Process Automation For Procurement Direct Materials_sep 2007

Process Automation for the Procurement of Direct Materials By Dan Harmon Director of CIBER’s SAP SRM Practice

Abstract:

Purchasing executives are discovering that plant closures, outsourcing, and price reductions gained from the supply base can only go so far in helping to improve the bottom line. What many leaders are missing is that they may already have the tools in place to automate their direct material procurement process. Recent studies have shown that automating this process provides significant cost reductions for processing purchase order data and also allows the procurement professionals to move away from transactional processing to more strategic activities such as sourcing, building supplier relationships, and performing purchasing analysis. This paper will present an analysis of a plan-driven procurement process for direct materials. This analysis includes not only the activities and steps in such a process, but also the data sets associated with each activity. Automation of this process will be explored to highlight where an organization can find process improvements that lead to positive impact on the bottom line. Several recent studies are referenced to identify the benefits companies have obtained by automating the plan-driven direct procurement process. Purchasing executives can use this information to analyze their own direct material procurement processes to determine what benefits might be obtained.



Process Automation of Plan Driven Procurement for Direct Materials

This paper does not attempt to analyze best practices for material planning, but begins the direct material process analysis with receiving a material requirement. Starting with the material requirement allows this paper to focus on establishing a process framework for direct material procurement activities, and not with the planning or sourcing process. Establishing this process framework is necessary, as there is not a true industry standard for plan-driven procurement and most companies that implement such a process will undoubtedly enhance and customize it to meet their own unique requirements. A basic understanding of the fundamental process and data establishes the framework for this paper to further explore the opportunities to automate and enhance the plan-driven direct material procurement process. Ultimately organizations can use the information presented to aid in the analysis of their own direct material procurement processes.

Scope of Paper

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For the past few years procurement organizations around the world have focused a significant amount of time and resources on improving processes and applications to identify the best source of supply for a material or service. Purchasing professionals have worked with their own IT departments as well as software vendors to increase this sourcing functionality. The results of these activities provided many benefits including material cost reductions, improved procurement process efficiencies, and consolidated sources of supply. Despite these improvements in the procurement process, many organizations are missing out on increased ROI and business benefits that can be obtained by reviewing their existing processes for direct material procurement. Today, the vast majority of manufacturing companies employ some type of enterprise resource planning (ERP) system to support their purchasing and material management processes. Typically, these ERP systems offer the functionality to automate a plan-driven procurement process. ERP systems are known for their ability to support multiple threaded processes and vast amounts of data and transactions. With the automation of the processes and transactions associated with the procurement of direct materials, companies can expect improvements to their bottom line by driving down transaction costs, reducing the amount of data and transactional errors associated with manual processing, and allowing their procurement professionals to move away from the support of daily purchasing transactions to a more strategic role such as sourcing.

Even companies with automated plan-driven procurement processes in place today can find improvement opportunities by reviewing the technologies used to support these processes. New and improved applications now use service oriented architecture (SOA) and common data standards such as XML. These technology improvements include multiple data transmission methods, faster transmission processes, and increased data validation capability. Additionally, these applications are making it easier to incorporate the supply base into the direct material procurement process. No longer is EDI the de facto standard for data exchange between a company and its supply base. With the introduction of internet-based applications and systems, such as portals, companies can now electronically exchange purchasing data with the majority of their supply base using the appropriate data standard and transmission method. Supplier enablement, or the incorporation of the supply base into all aspects of the procurement process, is another step in the direct material procurement process that if automated, will result in improved ROI.

