Author: Brett Knox
June 6, 2024 - 7 MIN. READ
Procurement risk management helps buyers identify, evaluate, and reduce risks in their procurement processes. It is important because failures in the procurement process can cause operational problems, delays, and substantial costs.
Definition and Types of Procurement Risks
Procurement risks are the potential negative impacts of procurement process failures. The main types are:
- Financial risk: procurement failure leads to budget overruns or penalties caused by the failure.
- Supplier risk: non-performance by the supplier, insolvency of the supplier, and acquisition by others.
- Legal risk: supplier violation of contract terms, disputes between buyer and supplier, warranty failures by supplier, or intellectual property disputes.
- Operational risk: Delays are caused by the failure of suppliers to deliver on time or according to contractual quality standards, resulting in cost overruns or schedule losses.
- Reputational risks: delays and other issues can sour relationships with customers.
Tools and Techniques for Identifying Procurement Risks
Clear, accessible procurement spending by suppliers is essential. You must have a real-time picture of how much you spend, on what, how often, and with which supplier. To do that, you need to automate your data management. Several software platforms on the market can help you do this.
To make it easier to deal with supplier issues early, you also need to digitize your procurement processes for transparency, from bid development to bidding to delivery.
Solid spend data management illuminates procurement results after the fact. It also equips you for procurement effectiveness and risk management. For example, strong spending data can reveal an over- or under-concentration of suppliers.
Without automation, you are blind and will learn about issues after the fact. To get ahead of issues, you can analyze potential holes in your processes by using tools like SWOT analysis to identify strengths, weaknesses, opportunities, and threats.
With SWOT, you analyze what you are doing well and not well and how you can improve. Do you have high-quality, readily available data, a well-thought-out procurement process, and enabling systems? How frequent are supplier failures? What have they cost your firm? If you cannot answer these questions readily, you have improvements to make.
You also need to ensure that your front-end processes are sound. If you have solid data detailing your spending, the next thing you need to know is the required service or product specifications.
For example, for retail store janitorial services, specify what tasks you need to perform, how often, and when. Then, you will need to determine how to evaluate supplier performance objectively. One way to do that may be through regular inspection and scoring by maintenance staff, with scores centrally stored.
That detail must be built into your bid documents and contracts. If done correctly, you will have a solid basis for supplier performance management and reduce the chances of bad surprises.
Case Studies of Companies Who Dealt With Procurement Risk
GEP, a prominent procurement consultancy, points to the case of a $10 billion multi-national food manufacturer that lacked a formal risk management strategy when a key single-source ingredient supplier failed a quality audit. That forced the company to scramble to find an alternate source.
GEP helped the company do a deep dive into their data, classifying suppliers based on spend magnitude and risk, ranging from high risk/high spend to low risk/low spend. High-risk and high-spend suppliers were prioritized to develop and implement detailed risk mitigation plans. Critically, the effort was led by teams from key areas of the company.
The result was new transparency into risk and solid risk mitigation plans. The article does not specify whether they already had good data, but if not, this was likely an expensive project.
Apple is another great example. Their procurement practices emphasize building strong, long-term relationships with key suppliers. They also build flexibility to change suppliers when needed and have a constant focus on intelligent cost reduction.
Finally, Amazon has a well-developed and skilled procurement group that is effective in driving down costs, but that is not all. They also emphasize productive, long-term supplier relationships. Their huge logistics network with dispersed warehouses and deep transportation networks helps mitigate distribution risks.
Mitigating Procurement Risks
To truly manage and mitigate procurement risks, you need a strategic approach that ties together strong data collection, solid bidding practices, and supplier management with a procurement platform.
Get Organized and Enlist Business Owners
Classify your spending into categories, for example, maintenance supplies, office supplies, project supplies, etc. Consolidate suppliers to the smallest practical number. A rule of thumb used by the author is that your business volume should be no more than 20%–25% of any supplier’s portfolio. Otherwise, you are creating a default risk.
To encourage buy-in, engage the business owners in strategy formation and processes with structured project meetings. Show them how your strategy aligns with their business objectives.
After contracting, involve the business owners directly in performance management. They are the first to see problems and are key to implementing changes.
Invest in Rigorous Supplier Evaluation
Make sure that the bidding process includes rigorous supplier risk analysis. Get audited multi-year financial statements and analyze profitability, revenues, expenses, levels of debt, judgments, and pending litigation, among other things. Look for negative trends to question.
Ask about current disputes and past canceled contracts. Seek references from other customers, preferably ones you know.
If your internal resources need help, several firms provide extensive information on a supplier’s past financial performance over time for a fee.
Be Prepared for Problems: Contingency Planning
Expect issues to arise. Solid performance management with business owners will give you advanced warning.
If a supplier fails substantially, you need to know how to replace them. Know your contract termination rights. Identify how much additional business other suppliers can safely take on in the bid process.
Put together a plan with the business owners that spells out when and how the plan will be triggered, the notices required, and the elected replacement contractors. Be clear about team responsibilities.
Collaborate With Suppliers To Identify Supply Chain Risks
Establish close communication with suppliers. Meet at least once per month with senior supplier representatives for formal performance reviews based on your data. Encourage the supplier to be open but be aware of changes in the climate of the meetings.
Challenges of Procurement Risk Management
Risk management is not black and white and requires flexible thinking to support and not impede business.
Balancing Risk Management with Cost and Quality
Getting the best, not the lowest cost, should be your objective. Beware of bids that are substantially lower than others. Suppliers may be overly aggressive and risk overreaching. And do not relax quality specifications to reduce cost. Defects can wreak havoc on your business.
Addressing the Unique Risks of Global Supply Chains
Global supply chains have inherent risks like political upheaval and transportation and production breakdowns like the ones faced under COVID-19. Solutions are to understand and closely monitor the political climates, maintain contingency inventory, and determine domestic replacement suppliers ahead of time as part of a contingency plan.
Ensure Consistent Risk Management Practices Across the Organization
Ensuring that procurement risk management practices are consistent and visible across the organization as a matter of policy backed by the C-Suite is crucial. Conflicting or muddled approaches will not be effective.
The Takeaway
Emphasizing and resourcing procurement risk management across the enterprise will reduce your risk of loss due to supplier failure, which can wreak havoc on your company. Process digitization and clear, accurate procurement data are keys to success.
Reduce Procurement Risks and Lower Costs
Purchasing programs like Raiven help companies reduce risks and lower their purchasing costs by enabling them to pay less for maintenance materials, replacement equipment, office supplies, and more.
Discover the benefits of participating in a purchasing program like Raiven. By leveraging the collective buying power of its members, Raiven secures exclusive discounts on electrical products, HVAC and plumbing supplies, and more. And Raiven performs all the supplier evaluations, tracking, risk audits, negotiations, and more.
Access pre-negotiated discounts of 7%-30% from industry-leading manufacturers and distributors, including FedEx, Ferguson, Grainger, Graybar, HD Supply, Home Depot, Koch Filters, Lowe’s, Office Depot, Schneider Electric, Sunbelt Rentals, and more!
Contact us today to also learn about how our intuitive purchasing platform streamlines buying and reduces procurement risks.
