As the starting point of the value chain for almost all enterprises, procurement is a vital business function. Although it’s often overlooked, it can make or break a business’s success, helping organizations control costs, enhance quality, improve supply chain effectiveness and comply with rules and regulations.
For aspiring unicorns, designing the Target Operating Model (TOM) for procurement can be a daunting task. Unicorns are privately held startups with a valuation of at least USD 1 billion and are not listed on the stock exchange. Startups and would-be unicorns face myriad challenges in designing TOMs, so it’s important to understand the major decisions and common misconceptions surrounding the process.
Procurement challenges for startups
Each startup grows under unique conditions and develops its own processes. When startups aim to reach unicorn status and compete at the next level, they must deploy cost-effective IT systems to manage, optimize, standardize and automate business processes.
Procurement business processes are not usually the core competency of such a company. If this function is taken up more seriously at an earlier stage, it can be a game changer that improves costs, reduces fraud and makes the business run more effectively.
Procurement typically includes business processes in the following areas:
- Requirement definition
- Supplier selection
- Negotiation
- Contract management
- Agreements
- Requisitioning
- Purchasing
- Supplier relation
- Demand forecasting
- Receiving
- Quality management
- Invoice processing
- Payments
- Insurance
- Transportation
- Service delivery management
- Expense control and budgeting
Established companies evolve their procurement practices and processes over a period because they’ve had the time to experiment and learn from failures. Mergers and acquisitions also give businesses a chance to inherit processes with proven track records. Industry standards, such as the APICS Association for Supply Chain Operations Reference (SCOR) model level 1-level 5, can help optimize business processes.
A simple process of creating requisitions and managing its lifecycle through to payment is an elaborate, albeit standard process defined in APICS. Startups can use these kinds of skeleton solutions to modify and adapt to standardize business functions.
That said, startups, which center on entrepreneurial culture and encourage risk-taking, face unique challenges while setting up TOMs. In a scrappy startup environment, various groups or departments within the company might want to be responsible for their procurement processes, as procurement business processes are often considered bureaucratic and time-consuming.
Finding the right balance
To improve the effectiveness of procurement, it’s important for any company to find the right balance of entrepreneurial culture, fiscal discipline, standardization, fraud prevention and cost control.
TOMs can improve these markers, saving significant costs for businesses. Finalized processes in TOMs can be easily used for business system modernization, packaged application implementation and change management.
3 key decisions for designing a target operating model for a unicorn
When designing a target operating model for procurement, unicorns keep the following decisions in mind:
Depth of purchasing needed
The traditional process of creating requisition at the point of need, followed by creating a purchase order and then sending it to the supplier is suitable for industrial supply chain-based businesses. But tech startups, service aggregators and other innovative business models cannot adapt to these processes.
Startups tend to order goods and services as needed and then record them in the books as expenses or liabilities, which don’t create a purchasing trail. This might sound easy, but it invites the inherent risk of fraud, unnecessary purchases and missing economies of scale. In purchasing, requisitions can be grouped to negotiate for better rates and terms, and invoices can be matched to purchase orders to help ensure companies only pay for what was ordered. This calls for approval metric, and it’s a tricky situation for startups because it can be bureaucratic and rigid.
Threshold-based purchasing, where you skip the paper trail and don’t create orders for low-value spending is one solution. But it requires a trust-based culture because employees can break large spendings into multiple smaller ones to avoid the process. Purchases below USD 5000 don’t need to go through purchasing because most of them are for office supplies and don’t need a purchasing paper trail. Strategic and direct spending above the threshold need to go through purchasing because you can use scale and negotiate better terms. However, recorded purchasing data offers invaluable insights for forecasting and strategy decision-making.
Whenever approval is needed for purchasing, there can be so many ways to design an approval process for agility, speed and fiscal discipline.
Categorizing expenses
This is the process of organizing a company’s spending into specific categories, such as office supplies, IT hardware or marketing services. It’s a process that can help companies understand where they are spending money, and if they are doing so efficiently. Each spending, if categorized properly, can be recorded in the books under the right header and then reported. Depending on the core competency of the business, the direct versus indirect purchases help companies pivot their operating strategy. Correctly categorizing spending is also key to estimating and budgeting funds for strategic initiatives. You cannot control direct production-related spending, but you can forecast and trend analyze them.
Level of centralization
A centralized procurement function—which means you operate the procurement business process centrally for all your units, geographies and product lines—enables standardization of processes, policies and procedures across the organization, helping ensure consistency and efficiency and generating economies of scale. It enhances the visibility of spending and improves supplier relations.
One can easily debate against a centralized approach considering it can be inflexible, bureaucratic and require long lead times. Any level of centralization requires setting up central or regional procurement teams, centers of excellence, processes and mechanisms to collate demands from all parts of the business.
A decentralized procurement function enables faster decision-making and gives a higher degree of empowerment to local teams. Finding the balance between these two approaches is not an easy task. As depicted below, it’s a journey for any organization.
Sometimes, a hybrid or center-led approach is most effective. Here’s what this entails:
- Global standards and policies: Establishing global standards and policies, while still allowing for local flexibility and autonomy.
- Regional centers of excellence: Creating regional teams for supplier relation, negotiation and market analysis provides specialized procurement expertise and support to local teams.
- Centralized or shared services model for common categories: Implementing shared services, such as procurement operation centers, to provide support and use economies of scale.
- Local empowerment for categories critical to business: Empowering local teams to make procurement decisions, while still providing guidance and oversight from a centralized function.
For startups, designing a target operating model for procurement is a complex task. However, having a correctly designed and well-oiled operating procurement function can give these companies the edge they need to achieve that highly coveted unicorn status.
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