Risk is probability or threat of exposure to danger, which can be avoided in business that leads to financial loss from direct or indirect impact of the manifestation.
Purchasing and supply with Nyasha Chizu
There are many uncertainties in business that prompt investors to employ different types of commercial and technical skills to minimise business risks.
The procurement function exposes organisations to some level of risks.
The risks are spread across procurement management activities of planning, approaching the market, evaluation of offers and contract award, contract negotiation and contract management.
We shall concentrate on risk in planning associated to needs identification. Definition of needs risk is two-pronged.
It can relate to understatement or overstatement of specifications and understatement or overstatement of quantities.
There is a danger that quality is understated, rendering the procurement unsuitable for the intended purpose.
The risk is that cash is lost through procurement of items that cannot be consumed by the organisation due to inferior quality.
The second element of risk emanates from a time perspective, where inevitable downtime is encountered, while a remedial procurement is undertaken. Customer needs are delayed or totally not satisfied.
The downtime exposes the organisation to further financial losses emanating from liquidated damages, when delivery deadlines are not met and the goodwill is lost.
Higher quality attracts higher costs. Overstatement of quality results in the organisation acquiring requirements at a cost higher than what other competitors are incurring for the same product or service.
Overspecifying affects the market in that it reduces competition. By incurring higher costs, the business inevitably becomes uncompetitive.
In the public sector, where the business is not in competition, the effects are that resources are wasted procuring superior quality at the expense of higher service delivery at an optimal quality.
The cost of the service will effectively increase, thereby, reducing the disposable income of the general citizenry.
The public then loses confidence in the government due to poor procurement management.
Procurement managers are, therefore, required to analyse needs accurately and explore use of alternative materials to reduce quality associated risks.
In order to open up for competition, use of functional and performance specifications is the best means to acquire appropriate technology at the right costs.
Use of brand names or specifications that indirectly point to a specific brand without mentioning the name erodes value for money in procurement.
Quantification of needs requires special skills. Some organisations invest heavily in software for quantification of requirements.
Overstatement of quantities may result in the organisation tying up capital in stock without immediate use.
Efficiency of a stores function is measured by the rate of stock turnover.
Higher stock turnover is desired and implies that capital is effectively used when a reasonable average monthly stock generates high levels of sales that result in profitability.
There are other costs associated with holding stock, such as insurance, risk of loss, deterioration, redundancy and obsolescence that need to be managed.
On the other hand, underspecifying quantities results in the organisation failing to meet its targets. Failing to meet production or sales targets has a direct bearing on sales.
The organisation can only sell what is available. Loss of a potential sale is a direct loss of revenue, which impacts on profitability.
Secondly, confidence in the market is lost when customers’ requirements constantly go unsatisfied.
In view of the implications, organisations must invest heavily in training to ensure that procurement planning skills are acquired or enhanced.
Another risk in the category of needs identification is misinterpretation of user needs. This results in a totally unacceptable purchase or purchase of a product that is not most suitable for the requirements.
The implications are the same in that time is lost and there is a possibility of increased costs.
In view of the implications of the risks associated with needs identification, organisations need to put more emphasis in procurement planning.
Nyasha Chizu is a fellow of the Chartered Institute of Procurement and Supply writing in his personal capacity. Feedback: firstname.lastname@example.org Skype: Nyasha.chizu