Procurement – Definition

Cite this article as:"Procurement – Definition," in The Business Professor, updated April 8, 2019, last accessed October 26, 2020, https://thebusinessprofessor.com/lesson/procurement-definition/.

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Procurement Definition

Procurement is the process of obtaining goods, services, and works from an external source for business purposes. It may be a simple process of purchasing from a known supplier or may become a complex process involving various steps. The procurement is often done via tendering or competitive bidding process. A company wants to ensure that they are getting the best quality product or services at the best possible price. Finding the right product or service, assessing its quality and negotiating the price, placing the order, acquiring the product or service and making the are some integral parts of procurement.

A Little More on What is Procurement

Procurement is done both by individuals and corporations. Corporations follow certain procedures to acquire services or goods from an external source. This procedure is known as procurement. The following are some general steps that are followed in the procurement process.

Purchase Planning: The procurement process starts with purchase planning. After assessing the needs of the company, the concerned management decides to buy a good or service from an external source and plans to purchase it.

Standard Determination: After planning the purchase the management determines the standard they need for the good or service that is to be procured.

Specifications Development: In this stage, the management develops and determines the specifications they want for procured goods or services.

Supplier research and selections: In this stage, the employees who are responsible for this job do research on the suppliers who provide that service or good. They may already have a list of suppliers available to them or they may need to make one. Each company has their own method of doing this research. Usually, they do a background check, assess the quality of the goods and services supplied by them and tries to find out their client’s experiences with them. After preliminary research, they may call tenders or competitive bidding. The suppliers may need to submit their detail proposal along with a quote. Based on the proposal the company selects the most suitable one. Quality, quantity, and cost these three are the most important factor in this selection. If a company regularly procure the same service or good from outside, they may not need to go through this process. They may have some fixed suppliers who supply this material or service to them.

Value analysis: In this part, the company analyzes the value by comparing the quality, quantity, time and location. They try to determine the best possible price for their required good or service.

Financing: In this stage, the company takes care of the financing of the required good or service. They decide how to finance the purchase.

Price negotiation: In this stage, the companies negotiate the price with the supplier.

Contract administration: In this stage, the company enters into an agreement with the supplier. It’s a written agreement signed by both parties detailing the terms and conditions.

Making the purchase: The actual purchase is made in this stage. The company buys the actual product or service.

Approval of payment: After acquiring the service and product the company approves the final payment based on the agreement. Companies often need to pay a portion of the bill in advance, before acquiring the good or service.

Making the payment: Finally, the company pays the full amount to the supplier upon the satisfaction.

Procurement can be of two types, direct spend, and indirect spend. Direct spend is when a manufacturing company procures goods or services that are related to their production. This may include raw materials, components, and parts. Indirect spend is procuring the goods and services needed for the company’s operational purposes. It may be office supplies, capital equipment or consulting services.

A procurement process can become substantially complex and time consuming for big corporations procuring major materials or equipment. Shipping and delivery process and cost, fluctuating prices of many good and services, and the marginal benefit of the good compared to the cost of procuring it are some of the major factors that are taken into account while making a decision. The wholesalers procuring products for the retail market may have to consider the risk of losing profit in case the price of the product drops before it is sold. The company always try to make sure that the procurement is cost effective for them.

Companies usually appoint a Chief Procurement Officer (CPO) who is responsible for making all major procurements of the company. The CPO takes care of the whole procedure from making the purchase decision to approving the final payment.

The governments of the countries also procure goods and services from time to time. Government procurement constitutes more than 10% of the global GDP. All the countries have their own laws and regulations regarding procurement that aims to resist fraud and protectionism.

References for Procurement

Academic Research on Procurement

Public procurement re-examined, Thai, K. V. (2001). Journal of public procurement, 1(1), 9-50. This article briefly analyzes the literature to identify common elements of public procurement knowledge. The government efforts to improve public procurement practices are summarized. The article uses a systems approach to examine public procurement. It also discusses the possibilities of future research and study on public procurement.

Procurement and renegotiation, Tirole, J. (1986). Journal of Political Economy, 94(2), 235-259. This study analyzes the issue of the investment made by both parties in the relationship before renegotiation.  It uses a simple two-period procurement model in this analysis. In the first period, the firm invests, and then it learns its production cost. The sponsor also learns its value for the project.  The article argues that if a cancellation fee is introduced in this system, that may lead to less investment. Rather it proposes ex-ante price fixing as an alternative for increasing the commitments. It also discusses the problem of cost overruns. The study shows if the sponsor can observe the investment, then it may become a joint decision variable. In such a scenario the two parties may choose to under-invest or over-invest.

Incentives versus transaction costs: A theory of procurement contracts, Bajari, P., & Tadelis, S. (2001). Rand journal of Economics, 387-407. This paper develops a model to explain some stylized facts of procurement contracts. It uses the experience of the construction industry in developing the model. In this model, the buyer pays for providing a comprehensive design. Then the buyer needs to choose between providing incentives and reducing ex-post transaction costs due to expensive renegotiation. It shows that in case of a complex project cost-plus contracts are better than the fixed-price contracts. It also discusses briefly that cost-plus contracts or fixed-price contracts are preferable than other incentive contracts. The model also provides some micro foundation from Transaction Cost Economics.

