirect goods and services has several implications for the business.

Direct goods are those that are essentially component parts used in the activities of the buying company. The examples given here are raw materials for a manufacturer – for example iron ore for steel, pre-fabricated panels for a car manufacturer or wood pulp for packaging materials. In these examples the buying company will transform or process these in some way before onward sale. However, finished goods may also be direct, for instance a wholesaler or supermarket will buy finished products in bulk to then sell on to end consumers at a unit level.

Indirect goods on the other hand are those which are consumed as part of the day to day operation of the company and do not directly contribute to the final product. For instance, office supplies such as copier or printer paper. Every business will print documents or reports, but these will form no final part of a product in most cases.

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What What What

The following table (table 4) illustrates the distinction between direct and indirect goods and services. As mentioned before, this thesis focuses on indirect goods and services.

Direct Goods and Services Goods and services that are used directly in the production / value chain process of a buying company.

Examples: raw materials in steel production, parts in auto production, packaging for a consumer goods company.

Indirect Goods and Services Goods and services that support the operations of the business.

Examples: office supplies, temporary staff, furniture and fittings.

Table 4 - Distinction between direct and indirect goods and services

Implications related to direct or indirect purchas- ing

First, an essential distinction should be made between indirect and direct purchasing of goods and services. Direct purchasing is strongly related to the primary process and ends up in the product or service. Indirect purchasing however supports this.

The separation between direct and indirect goods and services has several implications for the procurement process. Table 5 illustrates these differences.

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What What What

Type of product Indirect Direct

“Owner” of item specification

Seller Buyer

Customer Internal External

Order triggers Random MRP or Forecast

Buyer's focus Price Value

Buyer Employee Professional

Supporting tools Catalogue ERP system Table 5 - Indirect and direct differences

The owner of the item specification for indirect products is usually the seller. A stationary supplier for instance will own, maintain and update the detail and design of ball point pens, whereas the specification of direct goods and services are normally owned by the buyer, and is often more complicated such as a helicopter rotor blade. This has implications for the way in which a catalogue will be maintained. As this thesis focuses on indirect goods and services, this means that in many cases, the seller will be the owner of the item specification. This is a very important aspect of the opportunity to standardise the procurement process.

The customer, for an indirect good or service is internal in that it comes from a central internal store and is sold or distributed to internal departments, whereas a direct item will be bought straight from an external supplier and delivered directly to the end user or consumer of it.

Indirect buy orders are triggered either randomly, when a shortage is discovered, or on a cyclical time basis. Cleaning materials for example will be ordered once a month. Whereas direct buys are bought in order to fulfil an anticipated demand such as a forecast or a manufacturing requirements plan.

The buyers focus for direct products will always be on achiev- ing maximum value. This will represent a combination of price, conformance, specification, total cost of ownership, after sales service, and a number of other factors which must all be taken into consideration. With indirect buys however, the key differentiator in what are essentially commodity markets is always

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Procurement Procurement Procurement

Procurement cycle: what is purchase-to-pay?

price. This is also the reason why the buyers of direct goods are usually dedicated professionals who have extensive product and negotiating experience, whereas the buyers of indirect goods, do not require such specialist skills or knowledge.

The tools which these buyers use relate to the product type as well. Most commodity products will only differ in price, volume and maybe one other key feature and so these are maintained in a catalogue, more complex products which are differ- entiated on many different levels are maintained and supported either in an ERP system or sometimes in dedicated engineering systems.

2.4 2.4 2.4

2.4 Procurement cycle: what is purchase Procurement cycle: what is purchase Procurement cycle: what is purchase Procurement cycle: what is purchase----to to to to----pay? pay? pay? pay?

The procurement cycle depicts the procurement process as a cyclical process in which the main activities are sourcing, ordering and paying. This cycle is based on IBM’s vision of an integrated procurement process, represented as a (closed loop) cycle to execute focused strategies, embedded by an integrated in- frastructure. IBM offers advice in every area of the cycle, mostly by helping organisations to set up their processes or by per- forming the processes for them in order to manage their spending. Figure 3 depicts this cycle.

Figure 3 - Procurement cycle

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The cycle can be explained by using the buying classes from the buying grid model (Robinson et al, 1967). The cycle starts at the right at identify & plan buying need. The purchase can be a new task, a straight rebuy, or a modified rebuy.

New task – When the purchase is a new task, this means a product has not yet been bought before; sourcing is required.

This is operational sourcing and takes place in the bottom half of the cycle.

Straight rebuy – In case of a straight rebuy, the purchase takes place on a routine basis. This means that the bottom part of the cycle will be a recurring event.

Modified rebuy – A modified rebuy might require additional sourcing. The distinctive element here is the reevaluation of al- ternatives, often the consideration of new ones.

