What Is Procurement?

Procurement

Investopedia / Candra Huff

What Is Procurement?

Procurement is the act of obtaining or purchasing goods or services, typically for business purposes. Procurement is most commonly associated with businesses because companies need to solicit services or purchase goods, usually on a relatively large scale. It can also include the overall procurement process, which is critically important for companies leading up to their final purchasing decision. Companies can be on both sides of the procurement process as buyers or sellers though here we mainly focus on the side of the soliciting company.

Key Takeaways

  • Procurement is the process of purchasing goods or services and is usually in reference to business spending.
  • Business procurement requires preparation, solicitation, and payment processing, which usually involves several areas of a company.
  • Procurement expenses can fall into several different categories, depending on the procurement demand.
  • Competitive bidding is usually a part of most large-scale procurement processes involving multiple bidders.
  • The strategic process of procurement is different from purchasing, which is a transactional one.

How Procurement Works

Procurement and procurement processes can require a substantial portion of a company’s resources to manage. Procurement budgets typically provide managers with a specific value they can spend to procure the goods or services they need. The process of procurement is often a key part of a company's strategy because the ability to purchase certain materials or services can determine if operations will be profitable.

In many cases, procurement processes will be dictated by company standards often centralized by controls from the accounts payable (AP) division of accounting. The procurement process includes the preparation and processing of a demand as well as the end receipt and approval of payment.

Comprehensively, this can involve purchase planning, standards, specifications determination, supplier research, selection, financing, price negotiation, and inventory control. As such, many large companies may require support from a few different areas of a company for successful procurement.

There are several steps involved in the procurement process:

  • Choosing the goods and services required
  • Fill out a purchase request and request quotes from various suppliers
  • Work out a price and contract with the vendor, and complete the purchase order
  • Receive the shipment and submit payment

Competitive Bidding and Procurement

Competitive bidding is a part of most business deals involving multiple bidders. The competitive bidding process for goods is usually more simplified than for services. Procurement is also the term used for purchasing goods and services on behalf of the government which has its own bidding processes and requirements.

Competitive bidding for all types of goods generally involves proposals that detail the per-unit price, shipping, and delivery terms. Competitive bidding for the procurement of services can be more complex since it may involve different things like individuals involved, technology services, operational procedures, client servicing, training, service fees, and more.

In each case, the solicitor of bids chooses the supplier they want to work with based on both operational business aspects as well as costs. The solicitor is then responsible for accounting for expenses depending on the goods or services involved. Government agencies and large companies may choose to solicit procurement proposals on an annual or scheduled basis to ensure that they continue to maintain the best relationships for their business.

Comprehensively, procurement can involve support from several areas of a company.

Types of Procurement

There are a few different kinds of procurement that businesses can undertake. These include:

  • Direct Procurement: This kind of procurement involves any goods and services used during the production process. This includes raw materials, machinery, and other components.
  • Indirect Procurement: Goods and services purchased under this type of procurement are used to meet the operational needs of a business. As such, they don't contribute to the company's revenues. This may include office equipment and supplies, furnishings, and marketing.
  • Goods Procurement: Any physical products that businesses acquire through the procurement process to serve the needs of the business. This can be direct or indirect, such as raw materials and office supplies, respectively.
  • Services Procurement: Like goods procurement, there are two types of services procurement: direct and indirect. Both rely on services provided by people. Direct services procurement may refer to labor that is directly involved in the business. Indirect services procurement can include things like on-site security to safeguard the premises.

Procurement vs. Purchasing

Procurement and purchasing are both processes that involve the exchange of goods and services, so it isn't uncommon for people to confuse the two. But there are certain distinctions between the two.

For instance, procurement is more of a strategic process that involves the acquisition of goods and services. It places a greater emphasis on the value of products and uses a series of steps (as outlined above) to complete the acquisition. Businesses generally take a proactive approach when they submit procurement orders. Doing so allows them to identify future deficiencies and fill them before they are needed.

Purchasing, on the other hand, is a transactional process. As such, it involves buying goods and services. When an entity purchases goods and services, it places greater importance on price rather than value. Purchasing is usually a reactive process that satisfies a more immediate need.

The table below highlights the comparison between these two processes.

Procurement vs. Purchasing
Procurement  Purchasing 
Strategic process  Transactional process 
Greater emphasis on value   More importance on price 
Proactive approach  Reactive approach 
Spot and fill future deficiencies  Satisfies immediate need(s) 

Accounting for Procurement

Procurement costs are generally integrated into the financial accounting of a business, as procurement involves acquiring goods and/or services for the revenue goals of the business. As such, some companies may hire a chief procurement officer (CPO for short) to lead these efforts. The CPO:

  • Oversees procurement standards
  • Works with accounts payable to ensure procurement standard integration and efficient payment
  • Serves on procurement teams making procurement decisions when there are multiple competitive bids

Procurement processing can be divided and analyzed from several angles. Companies and industries have different ways of managing the procurement of direct and indirect costs. Goods companies, as compared with services companies, will also have different ways of managing costs.

Direct vs. Indirect Procurement Costs

Direct spending refers to anything related to the cost of goods sold and production, including all items that are part of finished products. For manufacturing companies, this can range from raw materials to components and parts. For merchandising companies, this will include the cost at which merchandise is purchased from a wholesaler for sales.

For service-based companies, direct costs will primarily be the hourly labor costs of employees performing services. Procurement for items pertaining to the cost of goods sold directly affects a company’s gross profit.

By contrast, indirect procurement involves non-production-related purchases. These are purchases a company uses to facilitate its operations. Indirect procurement can involve a broad range of purchases including office supplies, marketing materials, advertising campaigns, consulting services, and more. Companies will generally have different budgets and processes for managing direct costs as compared with indirect costs.

Goods vs. Services Procurement Accounting

Procurement is part of the expense process for all types of companies, but goods and services companies account for revenues and costs differently. As such, accounting for procured goods will also differ from accounting for procured services.

Companies focused on goods will need to deal with the procurement of those goods as inventory. These companies place a lot of importance on supply chain management. Service-based companies provide services as their primary revenue generator so they do not necessarily rely as heavily on a supply chain for inventory although they may need to purchase goods for technology-based services.

In general, the cost of sales for many service companies is based on the hourly labor cost of employees providing the service so procurement as a direct expense is not a major factor. However, service-based companies will usually have higher relative indirect costs because they typically deal with their own procurement as an indirect expense through marketing.

What Is Meant by Procurement?

Procurement is the process involved in obtaining or sourcing something that is needed. Businesses procure supplies and raw materials, while governments may procure contractors or service providers.

Is Procurement the Same As Purchasing?

While they are similar, procurement typically deals with finding suppliers and sourcing materials, whereas purchasing involves the costs and transactions related to buying those goods or materials.

What Are the Types of Procurement?

Procurement can be carried out in several ways. Organizations may submit an open tender to allow competitive bidding among potential suppliers. They may also restrict the number of bidders or establish criteria for who is allowed to bid. As an alternative to an auction process, an organization may solicit a request for proposals (REP), where applicants then compete with one another on price along with competencies. Sometimes procurement is done under contract with a single source or small group of exclusive suppliers.

The Bottom Line

Procurement is a strategic process that involves the acquisition of goods and services. Unlike purchasing, it involves a series of steps that are usually taken by businesses to meet certain needs, such as production, inventory, and sales. It often involves a series of documents like demands and receipts for payment. But don't confuse procurement with purchasing. Although the two terms are often used interchangeably, they are very different. Unlike procurement, purchasing is transactional and normally fulfills more immediate needs.

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