Introduction





Process Automation of Plan Driven Procurement for Direct Materials

The Process Figure 1 represents a high level view of a direct material procurement process. It has purposefully been simplified in order to facilitate the discussion of the various process activity steps and their associated data sets. While it is by no means a complete end-to-end procure to pay process, the process flow contains enough activities to facilitate a high level presentation of what the process is, and allows the inclusion of sub-processes where appropriate. Each activity is uniquely numbered to easily identify it later in the paper

1

5

Material Requirement Generated

Purchase Order Delivery

9

2

6

10 Invoice Sent

Purchase Requisition Created

Purchase Order Response

3 Way Match Performed

3

7

11

Purchase Order Created

Advanced Shipping Notice Sent

4

Purchase Order Combine

8 Goods Received

Payment Data Generated

Figure 1 – Automated Plan Driven Procurement Process for Direct Materials

Step 1 - Material Requirement Generated Most manufacturing companies have deployed some ERP system that includes material resource planning (MRP) functionality. MRP is a complex process in and of itself that takes into account existing inventory, sales orders, work in process, and forecasted material needs. With MRP analysis and explanation beyond the scope of this paper, we must assume that the output of this process is a direct material requirement. An organization can have multiple direct material requirement sub-processes and sources. Examples would include kanban systems, vendor managed inventory (VMI), and other alternative inventory systems. At a minimum the material requirement data set must contain the material number, the quantity required, and the due date. Typically most MRP systems add additional data as determined by an organization’s unique requirements for this process.

The key concept to grasp for this activity is that even with multiple systems or sources of requirements, it is still possible to automate this step to directly feed these requirements to a purchasing or ERP system. Automating this activity not only ensures that the requirements are delivered in a timely and reliable manner, but also reduces the data errors associated with manually entering requirements. Middleware is one technology that can assist with this process automation. Middleware is generally defined as software that allows for data routing and transformation between two or more systems or applications.1 There are a number of middleware software packages available, and many ERP systems come already equipped with some form of middleware. Examples of middleware include IBM’s MQSeries, Oracle’s Advanced Queuing, and SAP’s Process Integrator (PI).

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Step 2 - Purchase Requisition Created The second step of the direct material procurement process is to generate a purchase requisition. The purpose of this step is to check for sourcing, and perform preliminary data validations and approvals before creating a legally binding document such as a purchase order. Material requirements without a properly identified source of supply are held from purchase orders until the proper source of supply is determined. Direct material purchase requisitions rarely require approvals since the prevalent thinking is the MRP process insures the requirement is legitimate. As such many ERP systems allow for automatic approval of direct material requisitions. The key data found in a purchase requisition includes the material number, description, quantity, due date, sourcing information, company code, cost center, location code and address of the requesting plant or department. Most organizations will add additional data to the purchase requisition depending on their requirements. With an automated process it is possible to combine multiple direct material requirements into a single purchase requisition which ultimately helps

to reduce the amount of transactions and processing time later in the process. During this step material requirements that do not have a determined source of supply are identified and flagged for a sourcing activity. Purchase requisitions can be created either in the ERP system or in a purchasing or supplier relationship management (SRM) system. Purchase requisitions that are created in an SRM system may or may not be transferred to an ERP system. The decision to perform this transfer is based upon several factors including the level of control required to support the process, how much purchasing functionality is used in the ERP system, and how well the requisition process is implemented in the organization.

Step 3 - Purchase Order Created The purchase order (PO) creation is arguably the most important step in the direct material procurement process. This is a legally binding document between the buyer and the seller. The PO contains all of the data found in the purchase requisition and adds key data that is typically pulled from a contract. This data





Process Automation of Plan Driven Procurement for Direct Materials

includes supplier information (name, number, address, contact person), prices, shipping methods and costs, units of measure, and payment terms.

order that might include multiple plants, departments, and materials. Again, this is usually an automated feature of the SRM or purchasing application that will require some up front effort to properly enable. Certain customs, tax, and legal requirements will restrict the opportunity to combine PO’s but the benefit obtained from a combination process can easily offset the effort required to develop and support such an activity.