Procurement functions are often organised around categories or commodity groups, which are defined as a logical groupings of goods and/or services which organisations procure. In order to manage this portfolio effectively, one needs to assess the business impact and supply market positioning of each main category at a strategic level (Kraljic, 1983). The structure of a category is normally based on the supply market structure within a country or region. Kamann (2000) has suggested assessing three different perspectives: complexity of the buyer market, financial relevance and the complexity of the supplier market.

The top part of the cycle depicts strategic sourcing and this is where procurement professionals prefer to spend most of their time. However, the top and bottom part of the cycle are very closely connected, especially where the three arrows connect:

1. Contract implementation and control – Identify and plan buying need: when contracts and controls are not properly implemented, it is hard to comply to these contracts when identifying and planning buying need.

2. Purchase order fulfillment – Invoice receipt and matching – Matching invoice and order (and goods receipt) is essential for an efficient purchasing process.

3. Payment approvement and settlement – Demand and spend profiling – When there is no transparent view on spend, it is very hard to locate possible savings.

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There is a strong linkage in the cycle. Whether sourcing is a simple process in which a buyer calls several suppliers, or more complex such as e-reversed auctioning; sourcing creates the conditions for purchasing. When one wants to focus on strategic sourcing, first purchase-to-pay needs to be organised correctly. The bottom part of the cycle is purchase-to-pay. IBM defines purchase-to-pay as:

The entire process from requisition to fulfilment of purchase orders, settlement of invoices and measurement of total cost performance.

Strategic, tactical and operational sourcing

When purchase-to-pay is properly designed and the end-to-end procurement cycle is operational, this will achieve transaction efficiency and greater visibility. This will begin to free up buyers to move away from transaction-based procurement to strategic procurement (Atkinson, 2001).

IBM distinguishes the following differences in tactical and operational sourcing. The top part of the cycle is seen as strategic sourcing.

When a purchase requisition is present, but no sourcing has taken place yet, this is considered to be tactical sourcing. In practice, this means that no contract is available with suppliers for this particular purchase requisition. When a purchase requisition is available, a contract with one or more suppliers is in place and the specifications are known, operational sourcing will take place. The following picture illustrates this distinction between strategic, tactical and operational sourcing. Opera- tional sourcing can be a three quote policy, which means that three quotes should be obtained before an order can be placed, but also a pitch or a mini-tender (figure 4).

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The distinction of strategic, tactical and operational concepts in procurement can be confusing in literature. In his oration, Jeroen Harink (2005) claims that strategic purchasing or strategic sourcing in most cases can be traced to tactical purchasing or sourcing and has nothing to do with strategy, as discussed in strategic literature.

Summary Summary Summary Summary

This chapter has defined procurement in IBM’s context. While many definitions of procurement exist, this research works within the boundaries of this definition. While the definition focuses on the “management of external spend”, this is considered to be an essential part of procurement. One can imagine that it is very hard to work within procurement without having good relations with Accounts Payable. The end-to-end procurement cycle introduced in this chapter emphasises this. The next chapter will zoom in on the essential difference between the purchase-to-pay channels and will introduce a theoretical framework that illustrates these differences.

Figure 4 - Strategic, tactical and operational sourcing

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Introduction Introduction Introduction Introduction

Chapter 3

Introduction Introduction Introduction Introduction

This chapter will continue to explore the concepts related to purchase-to-pay and will build a theoretical framework from it.

The following sub questions will be answered:

• What are purchase-to-pay channels?

• Which criteria determine the differences between these processes?

• How do these criteria differ from the criteria IBM’s clients prefer?

3.1 3.1 3.1

3.1 Wh Wh Wh What are purchase at are purchase at are purchase at are purchase----to to to----pay channels to pay channels pay channels? pay channels ? ? ?

Discussions with consultants resulted in an essential difference between the purchase-to-pay channels. The channels seem to differ from each other by the level of intervention of other people apart from the initial requestor during the buying process.

The purchase-to-pay channels are very specifically defined.

While not every organisation has the same channels, the focus of this research is not on these specific channels, but on the essential element that differentiates these channels, namely the level of buyer intervention.

This results in a hands-on or a hands-off process. Much intervention from people apart from the initial requestor of a good or service can be seen as a hands-on process, while little intervention can be seen as a hands-free process. These two processes will be discussed in the following paragraphs.

At first, a hands-on business process will be described. This means that a lot of activities take place related to the purchase of a good or service. It is a very labour intensive process. This process has been discussed with several consultants and describes a typical procurement process starting with a requestor with a plan to buy, finishing with the payment. It is a fictional process as it can be found in many organisations. Terminology has been borrowed from IBM consultants practice. The process can be found in figure 6.

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What What What

What are purchase-to-pay channels?

Hands-on procurement process

The following roles can be identified:

• Requestor – this is the employee who has a certain demand for something. In many larger businesses, this requestor can formally or informally communicate this with his or her manager.

