Last updated on December 7th, 2022
When running any kind of business, it’s important that you keep on top of costs but there’s one type of business cost that I feel that a lot of people either don’t fully understand or overlook – procurement costs.
Procurement costs are something I had to understand in order for my businesses to become successful and so, I think they’re incredibly important. Despite this, I’ve met business owners who simply can’t wrap their heads around them or how to keep them down.
If this sounds like you, then here is my personal understanding of procurement costs. I will also be covering the techniques I use to try and keep my business’s procurement costs down. Check them out and maybe, you will find that they work for your business too!
So, without further ado, let’s get started!
What Is Procurement Cost?
To understand what procurement costs are, you first need to understand what procurement itself is. I had to do the same when getting to grips with business jargon, so here’s my basic run-down of what procurement and procurement costs are.
Procurement is defined as the act of obtaining goods or services for business purposes. It’s vital for the success of a business as without this process, businesses cannot access the materials or services they need for the business to actually function and run.
However, procurement is not defined purely as the selling and buying of goods and services.
I have met a few business owners in the past who just assume that procurement is buying materials from this supplier and that supplier, and that’s it – but there are many more steps to the procurement process than just that.
It also covers researching what products will be in demand, sourcing the best suppliers for materials, negotiating prices, inspecting the goods to ensure they are the right quality for your business, and making records for every step of the process.
So, there are many steps in the procurement process.
There are different types of procurement that businesses deal with. This includes:
- Direct Procurement – This refers to obtaining things to produce an end-product. This could be components or raw materials if you are making your own products, or sourcing pre-made ones from a wholesaler for you to resell.
- Indirect Procurement – This refers to obtaining items that your business needs for daily operations such as office supplies, equipment, or advertising resources.
- Goods Procurement – This is the general procurement term that can refer to both direct and indirect procurement processes which help a business source goods like products or subscriptions to sell. It’s also what many people refer to when they simply say ‘procurement’.
- Services Procurement – This also includes both direct and indirect procurement but specifically for people-based services like hiring contractors, law firms, security services.
Because procurement is such a huge part of running a business, there is now a global procurement industry which is steadily growing. According to a 2022 report, global procurement is projected to market at $13.58 billion as a service market by 2030.
So, now you know what procurement is, understanding what procurement costs is super easy. Procurement costs are basically the costs that are incurred during your procurement processes.
There are many different types of procurement costs including:
- Base Costs – This refers to the procurement cost per product. It’s generally the largest procurement cost and the one most businesses struggle to lower.
- Transportation Costs – This refers to the cost of moving stock via transportation like shipping.
- Closing Costs – If you outsource the buying and selling of your inventory, then this cost is one you will definitely deal with.
- Tax and Duty – This type of cost can be difficult to understand, especially if you are conducting business overseas.
- Negotiation Costs – Negotiating with suppliers can be costly due to time and labor but getting a good deal on supplies or services can make it worth it.
As your business runs, all of these costs begin to add up. As a result, many businesses use procurement costs as a Key Performance Indicator (KPI) – including myself!
Why Procurement Costs Are Important To Businesses?
Myself and many other business owners believe that procurement costs are incredibly helpful to businesses, which is why I find it so baffling that some business owners are very dismissive of them.
Shockingly, only 31% of Chief Financial Officers (CFOs) say that procurement drives their strategic agendas, when 80% of Chief Experience Officers claim that procurement has helped make strategically valuable contributions.
This means that although many agree that procurement is valuable as a KPI, many are still under utilizing it when it comes to making informed business decisions.
I personally disagree with this totally because I have found that using procurement (see also, ‘What is Procurement Contract in Business?‘) as a KPI helps my businesses in so many ways.
Procurement costs can be used as a KPI to help check the overall health of your business. They can show you how efficiently your business is running and highlight any areas that need improving – a huge step (in my opinion) towards building up a successful business.
The more you do with less, the more profit you can make to further expand your business!
Here are some examples:
- Vendor Rejection Rate & Costs – If vendors are rejecting products due to low quality and your business has to spend more to cover that rejection rate, then this can be used to highlight quality issues you have with suppliers.
