The process of procurement optimization consists basically in finding the best deal possible. That means a product or service that satisfies the needs of your business while maintaining the lowest cost possible.
So, what the optimization must do is find the product that fulfill both aspects. However, that process is not that simple. Generally, companies are looking for more than one item and objective.
Considering that, we should have a better understanding of a process of multiple item procurement. Two basic concepts that will help clarify things are scope and scale.
Economies of Scope and Scale
Economies of scope and scale are concepts to reduce companies’ costs. While scope looks at the average total cost of production in multiple items, scale takes its advantage in producing higher quantities of a single item.
So, economy of scope seeks to decrease costs increasing the variety of goods produced. It maintains one core product but also invests in complementary ranges. Is cheaper to produce two products with on input than having an input for each one.
On the other hand, economy of scale has its advantage in an increase output of a good. The higher the volume of production, the lower is the cost per unit.
The basics of procurement optimization
First, we need to establish that procurement is an auction process. The first step is the procurement team estimating the needs of a performance period stipulated by the company.
Then they must communicate their needs to the suppliers, or bidders. That can happen in a lot of different ways, by e-mail, by conference or any means of communication.
After the need is established, the suppliers will submit a bid with requirements. The best option for procurement is sealed bids, because buying separate items will result in extra costs, then sealed bids will have a better profitability.
The stage end when the procurement team chooses the best fit for their needs. Then it will proceed to negotiations with the supplier.
Why Procurement Optimization?
The greatest vantage of an optimized procurement process is the possibility to develop a mathematical model that incorporates all bids from all suppliers.
With that, if a good solution is found, it will cover all the necessities, such as items, business rules and lowest costs. Because the model can trained, it is possible to test different rules and scenarios searching for a more efficient model.
The professor of supply chain management Larry C. Giunipero, from Florida State University, suggests some rules that may be tested to evaluate the impact on the business:
- Limiting the maximum amount of business allocated to any one company
- Requiring a minimum of business to be allocated to minority- or women-owned businesses
- Allocating all the business for a low-volume item to one supplier
- Only using suppliers who have adopted “green” or sustainable practices
That’s called scenario testing and is a fundamental part of the optimization process. The professor also explains that a mathematical model can reduce up to 10 percent over other approaches. Besides that, it saves time while keeping good relations with suppliers.
Another advantage of an optimized model is allowing the suppliers to bid on lot sizes, combining items or services for which they can make better values and prices.
It’s all a matter of data
The necessity for a well-implemented mathematical model is lots of data. Cleaned and structured data. The bad side is that these optimization models cannot be done in desktop applications and computers.
Because it’s many variables and constraints, is necessary to use servers with appropriate speed and memory. This data is collected from multiple sources, for instance, ERPs systems.
So, the process is collecting, cleaning, and enriching lots of data and then structure it in a way that will be valued to the company. With the data set in place, it’s possible to describe the needs, predict problems and improve performance.
Dealing with data will happen in three stages:
- Data Extraction: extracting data from all sources possible; consolidate it in a central database.
- Data Categorization: classify every extracted data the same way; put it in a standard way.
- Analysis: look for insights from the data you just categorized.
In the past, procurement focused in understanding previous cycles and trying to adapt based on it. Now, in a digital context, procurement is more efficient and automated, using data to make prescriptive decisions. Data analysis will impact not only the costs of orders but also establish a more strategic sourcing.
Supply Brain can help you define when to buy and what the ideal quantity is, taking into account the economic order. In the tool you can also get product insights, with recommendations and prioritizations. Would you like to schedule a demonstration? Get in touch!