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Procurement

Effective management of the procurement risks

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Procurement is a one of the most important functions that any organization or company performs.  Without procurement, it would be impossible for any business to operate. It is through procurement function that an organization ensures that all its requirements for goods / services are met in a cost effective and timely manner so that it can run its operations without glitches and profitably.  With most organizations spending almost fifty percent of their revenues from sales, it is extremely important for an organization to ensure that its procurement process is not only effective and efficient but also safe and secure from risks.  In order to achieve this objective, organizations develop risk management plans and adopt risk mitigation & contingency strategies.

Risks are essentially the happenings that are uncertain in terms of their occurrence that impede achieving one’s goals / objectives. Procurement risks are something that can go wrong as planned in an organization’s procurement related activities. Due to procurement risks, the process of purchasing or sourcing goods / services becomes unreliable and is not able to serve the intended purpose.

There are numerous procurement risks, such as the poor quality of procured goods / services, delays and short supplies attributable to the suppliers, production disturbances at the suppliers’ facilities, natural disasters, cybersecurity, organizational and operational issues, etc.

Having a robust procurement process and procurement risk management strategy in place is necessary to avert the undesirable outcomes.

Procurement Risks

  • Shortfall in the requirement identification

Clear identification of the organization’s requirements for goods and services in terms of who needs what, when they are required, in what quantities, their specifications, who are the potential suppliers of the required goods and services, etc., is a perquisite for the success of the procurement operations. Lack of such requirement identification is a major risk that can come in the way of an organization functioning to its full potential

  • Poor Supplier Selection

Qualifying suppliers on the basis of their ability to meet the organization’s requirements is essential for the success of its procurement actions. Any flaw in the supplier selection / sourcing process can potentially affect the organizations ability to obtain the required goods / services according to its expectations. The impact of flawed selection process on the organization could be profound. The supplies may be of poor quality and deliveries may be delayed. To overcome such issues, organizations must follow a transparent and robust supplier evaluation methodology that is supported by a transparent and efficient process for purchasing, approvals, and payments.

  • Weakprocurement management

The organization for its procurement to be effective & efficient and not run into difficulties must have a procurement management system that is centralized, transparent, and well organized & supported by a good supplier information gathering and order & payment approval processing method. Otherwise, the procurement department’s productivity and ability to work with good suppliers and negotiate favorable contractual terms with them will suffer.

  • Unorganized supplier management system

An organization, in order to be successful in procuring goods / services to meet its requirements, must have in place a good streamlined system to manage its relationship with its suppliers. With the help of the supplier management system, an organization will be able to build a mutually beneficial relationship with its suppliers, regularly track & assess suppliers’ lifecycle performance, and initiate actions for improving their performance and thereby minimize risks.

  • Error-prone, manual internal processing

Manual processing of procurement activities can increase the possibility of the risks happening. Because manual processing is error prone and time consuming, numerous mistakes relating to the quantity of items ordered, delivery stipulation, approval and payment process, etc. can occur, endangering the orderly functioning of the supply chain.

Risk management plan

Risk management is the process of managing the potential risks to minimize their impact on the functioning of the organization. The goal of risk management is to reduce the exposure of the organization to the risk-contributory factors and lessen their negative impact. The risk management involves identifying the potential risks, analyzing and assessing their impact, developing & implementing the risk management plans on a regular basis.

Risk management helps companies ensure the smooth and successful running of the purchasing and supply chain operations. Minimizing risk should be an important evaluation factor while selecting the suppliers and choosing between alternative courses of action.

For the risk management to be effective, it must be methodical and structured.  The risk management plan’s important constituent elements are the following.

  • Identify risks

Risk identification is the process of recognizing and documenting & categorizing potential risks that could keep an organization from reaching its objective or a program from succeeding. Through risk identification, organizations can develop and put in  place the mitigation plans that will eliminate / minimize the impact of potential risks. 

  • Analyze and Assess

Risk analysis is performed to assess their impact of each of the identified risks on the organization’s performance.  With the help of the risk analysis, the organizations can develop the recommendations that can be used to mitigate, transfer, accept or avoid the risk. The risk analysis typically helps an organization to identify and classify risks into those that can be addressed through appropriate planning and risk mitigation measures and those that may require to be handled only through contingency measures.

  • Develop the risk management plan

The organization can develop the risk management plan based on the findings of the risk identification and risks analysis so as to avoid the risks or minimize their negative impact on the organization’s performance.

  • Implement the risk management plan

Implement the risk management plan to reduce the risks down to the manageable levels.

  • Review risk management plan regularly

Risks can vary over time. Therefore, organizations must ensure that they assess and review their risk management plans on regular ongoing basis.

  • Procurement risk mitigation

Risk mitigation is one among the four elements of the risk management; the other three being avoid, transfer and accept the risk. Risk mitigation is the process of managing the potential risks to minimize their impact on the business functioning. The goal of procurement risk mitigation is to reduce exposure to factors that jeopardize the procuring organization’s efforts to obtain the required goods / services. Risk avoidance are strategies aimed at reducing the probability of a risk happening. Risk transfer involves transferring or sharing risk with an external or third party. Risk acceptance basically involves accepting the risk associated with particular action as it cannot be avoided.

Actions for mitigating the procurement risks

  • Automate

The procurement process can be made more efficient and efficient by automating it with the help of procurement software suite, such as procurement-to-pay.  Automation will eliminate the human errors and improve the throughput. The automatic reporting and dashboard facility available in the procurement software will provide an overview of all activities relating to the procurement and make them information driven

  • Undertake strategic sourcing

Develop a strategic sourcing plan and implement the same with the help of strategic sourcing software. The increased understanding that the procuring organization gets, with the help of strategic sourcing software, about the supplier markets and supplier profiles can help identify potential risks factors and evolve sourcing plans to overcome them

  • Develop supplier performance metrics

An organization undertakes procurement process with the objective of obtaining the goods / services required to sustain its operations without interruptions at the lowest cost of ownership and thus improve its profitability. It is necessary for the organization to develop metrics to measure the performance of the suppliers and success of the procurement strategy. 

  • Create procurement risk strategy

Procurement involves numerous risks that can jeopardize the supplies that, for any organization, is unacceptable. It is essential for the procuring organization to have a strategy in place to mitigate risks in the first place. The risk management strategy must be developed by doing the risk analysis to identify possible disruptions and must establish plans to overcome or at least minimize their negative impact. The procurement risk strategy must not only look at external risks but also the internal risks

  • Contingency plan

While the risk mitigation plan helps reduce the probability of the risk happening / the impact of the identified risk, the contingency plan is aimed at controlling the impact of the risk as it unfolds. The contingency plan works as a fallback plan for high impact risks. It is good for an organization to have a backup contingency plan in addition to the mitigation plan so as to minimize the impact of serious risks that, should they happen, can have severe consequence on its operations. The contingency plan, developed on the assumptionthat certain risks cannot be mitigated, include finding alternate suppliers, working with the supplier to overcome the situation, etc. Procurement is one among the important functions that any organization or company performs.  It is through the procurement function that an organization ensures that all its requirements for goods / services are met in a cost effective and timely manner so that it can run its operations smoothly and profitably. Recognizing the important role of the procurement, organizations are investing in procurement software solutions to streamline and automate their procurement process, adopt risk management strategies to ensure that the procurement process is safe and secure, and put in place risk appropriate mitigation and contingency plans to avoid and minimize the attendant procurement risks.     

Author

Rajabahadur V. Arcot is a Senior Advisor, Quadrant Knowledge Solutions