The Importance of Contracts Contracts are extremely important in an automated direct material procurement process as they provide a reliable source of data that facilitates the generation of the PO and insures the buying organization is getting the best negotiated price for the material. The use of contracts increases an organization’s compliance with purchasing policies while reducing the amount of maverick buying. The Gartner Group also emphasizes the use of contracts as a best practice. “The identification and efficient management of all contracts with suppliers is an underrated process,” it reports. “Although contracts are at the heart of the supplier management activity, most enterprises have no formal systems in place to manage the contract lifecycle. This lack of visibility and control will often cause an enterprise to fail to extract full value from the contract and the supplier relationship.”2

Step 5 - Purchase Order Delivery Key to automating the direct material plan-driven procurement process is the ability to exchange purchasing data electronically with your supply base. This activity, also known as supplier enablement, provides several benefits including reduced data processing costs, improved processing time, and enhanced communication with the supply base. A 2005 study to determine future procurement trends revealed that information sharing between the purchasing organization and its supply base was key to collaboration and cost reduction efforts.4 As the PO is one of the more important purchasing data sets, logically it must be included in any supplier enablement strategy.

Many software vendors that provide purchasing applications are enhancing their contract and sourcing functionality to meet the growing needs and demands of their clients. Contract management was identified as a key strategic advantage for best-inclass direct material procurement in the 2007 Direct Material Sourcing Study by Aberdeen. Best-in-class procurement organizations had 98% of their direct materials under spend management which resulted in 63% greater contract compliance.3 Clearly, contracts play a vital role to these best-in-class performers.

Electronic PO delivery generally falls into the following methods: electronic data interchange (EDI), extensible markup language (XML), FAX, or e-mail. Regardless of the type of transmission method used, a standard PO form must be developed to insure that the right data is consistently delivered to the supply base. While one could debate that FAX and e-mail are not truly electronic, these transmission methods are typically much faster than the traditional process of printing a hard copy PO and sending it via postal mail.

Step 4 - Purchase Order Combine

Supplier Enablement Strategies

Purchase orders using the same vendor can be combined to reduce transactions and processing. This allows a vendor to receive a single purchase

As in step 1 of this process, middleware can be used to enable the electronic sharing of purchasing data with the supply base. A key issue with this solution is the

... Key to automating the direct material plan driven procurement process is the ability to exchange purchasing data electronically with your supply base.

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amount of effort required to develop the connections (or interfaces) to each supplier. As the supply base grows, so do the number of connections and amount of resources required to support the process. Middleware is generally considered an acceptable solution for EDI and XML transmission methods. However most SRM and ERP systems have built-in functionality that permit purchasing data to be sent via FAX or e-mail to the supply base. This will require the development of standard forms but the cost of enabling this transmission method in an SRM or ERP system is typically less than the effort required to do it using middleware. Supplier portals can also be used to electronically transmit procurement data to and from the supply base. Most SRM systems offer some form of supplier portal to facilitate the electronic exchange of data and communications with the supply base. These portals can be configured to offer better electronic data processing for those suppliers that might not be able to support EDI or XML transmission methods. A final strategy for supplier enablement is the use of a third party company that specializes in providing access to a supplier network. The supplier network is a preexisting organization of various suppliers and vendors that are electronically connected via an e-market software system. Procuring companies that join an existing supplier network receive an immediate benefit when their suppliers are already part of the network.

Development effort and testing will be required to enable new suppliers to join the network. Most supplier networks charge a fee to join the network. This fee is usually passed on to the supplier which in turn receives the positive opportunity to perform electronic transactions with any company that is on the network. Another added benefit to a procurement organization is that the company providing the supplier network assumes the responsibility of ensuring that the proper connections and transmission methods are made with the supply base. For companies with a very large supply base this can become a significant time and resource savings. Procurement software vendors such as Ariba, Perfect Commerce, Oracle, and SAP either offer their own supplier network or have partnered with at least one company that specializes in providing a supplier network. Regardless of the solution chosen it is important to establish one method of communication with each supplier for all data sets. This reduces the amount of maintenance effort for all parties and aids in developing a standard communication strategy with the supply base.

