For those unfamiliar with the impact and purpose of procurement departments, how this system of connected processes operates may be as simple you need something, you find it, you pay for it, and then you have it. While this summary is accurate, it doesn’t illustrate just how complex procurement can be, nor does it tell us much about the impact procurement can have on the business as a whole.
For a better understanding of the importance of procurement, let’s look at a few different variations on this process and the roles they play in the broader business framework.
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3 types of procurement methods
Direct procurement
Direct procurement deals with the purchasing of products or services that are essential to the business core. In other words, producing value for customers and generating revenue for the company. For example, direct procurement is used to source and obtain parts, materials, and services to support the manufacturing of a product.
Indirect procurement
Indirect procurement involves the purchase of services or products essential for day-to-day business operations that don’t necessarily provide direct value to customers or generate revenue. For example, supplies for the HR department or IT equipment for facilities management are obtained through indirect procurement.
Direct vs. indirect procurement
Direct procurement involves sourcing and procuring core supplies, whereas indirect procurement involves more operational, day-to-day, and ad-hoc costs, so examples of indirect and direct procurement also vary based on the following purchase types:
- Rigid vs. flexible: Does the purchased item need to come from a specific supplier every time? Or can the items be purchased from various suppliers based on what’s more cost-efficient? It’s more common for direct procurement to involve rigid purchasing (i.e. sourcing a specific product or part from a specific supplier) and for indirect procurement to involve more flexibility (i.e. no sourcing restrictions).
- Required vs. supporting: Is what’s being sourced essential or non-essential to a finished product? Because direct procurement typically involves purchases that are essential, purchases are classified as required but supporting or non-essential costs provide more leeway in terms of sourcing, delivery, and cost.
Services procurement
This type of procurement focuses on identifying and obtaining the services a business requires in order to operate. Examples include outsourcing labor or hiring third parties to assist with or advise on specific projects.
| Direct | Indirect | Services | |
|---|---|---|---|
| Purpose | Essential items or services that support the creation of a final or finished product | Products or services that support day-to-day business functions | Project-based and specialized people-based services for individuals, departments, or the entire organization |
| Purchase model | Planned, spending based on customer needs | Flexible, spending based on business operations | Flexible, spending based on business operations |
| Priority | Priority is building supplier relationships | Priority is saving money | Priority is cost savings for business and improving workload management for procurement |
| Examples | Raw materials, labor, mechanical components | Office supplies, software, product licenses, facilities management | Marketing, IT, accounting, insurance, legal representation |
3 types of purchasing models
Beyond the different types of procurement, it’s also important to understand the different types of purchasing models that businesses use. These are centralized, decentralized, and hybrid. Each has its own benefits and use cases.
Centralized purchasing
In a centralized purchasing model, all purchases for the business are managed by a single department or team. This means that every purchase — regardless of who requests it — must be submitted, reviewed, and approved through a single purchasing or P2P process. This model centralizes data and provides maximum control, but can be prone to delays if/when bottlenecks occur.
Decentralized purchasing
In contrast, a decentralized purchasing model allows purchases to be managed by different teams or departments, depending on the source or type of purchase request. The advantage of a decentralized purchasing model is that purchases can be managed by teams who specialize in a particular purchase type. This brings more expertise (and speed) to the process.
The primary disadvantage is that data and activities from these different teams must be coordinated and consolidated. Decentralized purchasing may also lead to unstandardized processes. In other words, each team handles purchasing in its own unique way.
Some businesses avoid choosing between centralized and decentralized purchasing models (or rather, create a system of their own) by opting for a hybrid approach. This model is also known as a center-led or coordinated model.
Center-led or hybrid purchasing
Some businesses reap the benefits of both centralized and decentralized purchasing models by opting for a hybrid approach. This model is also known as a center-led or coordinated model. This more coordinated and customized alternative can be used to maximize the benefits of purchase process standardization, data centralization, supplier diversity, increased supplier knowledge, higher purchasing autonomy, risk mitigation, and faster delivery times.
This center-led or coordinated procurement model is made up of cross-functional teams. A centralized team operating as a center of excellence is responsible for strategy, knowledge sharing, and supply chain optimization, which in turn empowers those in charge of more tactical and transactional front-line purchasing roles. Some larger enterprises prefer this model because it allows both strategic and tactical procurement teams to be agile and makes for more flexible and customizable processes and spending strategies.
With this model, it’s also easier for procurement managers to better align the purchasing process and procure-to-pay processes with overarching business priorities. This model combines the autonomy of decentralized purchasing and the control of centralized purchasing.
4 types of purchase orders
Now that we’ve reviewed the various types of procurement and the different purchasing models, it’s helpful to consider the starting point or trigger for the P2P process: the purchase order.
Purchase orders are requests for goods or services that the purchasing organization provides to the vendor or supplier. The purchase order acts as a record that defines the goods or services being bought. The purchase order (PO) is also one of the documents involved in three-way matching, a process that occurs before payments are issued.
There are four distinct types of purchase orders: standard, planned, blanket, and contract.
Standard purchase order
A standard purchase order provides clear purchase information, such as identifying the item or service needed, the delivery date, the quantity, and payment terms. In other words, what’s needed, when it’s needed, and how much is needed. This type of purchase order is the most common, the most rigid in terms of timelines, and can be used by businesses for different functions, such as subcontracting or one-time services.
Planned purchase order
A planned purchase order is a more flexible version of a standard purchase order. Planned POs are usually submitted in advance or in anticipation of a need and include information similar to standard POs — such as what is needed, payment terms, and the cost — but the timeline for delivery of the goods or services is tentative. This type of PO is usually issued with repeat or regularly placed purchases, such as office supplies.
Blanket purchase order
A blanket purchase order is a standing order for future purchases, including every detail except the item quantity and delivery times. By using a blanket PO, buyers can simultaneously source from multiple suppliers in order to negotiate the best, discounted price. However, it also limits them in the sense that some suppliers may not be able to meet the need if the required delivery time is too soon or the purchase quantities are not readily available.
Contract purchase orders
A contract purchase order is a signed contract that outlines the terms and conditions agreed upon by the buyer and supplier. No other details are included besides the intent to buy from the specified supplier.
Similar to planned purchase orders, a contract purchase order can be used for future orders. It also provides the buyer and supplier with protection against either party backing out of the purchase. Once a specific or formal purchase order is issued, the buyer will reference the contract PO in the official purchase order.
