While most of us will agree that sourcing is one of the key processes of an organization where substantial part of risks exist (including fraud and corruption risks) and losses could arise to our organizations if the internal controls are not strong, and that we need to bring as much transparency as possible in that process.
Some of the key controls are commonly forgotten from being specifically defined within the documented procedures.
Some of these key controls are related to anti-fraud topics, and others relate to better efficiency of the sourcing process:
- Prequalification checks:
One of the key controls to be exercised within a sourcing process is to ensure that we do adequate amount of back ground checks on the potential vendors identified by us for calling the bids. This is important because if the pre-qualification is not adequately done, we may end up with the vendors which are not the best suited for our job.
These checks embrace knowing the compatibility of the vendors to the specifications, general market reputation, their financial stability, their experience of working in similar previous conditions, and their legal status (key registrations as per law etc). Sometimes attending the industry associations/forums could provide us with more information on these aspects than what is told by the documents. It is important to ensure that all these checks are mentioned within a sourcing process to ensure awareness and compliance.
- Structured Decision matrix:
While most of the sourcing procedures talk about cross functional teams, and comparative bid statements, however, having a structured comparative for decision making containing the qualitative aspects also is a normally forgotten item. So we may end up being only price focused, and may also invite difference of opinion on the subject as everything is not so clear. Now, the question is how to structure a sourcing decision? The answer does not look as simple as the question is, however, some key things can be kept as a guideline for devising a decision matrix.
Ultimately, every sourcing will have a different decision matrix, as the weightage attached to each of the parameters will be different. For example, the weight age attached to price while procuring a chair will be more in comparison to the weight age attached to the price while procuring the consulting services. Some of the key components of a decision matrix could be:
- Compliance to the user specifications (for example for a chair, the ergonomics of the chair is important)
- Quality of presentation made by the vendor
- Vendor’s brand and image compatibility with the organization
- Green credentials (if the organization is promoting the green initiatives as corporate social responsibility)
- Stability of the vendor (for example for a transport vendor, the fleet available and its ownership is important, location of the vendors is also important)
- Vendor’s comfort on organization’ s standard contract terms
- In case of some strategic sourcing, the organization also needs to visualize the key possible risks and each vendor’s mitigation plan/capability on them (through discussions), and
- the price terms
The above parameters can be defined as a guideline in a purchasing process to ensure better awareness and structured decision making. This is also helpful to the sourcing team in justifying a decision of not going with the lowest bid (although such cases should be limited and require approval/review from senior management).
- Role of purchasing team in sourcing professional services
Generally, hiring professionals such as consultant services, trainers, auditors, and lawyers requires a different level of experience, skill and knowledge. Thus, most of the times the purchasing teams are reluctant to join the process and want to go by what is being recommended by the user functions. While this practice is not strange and seems to be logical, it is important to know that besides the skills, knowledge and experience of users, there are some other important things which are part of a sourcing process and if the purchasing team is not involved in the process, it suffers from those deficiencies.
While the users should take the front seat in the sourcing process for such cases, purchasing team has to be involved at all steps to ensure that:
- a structured decision making process is followed,
- adequate amount of documentation of the sourcing process is ensured
- better level of negotiation is reached(wherever possible – it may not be possible in all cases)
- overall sourcing process defined in the organization is complied (as users may not be fully aware of sourcing procedures/policies)
Unless this is specifically mentioned in the procedures, this is normally not ensured. It is also important to define what is meant by the professional services.
- Renegotiation process/strategy
With the passage of time (say 2 years), economic realities may change which also means that in light of our overall business strategy and the overall market scenario, our business needs may have also taken a shift. But how do we determine that it is a time to continue the contract in the same way as it is, or to go for re-negotiation or for a fresh RFP (request for purchase).
In many situations, simply identifying the opportunity to tighten the screws on your existing supplier and negotiate a price reduction is not a valid justification for re-negotiation (especially where suppliers have been hard hit by economic downturn). However, it is equally unhelpful to continue to hire services/goods we may no longer need in line with the new/fresh business strategies. For instance, the initial contract may have been designed to take care of innovation objectives; however, with the change in situation, the organization needs to focus more on cost reduction. Thus, normally the following factors should be considered while developing a renegotiation strategy:
- Has there been any change in our business objectives with which the contract was signed with supplier?