• Approver – The approver is somebody with the author- ity to approve a request from the requestor. In most cases this will be the direct manager of the requestor.

• Buyer – The buyer is the person who will eventually place the order or put out an request for purchase (RFP).

• Supplier – The person or business that will take care of the purchase order (PO) and will deliver the goods and/or services to the requestor.

• Accounts Payable – The person or department that will take care of the payment.

The general hands-on purchasing process has been mod- elled in process swimming lanes in figure 5. A better view of this picture is provided in appendix 1.

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What What What

First, we will zoom in on the different activities in the process.

Requestor plans to buy – The requestor has demand for a certain product or service and will ask his or her manager to approve the request. This can be a formal purchase requisition or an informal authorisation.

Requisition approved – A manager can approve a requisition.

In large organisations, people are often authorised to sign for a specific amount of money. When they plan to purchase which exceeds the budget, more approvals can be necessary. Smaller organisations however can have an informal authorisation process and the approver can also be the requestor.

Buyer checks supplier base – A buyer, often in a purchasing department can check a supplier base. He or she might select a supplier from a list of preferred suppliers, or a (tactical) sourcing processs might be necessary. The buyer can also be the requestor, depending on the type of product or service. The buyer might send out a Request For Purchase (RFP) to a selection of suppliers, and will eventually choose a supplier and send out the order.

Supplier receives RFP – A supplier receives an RFP and makes an offer. He or she will send the quotation back to the requestor or buyer. This can be a formal or an informal quotation.

Buyer selects offer – A buyer will then select an offer from one or more suppliers. The buyer can check with the approver or with the buyer whether the price of the order is correct.

Supplier receives purchase order – When the order is approved, the supplier receives a purchase order and can deliver the good or service.

Requestor receives goods or services – The requestor will re- ceive the good or service. Physical goods often come with a goods receipt note, which will be received by the requestor.

Supplier sends invoice to Accounts Payable – A supplier will send out an invoice to the organisation and will be dealt with within Accounts Payable.

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What What What

Invoice matching – In a well organised process, the invoice will be matched with the order (two-way match) and sometimes with the goods receipt note (three-way match).

Accounts Payable pays – Accounts Payable pays the invoice.

This might seem an oversimplification of the procurement process. Nevertheless it provides insight in the activities of a procurement process.

Hands-free procurement process

Contrasting this hands-on procurement process is the hands- free process. Again, this model is purely fictional, but it should give an idea of a process in which hardly any intervention apart from the requestor and the supplier will take place.

The actors or roles are the same as in the hands-on procurement process and will not be re-introduced. The process is represented in figure 6, however, a bigger view of this picture can be found in appendix 2.

Requestor plans to buy - The requestor has demand for a certain product or service and will try to order it, for example by using an e-procurement system on an intranet. He or she can select the goods and services from a catalogue. Another option would be a purchasing card.

Figure 6 - General hands-free purchasing process

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Stan Stan Stan

Standardisingdardisingdardising procurement processes dardising

Approver approves request – An approver, for example a manager can approve the request when certain conditions apply.

An e-procurement system for example can send out non- confirmation mails to a manager. A manager can decide to do nothing, so that the order will be approved, or he or she can re- ject the order.

Supplier receives purchase order – A purchase order can be sent out to a supplier, but this is not always necessary. For example, a cleaning contract does not require an organisation to send an order each time a building gets cleaned.

Supplier delivers goods or services – A supplier will deliver the good or service, just like in the hands-on procurement process.

Accounts Payable receives an invoice – Whether an invoice is electronic or physical, an invoice is always required in a procurement process for tax reasons.

Invoice matching – The invoice will be matched accordingly, depending on business requirements.

Accounts Payable pays – Accounts Payable pays the invoice.

Both the hands-on and the hands-free procurement processes have been explained. The vital difference between both processes is the sourcing aspect of procurement. Moreover, there is hardly any intervention in the hands-free process.

The main question remains: when does a product or service fit in a hands-free and when does it fit in a hands-on channel?

3.2 3.2 3.2

3.2 Standardising procurement pro Standardising procurement pro Standardising procurement pro Standardising procurement proc cc cesses esses esses esses

A common goal in creating efficient procurement processes is to standardise these processes as much as possible (Hirsch &

Barbalho, 2001). This is not an easy task, while the spend categories are very different and require different approaches. As an example, Hirsch and Barbalho explain several options for purchasing office supplies. Employees could actually drive to a local superstore, browse through a catalogue and call a pho- nenumber, fill out a paper purchase order and fax it to a supplier, use a supplier website or use a corporate e-procurement system to place the order. A purchasing process can be more complicated however, for customised items such as a telecommunications network switch or a service like management consulting.

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Which Which Which

Which criteria determine the differences between these processes?