Step 6 - Purchase Order Response The purchase order response (POR) is sent from the supplier to the buyer providing notification that the supplier has accepted the PO as is. A POR containing changes to the original PO may also be sent to the buyer. This situation typically triggers a PO change request in the buyer’s purchasing system that ultimately results in





Process Automation of Plan Driven Procurement for Direct Materials

... The advanced shipping notices are important to the buyer as they provide notification as to when to expect delivery of the goods ordered. a new PO containing the changes being issued to the supplier. Upon receipt of this new PO, the supplier would then issue another POR to accept the new PO. This can become an iterative process as the supplier attempts to address both the demands of the buyer as well as their own inventory and production levels. Automation of this process ensures that multiple versions of the PO and POR can be simultaneously supported without causing interruption to either business.

technology advances in radio frequency identification (RFID) tags and advanced bar code reading systems are allowing some companies to automatically confirm received materials in the appropriate system.

Step 7 - Advanced Shipping Notice Sent

Step 9 - Invoice Sent

The advanced shipping notice (ASN) is sent from the supplier and/or freight company to the buyer when the order is ready to be shipped out. The ASN contains order information, shipping instructions, delivery methods, and due dates. ASN’s are important to the buyer as they provide notification as to when to expect delivery of the goods ordered. This provides the buyer with the necessary lead time to prepare for the arrival of the material.

The invoice is the process step where the supplier requests payment from the buyer. In general an invoice is not issued until after the materials have been shipped. The reality of this activity is that many times the buying organization can receive the invoice before the materials arrive and are received into the system. This can be due to logistical issues, shipping delays, and the fact that an electronic invoice can be delivered in much less time than it actually takes to ship the materials. Also, changes to the PO, the return of unwanted, unordered, or damaged goods, and data errors found on the invoice leads to mistakes in invoice processing, which ultimately results in either over or under payment to the supplier.

Step 8 - Goods Received Much like the POR activity in step 6, the goods receipt step can initiate a multitude of sub-processes and activities. In its most simple form, the goods receipt is entered only once in the buying organization’s ERP or SRM system. This single entry would complete the order-to-confirmation sub-process. The reality of this activity is that many orders are delivered incomplete, or in multiple stages, or contain poor quality materials that must be returned, or contain the wrong materials that must be returned. As such the goods receipt process typically is an iterative activity that continues until all materials on the PO have been received. While most SRM systems allow for a confirmation document to be created ahead of the actual goods receipt, the goods receipt is typically manually entered by a receiving clerk when the materials arrive. New

A goods receipt contains much of the information found on the PO but also includes quantity delivered, delivery address, date and time of receipt, recipient identification, and supplier address and contact information.

Invoices are generally processed by the accounts payable (AP) department of the finance organization. Given that the AP organization is very rarely aware of what is being procured by the purchasing organization, and the renewed emphasis on auditing and spans of control required by the Sarbanes-Oxley (SOX) act of 2002, most invoices receive considerable scrutiny from the AP department. As many companies can process upwards of thousands of invoices a day, there is a tremendous benefit to be realized to both the supplier and the buyer when invoices can be transmitted in a standard electronic format. Electronic invoices benefit suppliers by providing faster posting and transmission

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times, helping them to receive payments in a more timely manner. Electronic invoices benefit the buying organization by removing the manual process of receiving the invoice and entering it into the system, and the associated data errors that occur with manual entry. As detailed in the Supplier Enablement Strategies section, there are a number of systems and delivery methods available for handling electronic invoices. Regardless of the chosen solution, it must be able to support a number of transmission techniques as not all suppliers will be able to standardize on one or two transmission methods.

Step 10 - Three-Way Match Performed The three-way match activity involves analyzing the data found on the purchase order, the goods receipt, and the invoice to determine that the quantities and prices are within predetermined tolerances. Payment data is generated only when the evaluated data fields are within the tolerances levels. Out of tolerance data flags the invoice for manual processing and an AP clerk must manually determine why the match did not occur and what steps can be taken to correct the issue. Usually this involves contacting the receiving clerk, vendor, and/or buyer to understand the discrepancy.

