The construction industry is undergoing a major technological revolution.
Companies large and small are onboarding critical software infrastructure to digitize their operations, leading to improved profitability and the ability to successfully deliver more complex projects. Among several other things, the need for reliable, real-time information at their fingertips to make decisions on the fly has become a key driver for this digital transformation.
Getting all the vital information together in one place to give the complete picture of a project’s health to the people who need it most, has required companies to rethink some traditional processes. One core process that is shifting is that of construction project procurement. The role of procurement and supply chain in most organizations has historically been managed out of the finance department. In fact, 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 that project procurement should be owned by the project team.
This misalignment does not necessarily mean these two groups are at odds with each other. It’s more of an indication of how some operational processes are relocating away from a centralized approach in favor of them being owned by the functional team – closer to the source of where they’re needed. In other words, it doesn’t make sense to farm out project procurement when it can be much more effectively done by the project team. Especially if they have the software system to do it.
Project Procurement vs. Corporate Procurement
Most finance personnel have learned throughout their career 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 goods necessary for the operations of the business, such as laptops, fixed assets, etc.
Project-based businesses, however – such as those in construction – have a second type of procurement that is focused on the purchasing and subcontracting undertaken on behalf of the project. Project-based procurement is a completely different thing than corporate procurement. Project procurement needs to be very tightly connected with the project team as a function of project controls, project management 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, and is thus critical to effective project management. 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 important metrics and current information. 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, with the additional complexities of expediting, logistics, warehousing, partial receipts, multiple revisions, etc.
Top 10 Reasons for Project Procurement
To dive into this a bit further, following are 10 essential reasons why construction procurement should reside with the project team, and in the project team’s software system.
1. 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.
2. 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 industrial 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.
Finance systems also often 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.
3. 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.
4. 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 (payment schedules) that coincide with each purchase order or subcontract. 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.
5. Subcontract Management
Another unique requirement of project-based procurement is that there’s a much higher need for managing subcontracts. Most construction projects rely heavily on subcontractors to perform specialized work. From engineering to civil work to E&I to trades, subcontract 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. It is therefore common for project teams to manage subcontracts out of Excel and Word documents rather than in a proper system.
6. RFQ/RFP Bid Management
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.
7. Document Management
An important aspect of construction procurement on major industrial projects is the requirement for vendors to produce documents such as drawings and technical specs as part of the contractual agreement. Often referred to as “Submittals”, the buyer team itemizes the list of submittal documents directly into the purchase order. As these submittals are received, the buyer team – along with engineering – will route the documents for approval. These approved submittals can often be linked to the vendor’s milestone payments. The importance of this document exchange can’t be understated as an integral part of industrial construction project procurement; and is often a capability that is not available in even the most advanced ERP systems.
8. Receiving, Expediting and Logistics
Industrial construction projects rely heavily on engineering to design equipment and materials that are custom fabricated or manufactured. This leads to the need for expediting and logistics to ensure the fabricated items are built, shipped and arrive at the jobsite on time for installation. It’s very rare for ERP procurement systems to be equipped with the tools that enable this type of complex procurement processes. As a result, expeditors will work outside the procurement team in cases where procurement is owned by finance. This is another disconnect that can cause errors, inflated costs and mis-timed deliveries.
9. Revenue-Generating Procurement
Depending on the contract model of the project, items that get purchased can often be invoiced to the client on a direct reimbursable basis or marked up and billed transactionally. Contractors don’t want to be out of pocket for any major materials purchases, for example, and so will negotiate to have materials costs written directly into the contract as an early milestone payment. It’s somewhat similar with subcontracts. Contractors will also invoice their client prior to paying subcontractors for any progress claims so as to ensure the cash flow trickles down without too much financial exposure. Juggling the finances this way – between AR and AP – is a unique scenario in construction projects, and rarely something corporate procurement has to manage. It is therefore not built-in capability in ERP procurement systems.
10. Accounts Payable Automation
Finally, project procurement systems have vendor invoice matching and approval tools for AP automation. This makes a lot of sense because the people closest to the project are much better able to approve invoices than those in the finance department. In fact, AP personnel will normally forward vendor invoices to project managers to approve anyway; so why not just eliminate that churn.
Attesting vendor invoices also implies that the accrual (receipt) is also held in the project management software system. This also makes sense since material deliveries are often received at the jobsite. On top of that, subcontractor progress claims are the business of the project manager to approve and enter into the ‘system’. The act of receiving is when cost is recognized on the project and also accruals are raised. It’s these accruals that the vendor invoices are matched against, making for a complete picture of three-way-match. All of this makes for accounts payable automation from purchase order commitment through to invoicing. And, as long as the system can integrate with your ERP, the vendor invoices can be synchronized live for ageing and payables.
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.
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.