Procurement KPIs – An Essential Part of the Procurement Management Toolkit
The procurement process is no longer the simple source-buy-pay cycle, it has grown into a full-fledged business function that plays an important part in the business’s growth strategy. The procurement manager has his task cut out – he needs to monitor, measure and manage the performance of his team. Procurement metrics are the most effective way to measure the performance of the procurement team. Procurement KPIs are essential to evaluate and measure the performance of the procurement process.
The Procurement Process at a Glance
The procurement process encompasses all the steps identified 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, 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 profit margins of the company 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 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 a must 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 (KPI) 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. Key performance indicators and key result areas are often mistaken to mean the same thing. Key result areas (KRAs) refer to general areas of outcomes or outputs for which a process or role is responsible. An individual or a group is responsible for outcomes of key result areas. The key result areas of the purchasing department help employees align their roles with the overall organizational goal. Modern businesses want the procurement function to deliver value beyond cost savings. Procurement managers are looking at ways to make the procurement function more sustainable and streamlined.
“If you cannot measure it, you cannot improve it” – Lord Kelvin.
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 set actionable performance improvement goals. Purchasing KPI may be created in conjunction with supplier metrics in order to measure the performance elements of the procurement process. Procurement KPIs are essential elements in the performance management toolkit of procurement managers. 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.
Having procurement management software can provide various KPI data on a dashboard. Key performance indicators for purchasing and supply, supplier performance indicators, and sourcing KPIs can be displayed on a dashboard.
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 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 into a contract with the former type of suppliers as they 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 defect rate of suppliers and quantity discounts they provide must also be considered.
2) Compliance 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 compliance 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 supplier 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, in order 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 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 the online purchase, mobile-commerce, and in-store purchase, merge seamlessly. In order 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 90% 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 Defect 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 closely 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 4 days or less may be categorized as short, cycle time ranging from 5 to 8 days may be categorized as a medium, and cycle time above 8 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 aids 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 KPIs are monitored.
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 the production model into the supply system.
- Purchase of the production model is the end result of the initiation of the purchase of the goods/services.
- 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 different time frames.
- 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 number of emergency purchases
It is normal for a business to have ad hoc requests but having a large number of unplanned purchases reflects poorly on the procurement strategy. Emergency purchasing ratio is a KPI that throws light on unplanned orders. Emergency purchases are usually done when the business forecasts a shortage of products or services.
Emergency purchases are usually done at higher purchase rates, so the lower the emergency purchase rate, the better is the business efficiency.
Having a low emergency purchase ratio helps businesses:
- Save costs
- Streamline procurement plans
- Ensure continuity (availability) of goods
- Minimize supply risks
This metric is a reflection of the efficacy of procurement strategy and 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 of time.
10) Purchases in Budget and Time – Helps monitor the purchasing time and cost(budget)
The procurement manager needs to be always 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 large 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.