As we enter an era of supply chain issues and slowdowns, we must have a KPI process in place to make sure we thrive and continue to grow whatever trade you are in. The procurement process has many steps in our trades and followed by a business to source and obtain goods or services. The steps in the procurement process vary in every business, for some, it is a simple purchase process, and for others, all the steps leading to purchase are part of the procurement process.
The steps in the procurement process are based on the following factors:
Business operating model
Size of the business
Location of business
Financial budget
Compliance management
Organizational structure
The company’s profit margins, and quality of services and goods depend on the effectiveness and efficiency of the procurement process. Identifying the need is the first step in the procurement process. Once the need is identified, finding the right vendor is the next step. Once a vendor is identified, the purchase order is prepared with all the specifications and terms and conditions. Upon receiving the purchase order, the vendor starts processing the order. Once the procurement team receives the delivery of goods and services, they either accept or reject the order after due inspection. If the order is accepted by the team, the next step would be the payment of the invoice. Documentation of all procurement steps is necessary for auditing and compliance purposes. The purchase requisition, purchase order, and vendor invoice are the main documents/receipts in the procurement lifecycle.
Need for Procurement KPIs
Key performance indicators (KPIs) are important metrics that measure specific aspects of performance. KPIs enable project teams to monitor and share progress in a lucid and objective manner. Procurement KPIs are more granular and specific goals that are easy to track on a monthly or daily basis. Modern businesses want the procurement function to deliver value beyond cost savings. Procurement managers (Purchasing Managers) are looking at ways to make the procurement function more sustainable and streamlined.
Process improvements can be done only when you can measure the outcomes. Key performance indicators help procurement managers make data-driven process improvement decisions. Procurement and purchasing department metrics or KPIs enable procurement managers to monitor, manage and improve process performance. Procurement performance indicators help organizations to optimize and regulate their purchase expenses, quality, cost, and time.
Purchasing performance indicators can be used for analyzing data based on performance objectives and setting actionable performance improvement goals. Purchasing KPI’s may be created in conjunction with supplier metrics to measure the performance elements of the procurement process. Procurement KPI’s are essential pieces in the performance management toolkit of procurement managers (purchasing manager).
Here is why you need procurement KPIs:
Evaluate and monitor the efficiency of the organization’s procurement management.
Optimize and streamline organizational spending, time, quantity, and sourcing of goods or services.
Enable procurement managers to make data-driven process improvements.
Align procurement process outcomes with the overall organizational goal and strategy.
Empowers organizations to decide on process improvements and competitive strategy.
List of Important Procurement KPIs
Procurement leaders look to improve their procurement process bank on an array of procurement metrics that help them monitor, evaluate, manage, and improve the procurement function. What is the procurement key performance indicator that matters most? Procurement managers decide on the KPI to track based on the business type, size, and operations.
Here is a list of procurement KPIs and metrics that are used to monitor the performance of the procurement function:
1. Number of Suppliers
Helps track the dependency level on suppliers. The procurement team of a business may have a single or multiple suppliers for a particular item. Instead of depending on a single supplier, it is better to have multiple vendor options for goods and services. This brings down the dependency on a single supplier. The supplier KPI keeps track of the number of suppliers the company deals with. Relying on a few select vendors and not diversifying sourcing creates a risk of dependency and last-minute cancellations by a vendor. Having too many suppliers is also not profitable as the possibility of discounts is reduced. Suppliers may be classified as contracted and unlisted vendors. Businesses enter a contract with the type of suppliers as they can comply with their terms and conditions. Unlisted vendors are those that do not agree to terms and conditions. Further, contracted suppliers may also be rated based on quality, discounts, and reliability. While measuring the supplier KPI, other metrics like the defect rate of suppliers and quantity discounts they provide must also be considered.
2. Performance Rate
Verifies if suppliers meet compliance requirements. Compliance rate KPI helps assess supplier’s compliance with business requirements. The entire procurement function is built on the basic agreement between the supplier and the company (buyer). This agreement covers terms like delivery time, exclusive discount offers, maximum reaction time in case of delays or issues, payment mode, etc. A drop in the compliance rate KPI results in an increase in indirect procurement or maverick spending.
The compliance rate KPI provides insights into supplier relationships and helps save costs through negotiations with suppliers. The metrics that contribute to this KPI are the ratio of disputed invoices to total invoices for that supplier, and the difference between the price paid and the price quoted. Engaging with Certified suppliers improves the compliance metric significantly since they have a better understanding of processes and work methodologies.
For a mid-size company, an overall performance rate of 50% is a reasonable purchasing KPI target.
