Where inefficiencies exist in Purchasing
Are hidden costs in your PO process hurting your bottom line?
Determining the true cost of running a business can be challenging since there are many hidden costs that do not appear on the balance sheet but can significantly impact profitability. These costs can include things like employee turnover and lost productivity due to outdated equipment or inefficient processes. It's crucial to identify and track these hidden costs, as they can add up quickly and have a significant impact on the bottom line.
One of the most significant hidden costs associated with the Purchasing Step of the 7 Steps of Procurement is the time required to process purchase orders. These costs may not be immediately apparent, but they can add up quickly and have a significant impact on the overall cost of procurement.
Have you ever calculated how much it costs your company to process just one PO? Knowing your cost per PO is a crucial indicator of how efficient and effective your purchasing team and processes are. Industry leaders have already calculated this figure, and they use it to identify opportunities to optimize their procurement operations and reduce back-office overhead.
On average, it costs $68 to process a single purchase order, and that's just for the back-office overhead expenses. Imagine the full cost at thousands of POs per year! With such a significant cost associated with processing POs, it's no wonder that smart contractors are always looking for ways to streamline the procurement process. By optimizing your purchasing process, you can cut down on these expenses and help ensure that your business stays competitive and profitable.
(We’ve built a spreadsheet template that you can download for free to help calculate how much your company spends every year on your procurement process and how much you could save by leveraging technology.)
We’ve also provided a quick example below using averages for a contractor with ~$25M in annual revenue.
Purchasers Avg. Hourly Rate: $30
Time per PO (min): 20
POs Processed Per Year (est.): 2,900
TOTAL COST PER YEAR: $29,000
Where are your inefficiencies?
Why is the purchasing process so expensive? To better understand why, you need to break down all that goes into it. This is what best-in-class contractors do. They proactively assess their processes to identify where inefficiencies exist to make improvements.
To gain a deeper understanding of where opportunity costs occur in the PO process, we'll walk through each step involved. Additionally, we've created a comprehensive guide that can help you identify areas where you can reduce overhead costs. Check out our book on reducing overhead for more information: [LINK].
1. Gathering what needs to be purchased
To ensure that your purchasing team orders the right materials while staying within budget, they need to gather information from various sources in a streamlined and efficient process. By effectively gathering information from these various sources, purchasing teams can improve their decision-making and reduce costs.
Field: Field requests from contractors often come in different formats, such as phone calls, emails, and even written down on pizza boxes. These requests may be urgent and require prompt action, leaving the purchasing team little time to make informed decisions. According to a survey by the American Productivity & Quality Center (APQC), a non-profit organization that conducts research to help organizations improve productivity and quality performance, 68% of companies reported that they struggle to manage ad-hoc requests from the field.
Vendors: Purchasing teams rely on quotes from vendors to determine the cost of materials. However, if vendors are holding materials already purchased by the contractor, this can lead to double buying and unnecessary costs. A study by CAPS Research, a non-profit research organization that focuses on supply chain management and strategic sourcing, found that double buying can account for up to 4% of a company's procurement spend.
Warehouse: If the contractor has a warehouse, the purchasing team needs to track inventory levels to know what materials are on hand and what needs to be ordered. Poor inventory management can lead to unnecessary purchases and waste. According to a study by Wasp Barcode Technologies, 46% of small businesses with up to 500 employees either don't track inventory or use a manual method.
BOM: The Bill of Materials (BOM) serves as a central location for tracking necessary and approved materials and their consumption. By starting with the BOM, the purchasing team can determine the budget and schedule status to make informed purchasing decisions. However, managing the BOM can be a challenge when it requires manually updating information on a regular basis.
2. Creating the PO
Levvel Research, an advisory and research firm that focuses on technology, digital transformation, and payment strategies, reports that 44% of companies still rely on manual processes for purchasing, with only 15% having fully automated processes in place. This is consistent with the purchasing processes we’ve observed in most contractors, where creating POs can be a time-consuming and error-prone task. After gathering information from various sources, the purchasing team must organize and make sense of it to determine what to purchase. This involves drafting individual POs for each vendor and ensuring that the correct materials and quantities are ordered. Unfortunately, this manual work can introduce errors such as typos, ordering the wrong parts, leaving out key delivery information and incorrect data entry.