- Has the market place changed (including inflation, recession, forex markets etc)?
- Is this the stage for asking more from supplier (because of economies of scale or the learning curve & optimization possibilities with their staff)?
- Is there any new regulation change affecting the overall contract effort /risks?
- Have the volumes changed since we first signed the contract?
- Do we require allocating some share of business to other suppliers now to manage risks for our critical procurements?
It is also important to note that a poorly conceived and executed renegotiation strategy can destroy a valuable relationship. Some of the common missteps are:
- Misinterpreting the market. You may not be as important to your service provider as they are to you.
- Using a hammer/push approach, where a gentler approach to renegotiation is warranted.
- Being ambitious on requirements and including the services that we don’t need.
Our procurement procedures should mention these factors as a guidance to the individuals supposed to implement this. A trigger point to ask these questions for an individual contract should be normally defined. For example, this point may be the passage of time (say 2 years) or the contract expiry, whichever is earlier.
- Need for a formal contract
If not mentioned in the guidelines, there may normally remain an ambiguity on the need to have a formal contract. Although the answer to this question may lie in the details of each sourcing being done, yet some guidelines could be defined within the procurement procedures to help the decision making in this regard. Involvement of organization’s legal team is a must in this process. We may like to go for a formal contract (in addition to the terms mentioned in the purchase orders) in following situations:
- Strategic sourcing (which could affect the normal running of operations if not managed well)
- Sourcing affecting employee security (for instance transport vendors or security staff)
- Sourcing value beyond a threshold (increasing the risk due to value involved)
- Where some of the regulations make our organization responsible, however, the implementation needs to be done by the suppliers (for instance, Contract Labour Regulation Act (India), HIPAA (USA), FSA regulations – UK, FCPA etc.)
- Where suppliers are not under the same laws as of our organization (for example, while dealing with an imported item) etc.
This list cannot be comprehensive, and the role of legal team is critical in deciding where a contract is needed, however, having this mentioned within the procedures can reduce/simplify the decision and help in expediting the process.
- Process for removal of vendors
While most of the procedures would mention in detail the vendor selection process, the removal process gets missed quite often. It is equally important to define the removal process to ensure full transparency and documentation in the removal of a vendor.
- Purchases made on behalf of customers
This is more applicable in case of service contracts (especially in IT sector). In the situations where the customers ask our organization to purchase specific assets on their behalf, generally the tendency with the project managers dealing with the customers will be to bypass the normal sourcing procedures and just purchase it for the customers on their own without involving the purchasing team in the negotiation process with the supplier of the asset. As one may argue that once the customer has given a specific requirement, and is ready to bear the costs, there is not much to do on our side. But, it may mean that we are not exercising the same level of control on such purchases as we would do for ourselves! If we provide our customers with better negotiated prices, it will only help us in building the relationship.
Another factor is the accounting/recording of such assets. If the normal procedures of the company are by passed, it is probable that such assets will not be recorded at a centralized level within the organization. Thus, to ensure this, there is a need to mention such aspects within the purchasing procedures of the company.
- Exceptions to the purchase order process
There are some costs for which an organization may feel to do away with the requirement of making purchase orders. Additionally, there are some costs (such as utility costs) for which purchase orders are normally not applicable. However, it is important to list down such exceptions at one place and then monitor the compliance to the process. These exceptions may alternatively be formalized as part of accounts payable procedures also.
- Management Reporting
It is important to define the different reports that could help the management in monitoring the effectiveness and health of the process. Such reports may pertain to:
- Timelines monitoring dashboards (for stage of procure to pay process)
- Savings dashboard (for achievement through re-negotiations)
- Purchase Order usage report & non-compliances
- Vendors rating/appraisals report
- Open purchase order report
- PO modified/cancelled report
- Supplier master changes report (periodic)
However, the usefulness/applicability of the above reports depends on the level of automation as well as the size of the purchasing.
- RACI Matrix
RACI (Responsible, Accountable, Consult, Inform) matrices are a useful tool for clearly defining the roles and responsibilities at each step of a process. Having a formalized RACI matrix is important in purchasing process to implement some important segregation of duties controls within the process.
(The author is a Certified Internal Auditor from The IIA USA, an Indian Chartered Accountant, and is currently working as a Senior Manager in the Global Internal Audit department of a French MNC)
- Naval Bajaj
Email: [email protected]