Clearly this becomes a labor intensive process when mismatches occur. While process automation and electronic data transmission help insure that accurate data is reliably delivered in a timely manner, there is no process that can guarantee 100% three-way match success. A study published in 2005 commissioned by the Commercial Solutions division of Visa revealed that best practice organizations achieved automated payments on only 71% of their transactions.5 The three-way match is not the only way to insure that proper payments are scheduled and made. Many companies perform some form of a two-way match that includes variations of the data found on the PO, the goods receipt, and the invoice. Additionally, evaluated receipt settlement (ERS) offers another alternative for generating payment information. ERS typically involves generating payment data after receipt of the materials; an invoice is not required. Previously mentioned supplier enablement strategies such as middleware, supplier portals, and third party supplier networks all offer some form of electronic invoice processing. Additionally, many of today’s ERP systems have functionality in their finance modules to facilitate electronic invoice processing. Finally, there are a host of vendors that offer services for electronic



10

Process Automation of Plan Driven Procurement for Direct Materials

or department as the supplier already knows how to interact with the new organization due to the standard process. A key finding of the 2006 Aberdeen Direct Materials Sourcing Benchmark Report revealed that true direct material cost savings can only be obtained with an enterprise wide process.6 Legal, regulatory, and regional issues will impact process standardization as customization must be performed to meet these unique requirements. The key is to limit this amount of customization to address only the pertinent issues.

invoice processing, paper invoice processing, and the conversion of paper invoices to electronic invoices. Companies that receive a large amount of paper invoices that require significant resources to process manually should consider the ROI that could be gained by moving to an electronic invoice process solution. Not only will an electronic invoice solution reduce the headcount required to process invoices, but additional savings can be obtained by processing the invoices in a more timely manner and taking advantage of improved payment terms.

Conclusions

Step 11 - Payment Data Generated

With most manufacturing companies today employing some form of ERP they clearly have the opportunity to automate their direct material procurement process. Given the advancements in functionality and ease of use of today’s web based SRM systems there is also opportunity for significant ROI for the implementation or increased use of an SRM system. In a March 2007 article, Andrew Douglas, UK director of procurement at Oracle, estimates that most organizations with purchasing technology use only half of it, defeating one of the key objectives for having it.7 SRM systems were predominately known for supporting the indirect material procurement process but with increased esourcing and direct material processing functionality, companies need to evaluate the cost benefits of using an SRM system in addition to their ERP system.

The final step that we will address in this paper is the generation of the payment data. While this is not the final activity in an end-to-end procure-to-pay process, it represents a logical termination point as this is a financial process and must be performed in a finance system. An ERP system will offer this functionality but an SRM system will not. However, there is overlap in how ERP and SRM systems handle invoice processing. An SRM system can accept and process an invoice; however, it is not a financial system. The SRM system flags the finance system for the actual payment to be scheduled. An ERP system can both process the invoice and generate the payment data. The optimum process will depend on how the finance and procurement organizations are structured and what SRM and ERP functionality has been deployed. Standardize, Standardize, Standardize! It is important to note that as with any process, companies that employ a consistent, standard process throughout their organization are more likely to experience success. Standard procurement processes are effective in reducing maverick buying, improving compliance, and facilitating reporting on total spend. Additionally, standard processes make it is easier for a supplier to support a new division

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A shift to using more SRM functionality also correlates with a broader movement by many organizations to elevate the status of procurement to a strategic and executive board level. With an increased focus on the bottom line many organizations are realizing that creating a chief procurement officer (CPO) leads to a strategic investment in the procurement organization. As a strategic function procurement can better drive component and module standardization, and form strategic partnerships with the supply base to better support new product introductions.8

The key is to limit this amount of customization to address only the pertinent issues.