Furthermore, contractors who rely on outdated technology may have to manually enter the PO information into their accounting system, which is an additional task that’s prone to errors. It's important to note that this step of organizing, making sense of the information, and drafting the POs is crucial in ensuring that the purchasing team stays within budget and orders the right materials. Best-in-class contractors have recognized this and have invested in modern technology to eliminate manual tasks, giving their purchasing teams more time to make better decisions.
3. Accepting an Order Acknowledgement (OA)
Just sending a PO to a vendor doesn't necessarily mean that the order has been confirmed. Vendors need to acknowledge the order by delivering an Order Acknowledgment document (OA), which may have different pricing or availability quantities than found in the original PO. Then, a contractor might need to update their accounting system on the new pricing and item information, leading to more data entry. However, some contractors skip reviewing the OA altogether, considering it too time-consuming to do double data entry. This inefficient and error-prone approach can lead to significant accounting and bookkeeping errors, as well as throw off job spend and material usage numbers when analyzing a job's progress. It also increases the risk of paying an incorrect invoice, as discrepancies may go unnoticed until an invoice arrives later in the procurement process.
4. Updating records
Once a PO is sent, it needs to be kept up to date. Different materials might have different PO lifecycles from first send to being fully fulfilled. As an example, POs for system hubs [e.g., large air conditioning units or switchgear] and fixtures [e.g., sinks or lighting fixtures] often last for many months. These orders, along with hold for release POs and blanket POs, live for a long time, and change over the lifecycle of a job. As a result, accounting systems need to be kept accurate and vendors need to stay up-to-date with the latest version.
But most don’t have an easy way of creating order drafts and versions, or tracking changes between POs. As a result, much of that time per PO is spent on a few very time-consuming POs that need more intensive management and require office staff to create new versions of older records in the accounting system. There’s no doubt that updating versions across the lifecycle drives up the processing cost.
The Purchasing step is a critical component of any construction project, but it's also a process that's rife with inefficiencies. From creating a PO to updating records, there are multiple points where errors can occur, leading to expensive tasks that drive up the cost of processing an order. It's crucial to assess your current process and identify areas where you can streamline and optimize to reduce overhead costs and material expenses. By doing so, you can improve job profitability and ensure that your project stays on track.
What Great Purchasing Looks Like
Effective purchasing is key to the success of any project, and best-in-class contractors understand the importance of automating and streamlining manual tasks to optimize the process. By identifying inefficiencies and making changes to their purchasing process, these contractors have seen reductions in overhead costs associated with purchasing by up to 75%. When considering that the average cost to process one PO is $68, a 75% reduction would bring that cost down to $17. That adds up quickly when processing thousands of POs every single year.
In this section, we will cover some of the best practices implemented by leading contractors to enhance their purchasing process. These include optimizing the collection of necessary information to determine their purchasing needs, creating electronic purchase orders (POs), automating and tracking PO data, seamlessly updating OA data, and keeping PO data up-to-date. By adopting these practices, contractors can increase efficiency, reduce costs, and improve overall procurement effectiveness.
- Streamline material information gathering
If items that need to be purchased are submitted in different formats across different methods of communication, you’re going to have a big mess that needs to be sorted through. That’s why top contractors define standardized processes that they train their employees on, so that everyone at the company is requesting materials in the same format, through the same systems. For instance, gathering material information requests from the field is often a time-consuming task, with purchasing teams sifting through emails, texts, phone calls, spreadsheets, documents, and sometimes even photos of scribbles on pizza boxes. Adopting a digital tool that enables the field to build and submit requests online provides a standardized format that streamlines the process. This removes back-and-forth communication, saving time and providing a clean and organized set of information that’s ready for the purchasing team. Standardizing processes and requiring that requests are sent in a specific format, such as an excel sheet or an online document, can also help to streamline the material information gathering process. When team members feel that the standardization process creates additional work, it's essential to show them the bigger picture. For example, illustrate how using a standardized process leads to the right materials arriving on time, which ultimately benefits the project.
