Spotlight on Direct Materials Procure-to-Pay -- Part 1
on Apr 10, 2014
The procure-to-pay process (P2P) for direct materials resists standardization and automation. As the critical execution phase of source and procurement, it is where the rubber meets the road for inbound materials. This is the first in our series on direct P2P, based on recent research.
Shifting the Spotlight Back onto Direct Materials P2P
Until the late 90s, indirect procurement was somewhat of the ‘forgotten step child’ of the purchasing world. At that time manufacturers put most of their sourcing and procurement horsepower on managing those ever critical direct materials, without which the production line stops and the company makes no money. As a result, indirect spend was poorly managed with maverick spend1 rampant. To address this, we saw the advent of e-procurement software from the likes of Ariba, CommerceOne, and RightWorks.
Direct Materials P2P?
During my research when I said “I’m researching direct materials P2P,” more than one person said something like “but our P2P is only for indirect spend.” Of course there is a P2P process for both direct and indirect, but the term P2P has in some people’s minds come to be synonymous with their indirect spend software.
As a result, a lot more attention is now paid to indirect P2P. So much so, that direct spend, while still receiving a lot of attention from sourcing and procurement departments, has gotten considerably less attention in the press and analyst community. We decided it was time for us to do some research and take a deeper look at direct materials procure-to-pay processes, practices, and systems. We have surveyed and interviewed over 100 suppliers and will report on our findings in this article series.
Indirect vs. Direct P2P
There are some striking differences between indirect and direct procure-to-pay processes. Indirect procurement processes are fairly similar across industries. Whether you are in aerospace, or hospitality, semiconductors, pharmaceuticals, insurance, retail, healthcare, shipping, or any other industry, there tends to be many similarities in how you buy office supplies, computer systems, office furniture, or lawn mowing services. In contrast, there are fundamental differences between industries in how direct materials procurement, change management, quality, reconciliation and payment are done.
Direct P2P Process Stages
The direct materials P2P process can be broken down into four stages:
Demand-to-Confirm—Unlike indirect procurement, where demand usually originates with a requisition created by an employee, direct procurement demand typically is driven by some sort of planning engine; usually MRP for manufacturing companies, or project planning systems for construction and project-oriented industries. In some industries with long lead times or complex custom products, the process of the buyer and seller coming to agreement on delivery dates and quantities can involve a lot of back and forth negotiation.
Build-Change-Deliver—For simpler products with short lead times (often built-to-forecast and shipped from stock) this is usually a short and hopefully uneventful phase. However, for large complex products, such as a large, expensive, totally custom machine with a long lead time or for custom pumps and components going into an oil rig, this phase can last for a year or more and involve many back and forth tweaks to specs and sometimes re-negotiations of price and schedule.
Receive-Inspect-Accept—In more strategic relationships, the trend is to push inspection responsibilities back to the supplier and receive directly into stock. In many cases though, inspection will still be done by the buyer, including checking for damage during transport, quantities and correct item shipped, correct paperwork, documentation, and certifications, and in some cases in-house testing for compliance and performance to spec. At this stage there may be adjustments to the amount received, based on what is accepted or rejected. There may also be a series of quality-related actions, such as putting a component on hold, root-cause analysis and corrective action. The amount, type, and location of inspection varies tremendously by industry.
Invoice-Reconcile-Pay—Finally, an invoice is issued and checked against what was ordered and received. Any discrepancies are reconciled and payments made. Here again there is enormous variation. Some companies don’t even require an invoice to be sent, but rather schedule the payment (per terms) upon receipt of goods (i.e. evaluated receipts settlement). In some cases, the buyer or the seller may set up an early payment discount program. There are also third parties that may buy receivables or even take title to inventory sitting in a VMI hub or in transit, in exchange for a discounted payment.
In Part 2 of the P2P series we will explore industry-specific challenges, more results from our research, and a look at available systems and solutions for direct materials P2P.
______________________________________________ 1 i.e. employees buying off contract, not taking advantage of the savings negotiated by the procurement department. -- Return to article text above
To view other articles from this issue of the brief, click here.