Procurement — also called "buying" or "purchasing" — involves the acquisition of goods and services for an organization's direct benefit or use. In most instances, much of the organization's monetary focus centers on procurement activities, typically comprising one of the top two sources of expenditure. Most auditors therefore encounter procurement-related issues frequently during their careers and should develop an understanding of its core principles to gain a solid grasp of this important area.
The administrative details of procurement processes may be highly complex in practice. In fact, some organizations' procurement manuals resemble telephone directories in size. The fundamentals of procurement, however, can be distilled to a core economic challenge, in which competition plays a major role. An appreciation of the importance of competition can illuminate several procedural and internal control considerations in procurement activities.
The Core Economic Challenge
Procurement is an economic activity that seeks to allocate scarce funds among alternative uses. Organizational funds are "scarce" in the sense that every dollar spent on a good or service is a dollar that could have been spent on something else, or not spent at all and invested in a bank account. Reckless input of funds to a procurement process without due consideration of outcomes would serve no positive end — the scarcity of funds therefore forces organizations to make sacrifices, economize, and seek best value for money in their procurement actions. All other things being equal, maximizing competition among potential vendors of goods and services should lead to downward pressures on costs and thereby yield the best value.
Restrictions on Competition
Internal auditors should be aware of circumstances in which competition related to procurement actions can be reduced severely, or even eliminated. In the most obvious cases, a competitive market for specific goods or services may not exist, leaving no appropriate substitutes. When the price of a good or service is influenced — or fixed outright — by a monopoly or cartel, an organization must undertake procurement without meaningful scope for bringing competitive forces into play.
Organizations are not only at the mercy of external conditions, however. Valid reasons may exist for management to diminish the role of competition voluntarily in some of their procurement actions. For example, organizations commonly standardize some aspects of their operations, such as computer hardware, for a defined period — the procurement of compatible equipment and services can achieve significant efficiencies that outweigh a reduction in competitive procurement bidding for all available brands. In addition, most organizations are required by law or public opinion to balance purely economic factors with sustainability considerations. Even without adopting full-fledged "green procurement" or "ethical procurement" activities, organizations can still face noneconomic factors that limit competition.
A Word on Fraud
Fraud may be interpreted as a subversion of the smooth economic functioning of procurement processes, especially their competitive elements. Examples of competition-diminishing fraud include bidding rings among potential vendors to fix prices and collusion between potential vendors and employees of a procuring organization to favor specific vendors. To reduce the risks of anti-competitive fraud in procurement, an organization should treat all potential vendors on an arms-length and equal basis, and receive and handle all vendor communications in a rigorous, confidential, and transparent manner. The internal auditor should look for any warning signs of fraud in correspondence between the organization and potential vendors. Auditors could also assess the appropriateness of accounts payable and disbursement procedures, the responsibilities for which should be segregated adequately from the procurement function.
Intensity of Competition
Although competition is often diminished in procurement actions, for both good and bad reasons, competitive procurement remains a best practice in the acquisition of goods and services. Organizations commonly establish cost thresholds that trigger intensity levels for individual transactions along three levels of competition — low, medium, and high.
Low levels of competition tend to be reserved for small items of expenditure, for which the costs of administering competition outweigh any benefits. When organizations undertake "spot buying" using petty cash, for example, the competitive element may consist of merely casting an eye over prices displayed on a store's shelves.
With medium competitive intensity, a procuring organization normally seeks quotes from potential vendors. This category of procurement tends to be associated with small to medium acquisitions of goods and services. In a process sometimes referred to simply as "shopping," an organization selects and obtains quotes from two or more potential vendors.
The third and most intense category of procurement competition applies to major procurement actions, for which sealed-bid tenders are common. An organization may solicit bids for a procurement action from either pre-selected potential vendors or on the basis of an open tender advertised in the media. When potential vendors submit sealed bids, the procuring organization typically holds them in a secure location until their formal opening and recording. In some instances, organizations undertake auctions for large procurement actions. However, auctions are relatively rare in organizational procurement, in part due to complicated logistical requirements. In practice, auctions tend to be used for homogeneous items such as commodities and time-critical items like perishable foods.
The selection of potential vendors represents a crucial and sensitive part of the procurement process. Internal auditors should be aware of the risks arising from the exclusion of specific vendors, through carelessness or intent, which can materially impact the outcome of procurement activities. Most organizations maintain a database — also called a "roster" or "portfolio" — of existing and potential vendors. Before including vendors in the database, a procurement function should screen vendors for their technical capabilities and financial stability, and any amendments to the database should be subjected to strict control and authorization procedures.
Regular infusion of new potential vendors into the procurement process is essential to encourage fresh competition. An organization may source new potential vendors through active solicitation, either for specific procurement actions or for general registration purposes. Some organizations, such as the United Nations, maintain procurement Web sites through which vendors can register their interest in future procurement activity. Internal auditors should seek evidence that the organization selects potential vendors on a transparent and equitable basis, to maximize the scope for competition.
Specifications and Cost
For sealed-bid tenders, technical and economic evaluations underpin competitive integrity, representing crucial steps in the procurement process. Technical evaluations involve an assessment of whether the specifications of a good or service offered by a potential vendor meet the organization's requirements. Only submissions from potential vendors that pass the hurdle of technical acceptability should proceed to an economic evaluation. Vendor selection therefore is normally made on the basis of the economic evaluation of the best value for money offered by technically acceptable offers. The economic evaluation focuses on the costs proposed by potential vendors, alongside any other relevant costs and any compelling nonfinancial considerations.
In practice, procurement functions often find that there are degrees of technical acceptability. Moreover, organizations commonly use systems of weighted scores that intermingle technical and economic aspects. For example, an organization that wishes to stress quality over cost for a procurement action may apply a weighting of 70 percent to the technical evaluation and 30 percent to the economic evaluation. Auditors should be aware of the way in which scoring methods can influence the outcome of a procurement action, and how this area may be open to manipulation.
For complex procurement actions, especially in the field of emerging technologies, potential vendors may be asked to contribute to the development of technical specifications. Technical negotiations between the organization and potential vendors complicate procurement transparency, and the auditor should assess that safeguards are in place to encourage fair and competitive negotiations.
Transparency and Fairness
Although procurement processes comprise a range of fundamental procedures and internal controls beyond the scope covered here, the fundamental idea that good competition tends to encourage good procurement remains key to this important activity. Internal auditors must be sensitive to procedures and controls designed to encourage transparency and fairness and thereby safeguard the competitive elements of procurement.