3.3 3.3 3.3

3.3 Wh Wh Wh Which criteria determine the differences b ich criteria determine the differences b ich criteria determine the differences b ich criteria determine the differences be- e- e- e- tween these processes

tween these processes tween these processes tween these processes? ? ? ?

The problem statement was:

Which criteria determine why IBM’s clients prefer one purchase-to- pay channel over another when purchasing indirect goods or services?

In the last chapter we found that the main differentiator between the purchase-to-pay channels is the level of intervention of any other than the initial requestor in the procurement process. This can be plotted on a continuum as follows:

The box illustrates a slider. This means that in this picture, there is hardly any intervention from anyone else than the initial requestor in the procurement process. A highly optimised procurement process will have all kinds of business rules and procedures in place, as to have as little unnecessary intervention as possible.

In order to be able to answer the research question, the main question here is: when does an organisation want to have a lot of intervention in a procurement process for a specific indirect good or service and when is no intervention required?

This question will be answered in terms of buyer-, product- and seller related issues. Although these three perspectives might overlap, it allows a systematic approach to make a first attempt to answering the research question conceptually.

Product related issues

In the last chapter in the paragraph of implications related to direct or indirect purchasing, price is mentioned as the key differentiator related to indirect purchasing. I would expect to see a lot of intervention from other people apart from the requestor when the price of a purchase is high.

If a product is bought frequently, I would expect organisations to see opportunities to streamline the procurement process. The more frequently a product is purchased, the less interaction is desired. Frequent purchasing might result in much administra- tive work, such as invoice processing.

High intervention Low intervention

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Which Which Which

The complexity of a product might also be of importance. A non-standard, heterogeneous product probably needs more intervention than a standard, homogeneous product. Even when goods and services are purchased on a regular basis from the same company, their requirements may differ from purchase to purchase (Hirsch & Barbalho, 2001).

Combining the product related elements results in the following picture:

The sliders are all set in the middle. However, when for a specific purchasing category or product, the sliders would be on the left, this will mean that a purchase-to-pay channel is preferred with little or no intervention from anybody apart from the requestor of the good or service. With the sliders to the right, a lot of intervention is needed. This is illustrated in the following table (table 6):

PRODUCT

Price

low high

Frequency

high low

Specifications

known unknown

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Which Which Which

PRODUCT RELATED ISSUES

Price Low High

Frequency High Low

Specifications Known Unknown

Intervention Low High

Table 6 - Product related issues

Apart from these product related issues, there are also factors influencing the choice of a procurement process related to the buyer and the supplier.

Buyer related issues

The buyer related issues will be described from a people, organisational and technological perspective. Note that buyer is the role of the organisation, not an individual buyer within a purchasing organisation.

In an informal organisation where people are more or less free to do what they want, where not much emphasis is placed on procedures, products tend to be purchased without much intervention in the beginning of the process. However, a lot of flexibility in the beginning of a purchasing process means a lot of intervention at the end. Without an efficient ordering process for example, Accounts Payable cannot do much more than just paying the bills, not being able to match an invoice with an order properly.

When the buying organisation has mature technology, it will allow them to use technical solutions in the purchasing process easier.

The two elements within this buyer’s perspective are very much related and can be seen as procurement maturity. A formal organisation with high technological maturity can be seen as a very professional purchasing organisation.

The following depicts this perspective and shows that the sliders are probably interrelated; when the slides in the buyer box are set to the left, the intervention slider is also set to the left.

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Which Which Which

To illustrate what will happen to intervention, the following table has been created (table 7):

BUYER RELATED ISSUES

Culture Formal Informal

Technological maturity High Low

Table 7 - Buyer related issues

Supplier related issues

The supplier related issues will also be described from a people, organisational and technological perspective.

If a buyer and a supplier wish to co-operate, a buyer might prefer a technologically advanced supplier. A buyer who wishes to buy hardware for example probably prefers to buy from Dell compared to buying from a local hardware shop.

A buyer may be subjected to a suppliers working methods.

Kotzab and Otto (2004) have identified several contingency factors for managing a set of sequentially inter-dependent order-

BUYER

Culture

formal informal

Technological maturity

high low

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Which Which Which

linked factors. Power and size of the company is one of these contingency factors. Co-operative behaviour is at the heart of Supply Chain Management and also procurement. Depending on power relations, a buyer can influence a supplier or vice versa. When a buyer has enough power, an organisation can force its working methods upon a supplier. How willing a supplier is to co-operate will determine how purchase-to-pay channels will be designed for a specific category of products.

The effect of the supplier related issues on the intervention is depicted in the following table (table 8).

SUPPLIER RELATED ISSUES

Co-operativity High Low

Technological maturity High Low

Table 8 - Supplier related issues SUPPLIER

Co-operativity

high low

Technological maturity

high low

Intervention Low intervention