Importance of Effective Procurement Practices for Successful Hotel Operations

Written by Wang Min, MSIPMM

by Wang Min, MSIPMM

Importance of Effective Procurement Practices for Successful Hotel Operations

Written by Wang Min, MSIPMM

by Wang Min, MSIPMM

by Wang Min, MSIPMM

The role of procurement in a hotel operation is not immediately apparent. However, procurement costs are a core part of the profitability performance of a hotel business. The sustained availability of products and services used in the generation of revenue streams as well as for internal consumption keeps the business running like a well-oiled machine. Moreover, such availability at the best quality for the least cost is what businesses strive for. Procurement costs are different for an operating and opening hotel. However, before we look at that, it is important to understand what constitutes procurement and what costs are involved in that.

Terminology of Procurement versus Purchasing

To begin with, we need to understand clearly the difference between procurement and purchasing. Purchasing refers to the process of ordering and receiving goods and services. It is a part of the procurement process. Purchasing refers to the process involved in ordering goods such as request, approval, and the creation of a purchase order record and ultimately the receipt of goods. On the other hand, “procurement” is the function that describes the activities and processes to acquire goods and services. The key difference can perhaps be explained from the PP Organogram, as shown in the diagram below. Procurement requires active engagement with internal customers, as well as with suppliers.

PP Organogram of Procurement vs Purchasing

Thus the procurement function consists of a complete mechanism that includes processes closely involved with the vendor community, goods and services markets and the world of contracts.

However, when we dwell on the procurement function for a group of hotels, it takes on a completely different meaning as compared to say the function for a standalone hotel. Furthermore, the procurement function for an operating hotel is completely different from an opening hotel.

typical procurement cycle

The diagram above shows a typical procurement cycle.

Procurement Costs

Procurement costs can broadly be of two kinds – those that are adding to the cost of the product or service being acquired and the costs of running the procurement function. The procurement function normally reports to the financial controller and is a part of the finance department.

Procurement costs that are added to the cost of products and services are all those costs that are incurred to bring the items to the place of use. The other kind of procurement cost is the cost of running the procurement function itself. These are salaries, wages and benefits of employees working in the department, their bonuses, increments, the cost of supplies used, for example, the stationery like purchase orders (if these are still in the paper), the cost of the purchasing system which is used to administer the function and so on.

Standalone and Group Hotels

As is quite obvious, the demands of a procurement function for a group or chain of hotels are vastly greater than that of a standalone hotel. As more hotels are added to a group or chain, however, while the complexity increases, the opportunities do too.

In the present age when the customer is so particular about the quality of goods and services they receive, consistency in delivery is the greatest hurdle. And here, being part of a group or chain of hotels provides opportunities to get that consistency of delivery right. This is through a process of partnership with the vendors to provide exactly what the customer is looking for. Synergies and economies of scale help too.

The focus of the procurement function in a group of hotels is towards forging effective alliances with vendors not only to bring the requisite quality to goods and services but also do that at a mutually beneficial cost level. This is done through the creation of group vendor contracts. The philosophy of a group contract is that the individual requirements of group hotels based on consumption patterns are pooled together, collated and a group consumption quantity determined. Using this higher quantity as a factor, the group negotiates a lower price and other beneficial terms. It is a win-win situation. The vendor is assured of a big chunk of orders (which serve to bring down their unit costs), and the group can keep costs of consumption low. This allows cost savings are leading to enhanced profitability.

supply chain flow for hotel operations

The diagram above shows the supply chain flow for hotel operations.

Procurement Costs and Cash Flows

A fact that for the most part goes unnoticed is that procurement costs result in cash outflows for the hotel. In fact, if the function of acquisition is not managed effectively, the hotel ends up being susceptible to cash outflows, which could be avoided. How are cash outflows created in the procurement function?

Well, the most common form of cash outflow that results directly from a procurement process is that of deposits and advance payments. As soon as the specifications of a product or service are determined and the price, quantity, and quality decided upon, a purchase order is prepared which confirms the contract between the hotel and the vendor. In most instances, this purchase order (in particular with a new vendor) will specify an upfront payment in the form of deposit and an advance which can go right up to 50% of the value of the purchase order. The vendor will not do anything further until this deposit or advance is paid.

Thus, it is part of the function of procurement to negotiate deposits and advance payments with the vendor. It should be the endeavour of the purchasing department to eliminate advance payments or deposits, but this is difficult until a relationship is created with the supplier. For regular vendors, this is not an issue; however, new suppliers, for the most part, will insist on this. For them, it is a form of security against the risk of dealing with a new hotel or group.

Procurement Function and Direct Operating Costs

The main mantra or philosophy of a procurement function is the lowest price, highest quality for the longest term. By entering into a long-term relationship with a vendor and locking down prices over an extended period for key items of consumption, the procurement function plays a stellar role in keeping down direct operating costs for a hotel or group of hotels.

The methodology adopted is normally as follows. The procurement department will get hold of a customized report from the inventory management system (including the procurement function). This report sorted in descending order of importance will show the cost of consumption of major items in that particular operation. Using this report and picking the top 20% items which account for 80% of the cost of consumption (utilizing the 80:20 rule in inventory analysis), the procurement department will target these items for entering into a group-wide contract at lower prices. For example, in the food and beverage operation, the top 20% of items of food which account for 80% of the cost of consumption of food will be targeted for a long-term contractual arrangement with the relevant vendors. Over time this will assist in bringing down the food costs in the food and beverage operation.


References:

Poh, Philip (1988), “Defining and Clarifying the use of Terminologies”, International Federation of Purchasing and Materials Management conference, Brisbane.

https://image.slidesharecdn.com/procurementofenterpriseresourceplanningsystemsv6-final-140510225217-phpapp01/95/procurement-of-enterprise-resource-planning-systems-v6-final-8-638.jpg?cb=1399762428

https://source1purchasing.com/wp-content/uploads/2013/10/1001_S1P_Supply-Chain-Blog-Image.jpg

http://hotelexecutive.com/business-review/3628/role-of-procurement-in-a-hotel-operation

About the Author: Wang Min has substantive years of experience in the hotel industry, specifically in cost management and control. In recent years, she has embarked on effective procurement practices for successful hotel operations.

Wang Min is a qualified member of Singapore Institute of Purchasing and Materials Management (MSIPMM), and is completing a course at SIPMM Academy on Diploma in Procurement and Supply Management (DPSM).

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