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An organization need not undertake a global, enterprise-wide software implementation to realize noteworthy improvements in processing capability. Each activity step in the plan-driven direct material procurement process can be automated in some fashion, either completely or partially, and more than likely using existing applications and systems. An APQC study revealed that organizations which have an automated procurement process or which are in the process of automating, have an average cost of $7.41 per PO versus a cost of $19.21 for those without automation. Additionally, companies with automation were found to be able to process $1 billion in procurement with 34.5 FTE’s, versus 74.6 FTE’s per billion without automation.9 The automation of key activities in this process can lead to reduced process cycle time, increased data accuracy, and less human interaction; all significant reasons to perform an evaluation of the present process. Consider the following quote from a January 2006 AMI research alert: The automation of procurement execution as part of pull-based replenishment of direct materials is driving true process collaboration between manufacturers and suppliers. With the aid of technology such as that presented here, companies can expect to streamline buyer productivity, eliminate non-value-added activities, reduce direct material inventory across the supply chain, and improve the supply network’s capability to meet customer demand as is required for DDSN (demand driven supply network).10 Finally, today’s procurement organizations should consider updating their supplier enablement strategy to take advantage of technological gains in this area. With an increased focus on core processes and strategic initiatives, manufacturing organizations presently supporting their own internal supplier enablement strategy should decide if they are in the business of making a product or supporting a complex, point-to-point interface system with their suppliers. Many companies will discover that today’s supplier enablement solutions offer increased functionality, ease of use, and quick on-boarding for their suppliers. The costs for such a project can easily be justified given the returns of automated direct material procurement and improved communication with the supply base.

About the author

Dan Harmon Director of CIBER’s SAP SRM Dan Harmon is Director of CIBER’s SAP Supplier Relationship Management (SRM) Practice, which specializes in project implementations and upgrades for the SAP SRM suite of applications. Dan has more than 13 years of IT experience and 10 years of SAP project experience including multiple global rollouts of various SAP systems, modules and functionality. Prior to joining CIBER in 2005, Dan worked for more than 20 years at the Motorola Semiconductor Products Division, which was later spun off into Freescale Semiconductor. He held a variety of positions in manufacturing, test engineering, QA, and IT. Dan’s broad experience gives him a unique perspective on system implementation and process automation. He has presented at numerous SAP conferences on different topics and has authored articles on Product Lifecycle Management (PLM) processes and configuration management. He can be reached at 602-206-0244 or at [email protected].

1

http://www.middleware.org/ E-Business Best Practices. SupplyChainBrain.com. September 2002. 3. Aberdeen Group. “Direct Materials Sourcing – Living in a Material World.” May 2007. 4. Ogden, Jeffrey A., Peterson, Kenneth J., Carter, Joseph R., Monczka, Robert M. “Supply Management Strategies for the Future – A Delphi Study.” Journal of Supply Chain Management, Summer 2005, p. 36. 5 “Procure to Pay Best Practices.” Visa Commercial Solutions. February 2006. 6 Bharadwaj, Sudy. Aberdeen Direct Materials Sourcing Benchmark Report. March 2006. 7 Parker, Robin. Tomorrow’s World. Supply Management, March 29, 2007, p. 22. 8 “Procurement Benchmarks Show Wide Variation between Top and Bottom Performers.” Supply Chain Digest. October 4, 2006. 9 Loftus, Paul. “Procurement Practices for High Performance.” FAO Today. November 2006. 10 Aimi, Greg, Rizza, Mickey, and Swanton, Bill. “Supplier Collaboration Streamlines Direct Material Procurement.” AMI Research Alert. 1/19/2006. 2

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CIBER, Inc. (NYSE: CBR) is a pure-play international system integration consultancy with superior value-priced services for both private and government sector clients. CIBER’s global delivery services are offered on a project or strategic staffing basis, in both custom and enterprise resource planning (ERP) package environments, and across all technology platforms, operating systems and infrastructures. Founded in 1974 and headquartered in Greenwood Village, Colo., the company now serves client businesses from over 60 U.S. offices, 22 European offices and five offices in Asia. Operating in 18 countries, with over 8,000 employees and annual revenue of nearly $1 billion, CIBER and its IT specialists continuously build and upgrade clients’ systems to “competitive advantage status.” CIBER is included in the Russell 2000 Index and the S&P Small Cap 600 Index.

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