Governance in procurement

AN organisation’s procurement practices impact on all aspects of its capital and operational spend, yet all too often its contribution and influence on reputation, goodwill and financial performance is underestimated by the board and senior management. By cdv solutions director Garth Hamilton.
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Published in the September-October 2012 PNG Report magazine

Around 12% of complaints received by the New South Wales Independent Commission Against Corruption include allegations of corruption in NSW procurement.

Yet corruption is only one risk associated with poor procurement practices and processes. Other risks include the provision of incorrectly specified goods and equipment impacting on operational performance, delays, reputational and financial loss, stakeholder loss of confidence, reluctance or refusal on the behalf of vendors to deal with the organisation, the inability to negotiate effectively and increased costs.

Corporate governance consultant Jason Masters adds to this list inadequate and or obsolete solutions, the inability to leverage expected benefits, and failure of initiatives to bring the innovation and benefits they promised.

Corrupt behaviours do not necessarily arise due to criminal intent or unethical conduct; they may occur out of simple naivete of one party, as the following example illustrates.

An inexperienced person met with a vendor's representative for coffee by the Brisbane River during tender evaluation. The organisation's representative was a keen sailor and was admiring a boat on the river. The vendor's representative asked "what do we need to do to win the business?"

The response was a flippant "that boat over there tied up here". After a few seconds the vendor's representative responded "okay, we can do that".

The meeting was immediately stopped and the incident reported to management.

This situation came about for two simple reasons: the buyer was incredibly inexperienced and a technical person, not a procurement professional, and he was alone with the vendor. Organisational guidelines didn't cover when it was appropriate to meet with vendors and how that should occur, nor was he provided any procurement training.

Another example is when the author met with former vendors socially well after he was no longer responsible for procurement to be told: "The reason we like you and worked with you is that you're not a wealthy man: So many of your peers are on the take."

The existence of corruption and the potential for corruption is often ignored or simply disbelieved by senior management, with dire consequences.

Poor processes also present an issue for organisations. On a $US1.4 billion mine extension project it was common practice for the engineers to discuss vendor pricing in the staff lunch room in front of everyone.

What made this more appalling was that it was common practice often within an hour of tender opening, without having read the tenderer's responses, and not having assessed compliance with specification.

Yet the engineers were identifying preferred tenderers. Unfortunately this was not an isolated incident and on one occasion it was for a $40 million-plus work package.

Needless to say this was an example of sub-optimal decision making that resulted in relatively poor performance of the works. In this example the organisation's processes and the advice of procurement personnel were simply ignored.

The 2004-2006 off-the-road tyre shortages resulted in what was often euphemistically referred to as the "alternate tyre market". This was a volatile market of new, secondhand and retreaded tyres at grossly exaggerated prices as a result of demand.

Acquisitions were characterised by short time frames for decision making and payment: often a parcel of tyres would cost $1-2 million.

One FTSE 100 multinational had several teams procuring tyres. Both teams committed in excess of $60 million however one team lost only $250,000 whereas the other team lost $35 million!

Upon investigation by external forensic auditors it was found that the team with the multi-million dollar losses ignored basic procurement practices, whereas the other team insisted on prudent governance and procurement processes.

This team took the time to educate stakeholders and financial delegates on the need for quick informed decision making while complying with organisational processes. They also ensured that no team member was able to exercise financial expenditure, thus minimising the potential for fraud.

Fortunately, it is possible to introduce practices and processes that contribute to positive outcomes for the organisation that will reduce both corruption and costly process waste and inefficiencies. The term "corporate governance" is often bandied about and often out of context.

Robert Tricker describes corporate governance as "concerned with the way corporate entities are governed as distinct from the way businesses within those companies are managed" yet according to Masters the integral components of governance relate to the leadership, organisational structure and processes of an enterprise.

To optimise the outcomes of procurement activities and to reduce the risks, an organisation should examine and strengthen leadership, structure and processes within the procurement function.

