Along with corporate services, capital procurement is often the last part of the procurement organization to mature.
It’s an opaque category that doesn’t immediately get attention for a number of reasons. It’s usually non-repeatable spend. It’s often decentralized and managed by folks at the site level. It’s sometimes assumed by management that these folks know this technical category best and meddling in their business will cause problems.
Because it’s often the domain of engineering, procurement must sometimes wedge themselves a seat at the capex table.
Types of Capex
Most companies split capex into two broad categories: growth and sustaining.
Growth capital is the purchase of equipment that will enable the company to produce new or incremental end-product for sale to a customer. This also includes the downstream equipment – printers, labelers, vision inspection – that supports the primary equipment.
Sustaining or infrastructure capital is improvements to existing facilities. This could take the form of a new roof or a replacement chiller for a manufacturing facility. It could also be a major expansion such as adding a new wing to an existing building.
In most years, the growth capital will make up the majority of the capex budget. It’s typically the more strategic of the two categories.
The suppliers selected for growth capex will become long-term, strategic partners for your business. To achieve best-in-class, your department must establish a cross-functional team to properly source and vet these supplier partners.
Bridging the Procurement – Engineering Divide
It’s not controversial to say that procurement and engineering have had a somewhat antagonistic relationship over the years.
Because they are the technical experts on the equipment, many engineers are dubious that procurement really understands how the equipment works. Why should procurement have input on who we partner with for capital purchases?
On the flip side, engineers may be great at designing and evaluating equipment, but they are often not the best folks to source and negotiate large contacts. Attempts to combine the two disciplines have had limited success. It’s just not that common to find folks with equal parts technical skills and business acumen. When these talents do meet – and you add some excellent soft skills – these folks are often called CEOs.
For procurement folks first penetrating the capex world, it can be intimidating learning the technical aspects; particularly the jargon.
Focus on procurement fundamentals, particularly total cost of ownership. Reassure your engineering teammates that you’re not here to pick the cheapest supplier; cost is but one element of TCO.
Take charge of the selection process. Collaborate together on the RFP development for the candidates. Break down the RFP responses into the selection factors – cost, quality, delivery, others – and ask the team to score the candidates on each variable.
Become a good interviewer and listener. Defer to the engineer’s thoughts on the technical requirements of the equipment or project. This is where they most want to be heard and respected.
In other words, assume the role of facilitator.
Negotiating with Finalists / Risk Mitigation
After you gain agreement on the finalist(s), it’s time for procurement to show their true value. It’s useful to create a negotiation matrix before engaging the supplier. This matrix should include all the negotiating variables you will be addressing: price, progress payments, amortization, lead-time, warranty, etc.
At the top of this list should be the acceptance criteria. That is, what must be achieved – with specific metrics – before the project or equipment will be accepted by the buyer. For example: “machine must run for x cycles with no more x defects”. The acceptance criteria should be developed by your engineering teammates and agreed to by the supplier before the award.
Everyone has heard a home-owner horror story about an incompetent or dishonest contractor. Capital purchases have the similar potential to go awry. Mitigating risk is a major concern. Often times for growth capital, the supplier is manufacturing a one-of-a-kind machine for you. What if it doesn’t work as promised?
In addition to the RFP vetting, Procurement has two remaining mitigation tools post award: 1) the acceptance criteria mentioned earlier and 2) progress payments linked to the acceptance criteria.
A common cadence for a large capex buy would be x% down with order, x% upon meeting acceptance criteria at a predetermined benchmark such at factory acceptance testing, and the remaining x% after the equipment is in place at the production space and meeting final acceptance criteria.
Procurement can add tremendous value to the capex process both in terms of lowest TCO and risk mitigation.
Late adopting companies would do well to focus on building a cross-functional capability that not only standardizes how capex partners are selected, but renders this process into a competitive advantage.