Purchasing Methodologies (Centralized vs. Project Level)

This month we will explore a critical facet of every contractor’s business: Purchasing.

There are two predominant schools of thought on purchasing: centralized and conducted by an in-house purchasing agent, or performed by the project manager and/or superintendent at the project level. They both have their place in the world of electrical contracting, and we’re going to explore them in this article.

Project Level Purchasing

Project level purchasing is typically used by small to medium-sized contractors, and is a natural stepping stone in the evolution of a specialty contractor. Let’s begin by examining the development of a company’s purchasing methods, and we'll use an electrical contractor for our example.

A typical electrical contractor starts out as a one or two-man show. Someone decides to go into business for themselves, gets a license and goes to work. They set up an account at a local distributor and buy materials as needed for each project: they go to the supply house every few days, order the material they want at the counter and when asked for a purchase order number they give their name or the name of the project. This is really all you need to do when you’re starting out; you probably have 2-3 projects going at a time, they aren’t very large and don’t take very long to complete. You can easily track costs per project, manage your cash flow, and aren’t buying anything in sufficient quantities to qualify for bulk discounts. Your purchasing life is simple and easy, right?

But as the company grows, the projects get larger, the owner becomes more of a project manager, and now they’re buying materials for several projects, often placing multiple orders every week. Eventually they can’t keep up with all the requests coming from the different projects, superintendents and foremen: orders get misplaced or forgotten, the materials get delivered to the wrong job site, or they get billed to the wrong project. They need a better way to manage their purchasing, so they evolve into Project level purchasing: the PM or Superintendent buys the material for their project as needed. This fixes the problem! Now there is one person assigned to buy the materials for each project, and life goes back to being manageable.

At this point, Project level purchasing is in place and working perfectly. Project managers have autonomy and direct control over material and equipment costs, free to negotiate their own deals and discounts. Perhaps corporate has limited the number of ‘authorized’ vendors to help expedite accounting, but PMs have free range to operate within this framework.

As the company continues to grow, they develop standardized PO forms and language, numbering systems, phase codes, etc. More project managers are hired and trained to work inside the company’s purchasing policies. Each PM comes with his own relationships and preferences for vendors and manufacturers. They buy materials as needed for their projects, negotiate their own deals and discounts with distributors, and have more control over their individual project costs because they are personally issuing every purchase order. They are typically working closely with the superintendents to ensure that every line item is necessary for an attempt to control costs and maximize profit at the project level.

However, at some point, the company may grow to a sufficient size that project-level purchasing is no longer the most efficient method, and there may be something to be gained by centralizing the operation. They may start to realize there are discounts they are missing out on, or begin to examine opportunities to capitalize on economies of scale. They may begin to explore a shift to centralized purchasing.

Centralized Purchasing

Centralized purchasing is often employed by larger electrical contractors for several reasons. First, it facilitates large bulk purchases of copper and aluminum. If a company can predict the amount of copper or aluminum it will use in a year, it can lock in pricing per pound with a manufacturer or distributor and fix its costs for these materials for a set amount of time, typically 12 months. Purchasing agents can also negotiate long-term fixed costs for commodities materials such as conduits, fittings, straps, struts, and wiring devices. All of this helps to improve estimating accuracy and avoid material cost escalation between bid time and project award, which often lags several months on larger projects. General contractors love when they get a no-escalation guarantee with a bid proposal and this typically carries weight when they are evaluating bids.

Centralized purchasing also helps contractors get better multipliers (discounts) on large purchases such as switchgear, generators and lighting packages from distributors. If an EC can group similar purchases from multiple projects together and commit to buying them all from the same distributor, they can typically save 3-5% off the combined price. For example, if an EC has three projects with switchgear packages worth $75,000 each, and they can get a 4% discount by purchasing them all from the same vendor/manufacturer, that would result in a total of $9000 savings, or $3000 per project. On a larger commercial building the switchgear package typically costs between $500k-$1MM. If an EC has two buildings starting within a few months of each other, they could group these purchases with one vendor and save ~$50-100k. Note that these discounts can also be negotiated with Project level purchasing, but it’s more challenging to organize when there are multiple parties involved. A centralized purchasing agent will typically know the manufacturers and vendors better and have more negotiating power for these types of deals.

Centralized purchasing is also utilized by larger contractors to facilitate implementation of financial controls and minimize risk. A CP agent will utilize a company’s standard PO numbering format and coding system to help ensure that all purchases are assign to the proper project and phase/cost code. This greatly increases the accuracy of project level financial reporting, budgeting and forecasting. Remember that your reports are only as accurate as the information they’re based on. The CP agent will also use the same Purchase Order forms, language and terms across the company. There may be specific T&C language for distinct purchases (switchgear and lighting purchase orders usually have specific language to protect the EC) and the agent will ensure that all projects get the same levels of buyer protection.

One more benefit of Centralized Purchasing is the reduced workload on the Project Manager. With all the responsibilities the PM is accountable for, removing the purchasing component can provide a PM with additional time to focus on other critical activities, delve deeper into coordination issues, or even take on an additional project! Centralized purchasing is always more efficient at sending and receiving RFQ’s from vendors, entering PO’s and processing paperwork.

You may be wondering why all companies don’t eventually shift to Centralized purchasing, right? Well, there are always a few hurdles to surpass when making a shift of this size and impact.

The first challenge will be the hiring and training of a CP agent. Aside from the salary requirements of the position, the candidate must posses a certain skill set. They will need to have existing relationships with vendors, and the ability to generate and sustain new relationships as well. They must be an excellent communicator and negotiator. They must be organized and have a strong attention to detail. They must also have industry and field knowledge of materials so they can understand what a superintendent is requesting in ‘field language’. As you know, superintendents don’t always know the manufacturer’s catalog name for something (i.e.: CJ6 = Colorado Clip). I have found that seasoned project managers can make for excellent purchasing agents, if they don’t mind being in the office all day.

The next challenge is employee morale, especially with project managers. PM’s are a proud group, independent, full of confidence and ready for any challenge. They are likely to see this move as an insult to their skills! You may hear comments like “Why are you taking away my control over buying materials for MY project?!? Don’t you trust me?” There’s no sure way to remedy this, but one method I’ve seen work well is to keep large purchases (switchgear, lighting, generators, etc.) in the PM’s control at first. Let them ease into the idea of centralized purchasing by having the agent just buy commodities and wire to start. Let the PM’s keep control of the ‘important’ purchases, and you can also let them have final approval on any PO’s over a certain value, say $10k. This will also help the new CP agent to get to know the purchasing habits of each PM, and allow them to get comfortable working together. After a few months of not having to write miscellaneous PO’s every week, the PM’s will start to appreciate the shift in responsibility, and the reduced number of phone calls from superintendents looking for their materials!

We’d love to hear your thoughts on Centralized vs. Project Level purchasing. Let us know which way you’re operating, how long you’ve been that way, and what’s working for you. Leave a comment below, or email us here - I love success stories!

You can also drop me confidential note if you’re having problems with your current method and would like to discuss strategies, challenges or solutions by clicking here.

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