- Purchase Price Variance – This procurement cost KPI allows you to track how much you have spent on an item or service and compare it with the standard cost. This way, you can see if you are saving money or if you need to negotiate to lower your costs (see also, ‘How do I Start a Startup With No Money?‘) . I also use it to keep track of market fluctuations and keep this in mind if I ever need to change the prices of my products when they go on sale.
- Purchases In Time & Budget – This is one of the most important KPIs when it comes to business as it helps track how efficient your business is. You can keep track of your business’s spending and which processes are taking too long, accruing costs.
- Cost Of Purchase Order – This KPI can be tricky because there are many variables which can affect each purchase order. However, I like to use it to keep track of average costs for a better overview idea of how much each order costs.
So, there are many ways procurement costs can be used as a KPI to help provide important analytics to business owners. I always use these to help me make informed business decisions, particularly to help improve my business’s efficiency and effectiveness.
Keeping costs low is important for a successful business – but how can you reduce your procurement costs to achieve better efficiency?
My Top Tips For Reducing Procurement Costs
So, procurement is a big part of running a business and the process can accrue a lot of high costs. These can eat into your profits and reduce your business’s efficiency and effectiveness – so reducing these costs are a must.
Unfortunately, it can be tricky to keep procurement costs down. Issues like inflation or supply chain concerns can affect procurement costs and cause a lot of concerns.
In response, businesses do try to take steps by finding new supplies.
For example, in response to the huge surge of inflation in 2022, a survey found that nearly half of the businesses surveyed were searching for new supplies while 44% were re-negotiating contracts with their existing supplies – all of this is to help tackle high costs caused by inflation.
However, there are other ways you can reduce your procurement costs that are not affected by these kinds of topical issues. Here are some general techniques I have used to help effectively reduce the procurement costs of my businesses.
Automate Your Procurement Processes
I personally care a lot about the efficiency of my businesses and during my many years of experience, I have found that automating my procurement processes helps lower costs by a huge margin.
It streamlines my workflow so I spend less time on menial tasks, plus I found it easier to spot patterns in overspending and waste by using an integrated system.
And it’s not just me who is into automating processes to help boost efficiency. According to reports by both Grand View Research and Meticulous Research, automation and artificial intelligence in supply chain processes are projected to increase in the coming years.
This means that more businesses are automating (see also, ‘10 Examples of Simple Automation in Businesses‘) their procurement processes, and I assume it’s because they see the same benefits as I do.
Improve Inventory Management
If there’s one easy way to cut procurement costs, it’s by improving your inventory management.
A lot of businesses are guilty of leaving stocks of products sitting around in a warehouse (I’m guilty of this as well!) but improving your inventory management can help you avoid expensive stockpiles or failing to meet future demands.
Failure to manage inventory is actually one of the top ten reasons why startups fail, so what should you do to improve your inventory management?
I personally found automating my inventory management systems helped me keep better track of what I was spending for warehouse space, predict demand more accurately to avoid low or high inventory levels, and generally have a clearer picture of what my business’s inventory levels are.
Avoid Maverick Spending
Maverick spending, or rogue spending or tail spending, is defined as any spending that your business does outside of its regular purchasing policies. This can lead to purchasing equipment at higher prices than usual, or buying faulty equipment.
Maverick spending accounts for an average of 20% of total spending by a business – so cutting it out or reducing it can save you a lot in procurement costs.
To tackle maverick spending, it’s important to document every transaction to keep account of where your business’s money is going.
This way, you can identify the radical maverick spenders and cut it off. You can also get better deals by ensuring that even one-off purchases go through procurement processes such as negotiation.
So, I have striven to cut out as much maverick spending as possible through all my businesses to help lower my procurement costs.
So, my experience over the years in business has led me to pay close attention to my procurement costs.
Doing this along with some additional techniques, like automating certain systems and cracking down on maverick spending, has helped me lower the costs of running my business and increase my profits.
Because of this, I would recommend that every business pays attention to their procurement costs, especially as your business expands and your costs naturally increase.
I hope this guide has been helpful to you! Thanks for reading!