If you were to ask any CFO or Controller which department should be responsible for all Procurement for the company, they would naturally respond with the Finance Department. On the other hand, if you were to ask any project controls professional about procurement, they would naturally respond with the Project Team, they should own procurement.
So, who’s right?
It turns out they’re both right.
If you’re a CFO reading this, you’re likely thinking “There’s No Way! Procurement belongs with Finance, end of story.” Before you dismiss this, please hear me out. Everything you’ve learned in your career has shown that procurement is a key finance function that is tightly tied to accounts payable. This is because most organizations only have one type of procurement. Which is that they purchase stuff necessary for the operations of the business. Stuff like laptops, fixed assets, machinery, software, trucks, large equipment, etc. Project-based businesses, however, such as those in construction, energy and mining, have a second type of procurement. This type of procurement is focused on the purchasing and subcontracting undertaken on behalf of the successful execution of the project.
Project-Procurement vs. Organizational Procurement
Project-based procurement is a completely different thing than organizational procurement. Project procurement needs to be very tightly connected with the project team as a function of project controls and engineering. It’s often the case that the purchasing and subcontracting on construction projects can take up a significant portion of the total project budget. When procurement is handled outside the project (i.e. in finance), a disconnect and silo-effect sets in and the project team is left in the dark on critical metrics and current information. For example:
- Detailed Project Coding
- Fully Committed Budget
- Real-time project costs and accruals
- Vendor Productivity and Performance
- Cash Flow Planning
- Contract Management and Bid Management
Additionally, project procurement is more complex, and requires an intense amount of purchasing and contracting activity in a short amount of time. Finance departments aren’t typically experienced with this type of high-velocity action, with the complexities of expediting, logistics, warehousing, partial receipts, multiple revisions, etc.
Projects Require Detailed Coding
Finance systems lack the detailed coding and budget management required for a complex construction project. Projects are designed to breakdown the activities and cost codes to a much more granular level than what the finance department require. When procurement is owned by finance, they only have very high-level codes available to procure against, so when incurred or invoiced cost information gets passed to the project team from finance, it’s lacking in the detail they require to truly control the project budget.
Projects Require Visibility into Commitments
When procurement is handled by the finance department, the project team has no visibility into vendor costs or accruals until after a receipt or invoice is received by accounts payable. There’s typically no provision for visibility into committed cost – i.e. the total value of committed purchase orders, whether they’ve been received or invoiced or not.
Fully Committed Budget is a critical metric for project controls. They need real-time visibility into exactly how much of the project budget is currently accounted for, and how much is available. To understand what I’m referring to, the fully committed budget (FCB) is calculated as:
FCB = Budget – (Actual Cost to date + (Committed Cost – Accrued Cost))
When project controls has no visibility into FCB, it’s near impossible for them to report on current status or forecast remaining project spend. It’s too much of a blind-spot to truly manage the project’s finances.
Project Controls Requires Real-Time Project Costs
Having visibility into current costs is vital for the project team. They need to know in real-time when things are slipping or going over budget, otherwise their ability to take early corrective action will have vanished. There are far too many moving parts at play every single day, so keeping a complex project on track requires daily analysis and decision making.
When procurement is managed out of the finance group, there tends to be a delay in getting cost information to the project team. This happens for a couple of reasons:
- The finance department is only recording invoiced costs instead of accruals. This means that the project won’t be updated with vendor charges until well after the invoice is received. This can be weeks or months after the costs have been incurred (i.e. the work has taken place, or materials received).
- The project team is at the mercy of the finance department’s processes. Maybe, for example, they only send bi-weekly cost summaries to the project team. This is far too late for them to react to anomalies.
Project Teams Need Key Metrics on Vendor Productivity
When vendors occupy a significant footprint on the execution of a project, it’s clearly very important for project managers to stay on top of how well each subcontractor is performing against the plan. An unproductive subcontractor can have a devastating effect on a project’s health. Project management needs to be able to react quickly on any vendors that aren’t performing to lessen the overall impact on the project.
Cash Flow Planning
A principal function of project controls is to time-phase the budget so that they can forecast how and when cash will be spent (and revenue recognized). An essential input to this, is the cash flow plans that coincide with each purchase order. For example, advance payments, milestone payments, retainage, etc. Having visibility into how all the cash is going to go out the door is fundamental to project forecasting, but they have no access to this when procurement is handled in a faraway place that only provides periodic actual cost information.
Contract Management and Bid Management
Another unique requirement of project-based procurement is that there’s a much higher need for contract management. Most construction projects rely heavily on subcontractors to perform specialized work. From engineering to civil work to E&I to trades, contract management is a key part of project procurement. Finance departments are typically equipped only to purchase things like materials and equipment, and are not experienced in the world of managing subcontracts.
Equally common in project procurement is the need to tender bids to multiple vendors. Whether it’s an RFQ or RFP process, soliciting competitive bids from multiple suppliers or subcontractors is a common activity on construction projects. Finance departments don’t normally have the experience or the tools to manage a competitive bid tendering process. As a result, the project team manages that on their own using spreadsheets and word docs – outside the procurement department.
It Doesn’t Mean Letting Go
If you’re a CFO or Controller and your project controls team is recommending that the project-procurement function be managed as part of the project, using the project controls tools (instead of the ERP), you really need to hear them out. It doesn’t mean you’re letting go of a critical finance function – it only means that you’re recognizing that it’s for the best of the overall business if project procurement is closer to the project. It can even be that the buyer team still works in the finance department – they would simply buy for the project using the project team’s system to manage it.
Additionally, if the project procurement function resides with the project team, that doesn’t change who does accounts payable (AP). AP is still a finance function since they own the treasury and the actual finances of the company. Subcontractor and supplier invoices will always be routed through AP for processing and payment. We would never suggest that that would change.