3. Supplier Quality Rating
Evaluate the quality of suppliers. The supplier quality KPI helps evaluate the quality of suppliers. This is one of the suppliers KPI metrics that are critical for evaluating supplier performance management. It helps assess present and future supplier relationships. Suppliers that repeatedly deliver sub-standard goods or services have their quality rating lowered or corrective measures are implemented until quality issues are resolved. Other metrics like supplier availability also need to be considered for determining the supplier performance KPI. Supply of stock from suppliers whose availability is low cannot be relied upon. Businesses can suffer due to unreliable supplier availability.
The business needs to constantly monitor supplier quality KPI and evaluate the damaged or returned goods, defect rate, and supplier availability, to negotiate future contracts and agreements. It is important to back the evaluation of suppliers with data and analytics, and set clear goals, and monitor the supplier metrics in detail.
4. Supplier Product Availability
A measure of supplier’s ability to meet demand. This procurement KPI measures the supplier’s response to urgent requirements. This KPI helps businesses determine the reliability that can be placed on the vendor. Supplier availability is measured by the ratio between the number of times items were available on the vendor’s side to the total number of orders placed with the vendor. In the era of the Internet, the lines between various purchase channels are blurred. The retail experience is where online purchase, mobile-commerce, and in-store purchase, merge seamlessly. To ensure an uninterrupted supply of goods and services, it is important to manage suppliers across various channels efficiently.
Businesses can take decisions on the reliability of a supplier by continuously monitoring the supplier availability metric. Ideally, supplier availability of 85% and above is a sign of greater efficiency and functioning of the supply chain. Supplier availability KPI = number of times items were available with vendor/total number of orders placed with the vendor.
5. Supplier Non-Performance Rate
Helps evaluate the quality of individual suppliers. The supplier defect rate KPI is useful in evaluating the individual quality of the supplier. The final quality of the product can be evaluated by the purchasing department using this KPI. This metric is measured as a ratio of the number of substandard products to the total number of units inspected. The measure of supplier defect rate is usually in terms of defects per million. The procurement department can measure the supplier defect rate and break it down based on the defect type to gain actionable insights into vendor performance.
The percentage of products received from the vendors that fail to meet the quality and compliance requirements of the company can be calculated using the supplier defect rate. In industries such as aerospace, automotive, and defense where the stakes are high and multi-tiered supplier bases are maintained, the monitoring of supplier defect rate is crucial. Continuous tracking of the supplier defect rate and breaking it down into defect types provides key insights into supplier performance and reliability. Supplier defect rate KPI=total number of substandard products/total number of units inspected.
6. Purchase Order Cycle Time
Helps identify whom to address urgent orders to. The purchase order cycle time is the time from when a purchase requisition is submitted to when it is transferred to a supplier or contractor. The entire purchase order cycle is covered by this KPI. Order creation, approval, delivery, invoice generation, and payment are the steps in the purchase order cycle. The PO cycle time may vary from hours to days. The suppliers that respond to urgent orders can be identified from the value of this metric. Depending on the value of the cycle time, suppliers may be divided into various categories.
For example, suppliers with a PO cycle time of 3 days or less may be categorized as short, cycle time ranging from 6 to 9 days may be categorized as a medium, and cycle time above 10 days may be categorized as long.
An urgent order may be given to a vendor with a short PO cycle time. The overall cost and productivity of the procurement function and staff productivity can be improved by reducing the PO cycle time.
7. Vendor Rejection Rate and Costs
Helps evaluate internal quality management strategies. Vendor performance KPIs like the rejection rate and costs offer actionable insights into the internal quality management strategy. Continuous tracking of these KPIs is essential for sustainable business growth. Correlating the vendor rejection and vendor cost metrics helps in analyzing the cause of an increase in both measures and the possibility of seeking a replacement for damaged goods within a short duration.
A drastic increase in either of these two metrics calls for immediate action from the buyer. Seamless communication between the buyer and the supplier is essential to avoid bottlenecks and negotiate solutions to ensure healthy vendor relationships. Tracking the vendor rejection and cost metrics on a regular basis aid in avoiding unpleasant lawsuits for damages or guarantee claims. The cause of issues and ways to avoid them in the future can be worked out when these KPI’s are monitor.
8. Lead Time
Gauge the total time to fulfill an order. The total time required to fulfill an order is referred to as lead time. This purchasing metric is a measure of the time between the initiation of a purchase action to the receiving of the production model into the supply system.
Lead time is a measure of the latency between initiation and completion (execution) of the process. Vendor or supplier lead time is the time between receiving a purchase order to the time when the order is shipped.
