4 Types of Procurement Levers and How to Use Them

The pandemic highlighted the importance of supply chains, supplier relationships, and efficient procurement processes.

In procurement processes, it is vital to understand the underlying factors that drive cost or create value. When organizations get this understanding wrong, they pursue procurement policies and practices that diminish rather than create value for the organization.

What is a Procurement Lever?

Organizations need to understand the levers of procurement to get the best return on the money invested.

Procurement levers are the set of actions that enable the procurement function to balance multiple, seemingly contradictory targets — reducing cost, managing risk, and meeting socio-economic objectives — while also achieving larger organizational goals.

Types of Procurement Levers

• Price-based lever

This is the easiest to implement and most widely used lever for obtaining procurement value. The focus here is on procuring the product or service at the lowest possible price through a competitive bidding process. Pricing levers also involve strategies beyond obtaining the best price. These strategies include optimizing the procurement time for the best pricing, bundling contracts across the organization, etc.

• Total cost lever

This lever goes past the price and focuses on getting an excellent overall price for the organization. Focusing on the total cost requires a comprehensive view of all the costs of acquiring a product or service. This aspect involves alignment between finance, supply chain, and procurement functions. A combined focus on total cost ensures that the organization tracks savings down to the bottom line by focusing on disparate issues such as raw materials procurement, expenses on production machinery procurement/maintenance, utilities, plant facilities, etc. Total cost is a better measure of the actual cost to the organization since most purchases involve additional costs beyond the price of the product or service.

• Demand-based lever

This strategy ensures that all procurements are made strictly according to actual requirements. This goal can be achieved by standardizing specifications, promoting collaboration between internal stakeholders and suppliers to reduce procurement quantity, make-versus-buy analyses, etc. AI-powered tools can be used for trend forecasting and demand projection across supply chain categories. Supply chains need to be agile, responsive to changes, adaptable, and adopt new-age planning methods to map the supply chain, identify roadblocks, and design mitigation plans.

• Supply-based lever

This approach supplements the previous methods. This strategy includes measures such as supplier development, enabling supplier innovation through collaboration, reconfiguring the supplier base to achieve better value, etc. For example, some manufacturers may not have the necessary market intelligence to evaluate alternative supply sources. They must engage with tier 2 or tier 3 suppliers and create a strong supplier network to mitigate risk. In the wake of the pandemic, local sourcing is also being increasingly prioritized to bypass transportation requirements. Tech tools are also being used to efficiently verify and onboard new suppliers, manage existing supplier relationships, and enable regulatory compliance.

Strategies to use procurement levers

• Negotiated contracts

There will be instances where even though a contract has been arranged to procure an item within the same organization, some departments continue to buy the same thing separately. This inconsistency introduces inefficiencies in procurement since the item is purchased at different prices within the same organization. It is essential to consolidate requirements and maximize spending under centrally negotiated contracts. Consolidation of requirements enables more competitive pricing by helping leverage volume discounts.

For the success of this strategy, collaboration across departments is critical. It is necessary to club standard requirements. For example, IT hardware, office stationery, professional services, etc. Firms also need to sharpen their contract management skills. Contracts can be managed better by, for example, eliminating any fixed or recurring costs or, at the least, minimizing them.

• Rigorous competition

The procurement process should create rigorous competition among qualified and capable suppliers. The competition among suppliers can be incentivized by bundling or lotting requirements of similar items so that the suppliers bid more aggressively. However, sometimes, bundling items (such as office and lab supplies) can rule out small suppliers, who may lose out. Under such circumstances, procurement can bundle and accept bids on separate elements of the bundle (for example, office supplies). This method protects the interests of the good, but small suppliers, intensifies competition and gets the organization the best procurement value.

• Reverse auctions

Employing reverse auctions promotes intense competitive bidding and enables the best procurement value. Reverse auctions have the potential to deliver enormous savings to the organization.

• Multi-year commitments

Often, organizations have recurring requirements for some items. Such items can be identified, and their requirement across the organization can be combined. The suppliers can then be provided visibility of the multi-year requirement and offered multi-year commitments on these item(s).

This practice enables suppliers to offer better pricing — delivering significant savings to the organization. However, such contracts should include a price change clause for items with substantial fluctuations.

Conclusion

Organizations need to redesign their procurement function to benefit from any procurement value levers possible and incorporate technology and automation.