The ASX says there is no single model of good corporate governance and practices should reflect and be tailored to the specific circumstances of the company.

That said, some general principles may be applied:

  • Management and oversight. This addresses the organisation structure, training and personnel involved in the procurement cycle. Critical to this is clarity in the roles of employees and management ensuring separation of duties - no one individual is able to evaluate, decide and commit to a vendor without review and approval. Consideration should also be given to internal audit of procurement events.
  • Promote ethical and responsible decision making. Reputation is an intangible asset and should be protected. Education and training on the organisation's objectives as well as its values and what constitutes fair, equitable and ethical procurement practices will ensure that the enterprise's strategic and operational objectives are achieved.
  • Transparency and probity in the processes. Decisions are able to withstand independent scrutiny. The outcomes generate the best value for money, are impartial, avoid conflicts of interest and maintain the confidence of all parties in the quality of the business transactions and relationship.
  • Understand the risks and manage accordingly. Risk exists: there is no point taking the ostrich approach to risk management.

For convenience the procurement cycle can be broken into four bold steps and a number of steps taken to introduce effective governance.

Preparation

This stage includes the identification of clear outcomes, consultation with stakeholders to identify the user requirements and converting these to a specification. It generally also involves vendor identification.

This is a critical stage and its importance is often undervalued. It is at this stage many risks and waste are introduced into the tender process. These stem from poor specifications, incomplete tender documents, restricted vendor lists, biased selection of vendors, inappropriate communications to the market and creation of false expectations to name but a few.

A clear, well-established process, a sound consistent suite of tender documents, adequate consultation with end users, and sign off at key steps will alleviate risk in this stage.

Approach to Market

The conduct of the tender is equally as important as any other stage. This is where reputation and credibility is established: does the procurement team display professionalism? This stage involves the preparation of the tenderer's response and is characterised by queries from the vendors.

All too often the "old boy network" is accessed by vendors in order to gain information and possibly an advantage.

The need for transparency and probity is essential. Information should be distributed to all parties involved to ensure that each vendor can prepare their best solution as well as maintaining confidence in the process.

Some solutions include written correspondence only, provision of complete data packs with the tender documents and clear protocols on communication between the vendors and the company.

Evaluation and Negotiations

While the importance of these activities are well recognised, the examples at the beginning of this article demonstrate that poor practices are rife and can be costly. The evaluation process should be structured and evaluations documented.

The assessment criteria should be determined prior to the release of tender documents to make sure that the tender questions reflect what is important to the company, and that this information is evaluated.

If you are not prepared to evaluate a question then don't waste the vendor's time and your own by asking it. Likewise planning negotiations, training team members in effective negotiation skills and maintaining well documented notes not only minimises fraud risk, it will improve the result for the enterprise.

Pivotal is the preparation of a "recommendation to award" type of document detailing the reasons for the decision is useful. It allows the rationale for the decision to be communicated and provides quality information to enable decision makers external to the negotiation team to review and award a contract.

Performance

Contract administration is a well recognised skill in project management; unfortunately outside of this arena many companies do not invest adequate resources into this aspect.

Once the contract is awarded, there is still considerable risk to the organisation in terms of underperformance, cost and corruption. Generally all the organisation's effort goes into getting to contract and very little training, process development or oversight goes into contract performance.

Procurement is an incredibly important contributor to a corporation's strategic goals. It is the sourcing event that acquires the necessary services, goods, equipment, plant, consumables, or construction activites that are deemed necessary to achieve the company's goals.

While the concept of corporate governance is considered to apply at the enterprise level, governance principles can be applied to the procurement function to improve results for the organisation.

The benefits are many and varied; however, they can be simply stated as the avoidance of fraud, and buying what you need. If functioning well with sound leadership, strong processes and an appropriate organisational structure procurement can create value, foster innovation and achievement of organisational goals.

Further information: Garth Hamilton garth@cdvsolutions.com.au, +61 405 115 680 +675 7397 0410

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