Lead time must not be confused with the PO cycle time as they both refer to separate times. Lead time starts when the request is made and ends after final delivery and testing, while PO cycle time starts at request initiation and ends when the order is confirmed. Lead time is the sum of the production lead time and the administrative lead time.
Buyers must set targets for the expected lead time and monitor whether suppliers stick to those times. Repeated failure to meet the targeted lead time requires corrective action. Small lead times are ideal, provided there is no compromise on quality. Supplier lead time = Delivery time – PO acceptance time.
9. Emergency Purchase Ratio
Helps track the number of emergency purchases. It is normal for a business to have ad hoc requests but having many unplanned purchases reflects poorly on the procurement strategy. The emergency purchasing ratio is a KPI that throws light on unplanned orders. Emergency purchases are usually made when the business forecasts a shortage of products or services.
Emergency purchases are usually made at higher purchase rates, so the lower the emergency purchase rate, the better the business efficiency is.
Having a low emergency purchase ratio helps businesses:
Save costs, streamlines procurement plans, ensures continuity (availability) of goods and minimizes supply risks. This metric reflects the efficacy of procurement strategy and is a guide for planning future strategies. Efforts to keep the emergency purchase ratio low will help businesses avoid process bottlenecks and product shortages within the product portfolio. Emergency purchase ratio = the number of emergency purchases/total number of purchases over a fixed period
10. Purchases in Budget and Time
Helps monitor the purchasing time and cost(budget). The procurement manager always needs to be updated on the purchasing time and budgets. Ensuring that the purchases are completed within the stipulated time and that the expense is within the budget is critical for the purchasing department. Tracking this KPI helps procurement managers to identify gaps in the procurement pipeline and resource utilization.
Identifying the percentage of purchases within the budget and time can be accomplished by tracking this KPI. A sizable percentage of purchases outside the projected budget and time is a cause of concern for the procurement head. Analysis of why and how the purchasing budget KPIs were not met helps the manager streamline or revise the purchase plan.
11. Cost of the Purchase Order
Monitor and control the internal cost for each purchase. The definition and application of the cost of purchase order KPI may vary in every business. A broad definition of the cost of the purchase order is the average cost of purchasing an order, from purchase, creation to invoice closure. Practically speaking, the measurement of this KPI involves the tracking of several variables.
Each business produces a different list of variables that determine the cost of the purchase order. Some may consider direct and indirect costs, while others may only consider the direct costs and the time each order takes. It is important to understand the essence of tracking the cost of purchase order metric, which is to improve the efficiency of procuring to pay lifecycle and keep the errors and costs to a minimum. Once the intent of measuring this KPI is understood, businesses can decide on the variables that should be considered to measure it.
12. Procurement Cost Reduction
Helps streamline the tangible cost savings. The procurement cost reduction metric is an example of the procurement key performance indicators that focus on the cost of the procurement function. The procurement cost reduction KPI aids procurement managers to streamline the tangible cost savings of the procurement function. This KPI measures the % cost savings on every order through price negotiations. The cost savings made by negotiations and discounts over the years show the efficacy of the cost management measures followed by the procurement department.
Procurement cost reduction can be measured by comparing the old costs with the new (revised) costs for the same goods or services. A clearer picture of the cost reduction can be obtained by breaking it down into various supplier categories and tracking the ones with the highest savings. This KPI helps the procurement department to streamline and optimize the supplier lifecycle, educate and train staff on cost-saving measures, and increase efficiency by implementing supply chain analytics. The top management relies on cost reduction metrics for building a long-term cost management strategy.
13. Procurement ROI
Evaluate the profitability of investments. Procurement ROI is one of the most important metrics that determine the cost-effectiveness and profitability of the procurement investment. This metric is valuable for internal analysis of the procurement function. Although an important KPI, procurement ROI alone cannot be considered to get the complete picture of the procurement function performance. It should be correlated with other KPIs to get the complete picture of the performance. This metric does not take the cost avoidance metric into consideration. Setting the purchasing ROI target 6x the internal investments is a good procurement strategy. Procurement ROI = Annual cost savings/annual procurement cost
The list of procurement key performance indicators that every business uses to evaluate performance may vary with the size and type of business. Tracking the procure-to-pay (P2P) offers enormous potential for value addition and cost savings. The P2P cycle covers tasks from purchasing raw materials to obtaining goods/services like custodial services, office supplies, and utilities. Tracking p2p KPIs enables efficiency improvement and cost savings in procurement and accounts payable processes.
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