Public procurement and innovation—Resurrecting the demand side, Edler, J., & Georghiou, L. (2007). Research policy, 36(7), 949-963. This article analyzes how public procurement plays an important role in demand-oriented innovation policy. It discusses the importance of public procurement in innovation policy strategies at the level of the European Union and individual European countries. The concept of public procurement is defined and embedded within a taxonomy of innovation policies. It establishes how public procurement policies can boost up innovation and discusses the challenges and potential pitfalls. It also provides some recent empirical examples of good practice and discusses the best institutional practices. It confronts the public procurement approach with two of the most common objections two it and considers future prospects.

Assessment of the procurement system in Kenya, Authority, P. P. O. (2007). Nairobi: PPOA. This is a report that presents the findings of the pilot assessment of the public procurement system in Kenya, conducted by designated staff members of the PPOA and independent consultants. This pilot assessment was supported by the government of Denmark. This assessment attempted to establish a common understanding of the key issues related to public procurement in Kenya and create a baseline for measuring future developments. It also aims to create a benchmarking tool that can be used for comparing different systems. Along with presenting the findings, this report provides some recommendations for how to improve the procurement system through capacity development initiatives.

Procurement, Baily, P. (2017). In Contracting for Project Management (pp. 105-116). Routledge. This article is written by Peter Baily, formerly Chief Examiner for Chartered Institute of Procurement and Supply. It was published as a part of Procurement Principles and Management, an essential book for students and professional dealing with purchasing and procurement.

Managing procurement auctions, Dasgupta, S., & Spulber, D. F. (1989). Information Economics and Policy, 4(1), 5-29. This article discusses three mechanisms of conducting standard fixed quantity auction. The first one is sole sourcing with output chosen in advance by a buyer with downward-sloping demand, next is sole sourcing with an output schedule based on the revelation of cost parameters and the last one is multiple sourcing with output allocation across suppliers based on the revelation of cost parameters.

Moving procurement systems to the internet:: The adoption and use of e-procurement technology models, Davila, A., Gupta, M., & Palmer, R. (2003). European management journal, 21(1), 11-23. This paper shares the findings of research on the status of Internet-based procurement technologies. The result suggests that the final equilibrium may include several technologies, each of them serving different market segments. The transition of the industry to its growth stage is most likely to be delayed by this multiplicity. This research identifies mainly two types of strategies adopted by the companies in approaching the technologies. The first group is aggressive in their strategies in adopting e-procurement technologies and the second group is more conservative in this respect. The first group experiments frequently with different solutions while the second group experiment selectively, typically with one technology. This research concludes that e-procurement technologies are going to become an important part of supply chain management. The conservative group will adopt the technology more readily as and when the aggressive adopters share their experiences.

Public technology procurement and innovation theory, Edquist, C., & Hommen, L. (2000). In Public technology procurement and innovation (pp. 5-70). Springer, Boston, MA. In this book, public technology procurement is studied as an instrument of innovation policy. This argues that the present public procurement system is inadequate in using it for stimulating technological innovation. However, it observes that in the recent past there is a growing awareness among the policymakers in the EU and elsewhere regarding this issue. This book aims to contribute to this discussion so that the public technology procurement can be successfully used for boosting up the technology innovation.

Auctions versus negotiations in procurement: an empirical analysis, Bajari, P., McMillan, R., & Tadelis, S. (2008). The Journal of Law, Economics, & Organization, 25(2), 372-399. This paper conducts a comparative study between competitive bidding and negotiation, to identify their advantages and disadvantages. It aims to determine which of these processes is better for purchasing customized good. It uses data of private sector building contracts that were awarded in Northern California between 1995 and 2000. The result identifies some potential limitations of competitive bidding, especially for complex projects. An auction is also disadvantageous when the contractual design is incomplete, and the number of bidders is low. It also puts a communication barrier between the buyer and the seller and thus the buyer does not get a chance to use the expertise of the seller in designing the project.

Government procurement and international trade, McAfee, R. P., & McMillan, J. (1989). Journal of international economics, 26(3-4), 291-308. This paper discusses a model of bidding for a government procurement where the competition is unequal. Each of the bidders know their own cost better than either their rival bidders or the government and the distribution of the domestic firms’ cost is different from that of foreign firms’ costs. This difference is due to comparative-advantage effects.   It concludes that government operates a price preference policy to minimize its expected procurement cost. That means the government doesn’t necessarily purchase from the lowest bidder.

Optimal procurement mechanisms, Manelli, A. M., & Vincent, D. R. (1995). Econometrica: Journal of the Econometric Society, 591-620. This paper analyzes the optimal procurement mechanisms in which the sellers privately get to know about the quality. It shows the common auction mechanism is often not very efficient. It suggests, ordering potential suppliers and tendering take-it-or-leave-it is often the optimal mechanism for procurement. It characterizes the procurement environments ins which wither mechanism is optimal.

Adverse selection and renegotiation in procurement, Laffont, J. J., & Tirole, J. (1990). The Review of Economic Studies, 57(4), 597-625. The equilibrium of a two-period procurement model with commitment and renegotiation is characterized. The paper also analyzes the outcomes of renegotiated long-term contracts and compare it to the outcome of unrenegotiated long-term contracts and a sequence of short-term contracts and examines if these outcomes are identical. This analysis is linked with the multiple unit durable good monopoly problem.

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