- Eliminate manual work when creating POs
Issuing purchase orders (POs) manually is a time-consuming process that can significantly hinder productivity. According to Kojo’s data, a $25M revenue contractor typically issues an average of 2,900 POs per year. By leveraging a digital platform, you can eliminate manual work and streamline the PO creation process. Standardizing how you collect what needs to be purchased is a step in the right direction, but technology is key to unlocking greater efficiency.
When materials requests, warehouse inventory, and up-to-date status of your hold for release POs are available in a digital platform, you can easily take that information and create a PO, saving time and reducing errors. The value of automating the transfer of materials information from one place to another is most evident when a contractor’s procurement software is integrated with their accounting/ERP system. This integration allows the line items that the field requested, that are then turned into a PO on a digital platform to be automatically added, at a line-item level, into your accounting system. These integrations can also support entering in other key accounting information such as job, phase,and tax codes to automatically update in the accounting software. By utilizing technology and integrating systems, you can eliminate manual work when creating POs and free up time for your team to focus on other important tasks. - Automate and track POs with ease
Sending off a PO to a vendor via email may seem simple, but keeping track of every email can be time-consuming. With potentially thousands of email threads with vendors every year, it can be difficult to find the information you need quickly.
There are two main ways to improve this process: standardizing your email system or investing in procurement software.
Standardizing your email operation involves creating a folder structure within your email provider, such as Outlook or Gmail. This structure should reflect how your purchasing operation works, with folders broken out by job and subfolders for each PO. By moving email threads into the corresponding folders, you can easily find the POs you need.
Investing in procurement software automates the process even further. With software, POs are issued and tracked in one place. Since all the information is formatted the same way, you can easily sort and search by job, PO number, or vendor. This removes the need for manual filing and allows you to find PO information from years ago within seconds. It also applies to all users, so you have one central system used the same way to track your orders.
Other technologies, such as Electronic Data Exchange (EDI), enable some procurement software to issue a PO directly into your vendor’s system. Think of it like buying a stock with an online broker: you log into your secure online account, search for the stock you’re interested in, see what the price is, and then enter the quantity you want to buy. With a click of a button, the order is digitally sent and executed in the broker’s system. You have a log of every transaction you’ve ever made and it can easily be sorted and referenced. The same is true with EDI technology in a procurement platform. You can quickly see the price of the materials you need, enter the necessary details, and place the order with ease. Forrester Consulting, a global research and advisory firm, found that companies that implement EDI technology can achieve a 40-60% reduction in order processing time and a 35-50% reduction in order processing costs. - Ensure order acknowledgement data is updated
It's important for contractors to review the Order Acknowledgement (OA) document they receive from vendors after issuing a Purchase Order (PO), as those documents have pricing and may make changes to the PO. If the OA is not reviewed, errors may not be discovered until the contractor receives an invoice, which can take weeks or even months, and there will be no source of truth to map the invoice to later on. This can result in inaccurate job spend numbers and put pressure on the accounting team when they’re attempting to catch discrepancies between the invoice and the original PO.
To avoid this, best-in-class contractors incorporate OA review into their purchasing process. Accurate and up-to-date job spend numbers can lead to smarter purchasing decisions and fewer invoice errors, which are common. On average 20% of invoices contain at least one error.
Optical character recognition technology (OCR) can help streamline the process by automatically uploading the information in the OA document so that there is an accurate record of what was ordered for future reference. OCR technology works similarly to depositing a check on your phone with your bank. A robust procurement software comes with OCR technology and will update the PO and accounting software with accurate and up-to-date information for you.
- Keeping Order Info Up-to-Date
POs sometimes have a long life over the course of a project. Large bulk orders, POs for hubs and fixtures, and rental POs each are relevant throughout a project, and can have many versions. Keeping track of these changes adds additional strain to the work that’s already needed to stay organized.
Top contractors see these changes and invest in technologies that not only help them support their purchasing, but that support change orders. These change orders will be pushed into the accounting system, via the same integrations that are used to enter the PO. Keeping track of changes and versions puts some contractors Purchasing operations over the top!
