Procurement–whether for goods or services–is an essential element of any supply chain, and that doesn’t apply just to tangible goods. The benefit of procurement is that all businesses have relative strengths and weaknesses. An automobile manufacturer might have a very efficient process for producing high-quality cars, but might not be so good at sourcing raw materials. A bank might be great at structuring financial instruments and maintaining strong customer relationships but might lack the technical knowhow to operate a user-friendly and secure online portal. Procurement allows companies to focus on what they are good at by outsourcing what they are not-so-good at to business partners, potentially from anywhere on earth.
There are, however, risks inherent in the procurement process, and these risks need to be considered when evaluating the value of the benefits of any given procurement arrangement. We’ve broken these risks into three primary categories: business risks, financial risks and international risks. We’ll look at each in detail.
The business risks inherent in the procurement process are perhaps the most obvious. These risks could also be classified as risks arising due to a lack of centralized control over key products and services used as inputs in the supply chain. For example, the hypothetical automobile manufacturer might start to see the quality of the steel it uses as an input into its cars deteriorate, meaning customers are less satisfied. Or the quality of the hypothetical bank’s online portal could start to exhibit software bugs that diminish the user experience.
Even if quality remains more or less the same, there is a risk that the procurement partner starts to demand higher prices for its product or service. What if the bank’s software-as-a-service (SaaS) provider raises the price of hosting the bank’s online portal? The bank’s bottom line is going to suffer.
Finally, there is a risk that the procurement partner simply goes out of business. It’s not always fast and easy to replace a part of the supply chain. If the SaaS company uses a call center to support its customer service operations and that call center goes out of business, how long will it take to find a new partner at comparable costs? How long will it take the new call center’s employees to sufficiently learn the software company’s business?
As Marty Pine writes for The Balance, one of the primary benefits for outsourcing aspects of a business is typically cost. It’s often cheaper to pay an established, experienced company to handle your non-core business functions than to spend the time and money developing that expertise in-house. However, there are financial risks involved in the procurement process.
Writing in 2013 for Supply Chain Quarterly, Terrance T. Burton claims that the hidden costs of procurement “typically add up to somewhere between 14 percent and 60 percent of purchase price” and discusses 10 common sources of hidden costs such as the cost of cash flow and the costs involved in managing suppliers.
Another financial risk is that of currency fluctuations associated with transnational procurement arrangements. When the value of the currency in a company’s home country changes relative to the value of the currency it uses for international procurement, there’s a risk that inputs to the supply chain suddenly become more expensive. CGMA Magazine further breaks down currency fluctuation risks into risks from transactions and risks from translation and offers hedging strategies to deal with each.
Some of the financial risks we discussed above relate to doing business internationally; however, there are risks beyond financial that come with international procurement. For one, the political or economic situation in the country from which you’re procuring could be volatile. And–risks of a political, environmental or economic volatility aside–it can be challenging simply to deal with differing sets of laws and regulations, especially when you have procurement partnerships in multiple countries.
By and large, procurement provides many benefits to businesses. By allowing a company to outsource areas beyond its core competence to organizations that specialize in those tangential functions, procurement helps businesses reduce costs through efficiencies and even reach a broader market by capitalizing on the network of its procurement partners. At the same time, businesses need to be cognizant of the risks of procurement.
We’ve highlighted the primary risks categories above, and being aware of them is the first step in mitigating those risks. Companies engaged in the procurement process or considering implementing a new procurement program should look at the risks that are most likely to impact their own operations based on the nature of their business and set up an internal process to develop an appropriate risk identification and mitigation plan.
Michael Wilson is vice president of marketing and communications at Afflink. He has been with the organization since 2005 and provides strategic leadership for the entire supply chain team. In his free time, Michael enjoys working with the Wounded Warrior Project, fishing and improving his cooking skills.