How to use blockchain and smart contracts in procurement

Why do traditional supply chain processes need blockchain?

As a seasoned professional with years of experience in the dynamic world of business and technology, I can confidently say that the integration of smart contracts into procurement processes is undeniably a game-changer. I’ve seen firsthand how these innovative solutions can streamline operations, reduce costs, and foster trust among all parties involved.

In contrast to conventional methods, procurement and supply chain procedures often lack structure, are slow, costly, and intricate. Employing blockchain technology in procurement could streamline these processes, making them swifter, more systematic, and less expensive.

Acquiring products or services entails finding them, buying them, and receiving them. It plays a crucial role in the overall management of supply chains, but it’s frequently plagued by significant inefficiencies.

Acquiring goods or services relies on contractual arrangements, such as agreements and various documents including purchase requests, bills, and delivery slips. These documents may be physical or digital, with the associated procedures often being manual or involving several software tools.

The above challenges can cause:

• Errors and delays
• Lack of transparency
• Delayed orders and payments
• Inaccurate or hard-to-manage inventory 
• Poor communication between parties 
• Difficulty ensuring regulatory compliance

Acquiring goods or services for a business can lead to issues that damage relationships with suppliers, result in delayed production, and potentially lead to instances of deceit or misconduct.

Suppose a package intended for a particular department within a company gets misdirected upon arrival, and the delivery documentation is misplaced. In this scenario, the company decides not to pay the supplier, leading them to halt future deliveries. This predicament could result in the company’s failure to fulfill a client’s order on time.

How smart contracts enhance procurement processes

A smart contract, essentially, is a self-executing digital agreement coded into a computer system. It’s capable of managing and executing the terms of a traditional contract, such as procurement agreements, autonomously. This implies that once programmed, these contracts can automatically perform actions without requiring human intervention.

Smart contracts work on an “if/when…then…” basis.

As an analyst in procurement and blockchain supply chain management, I often explain how smart contracts work. Essentially, they serve as digital agreements that automatically execute transactions when certain conditions are met. For instance, if a delivery arrives safely at its designated location, the smart contract is programmed to initiate payment of the corresponding invoice. This streamlines the process and reduces the need for manual intervention, thereby increasing efficiency in our supply chain operations.

As a researcher, I’d express it like this: In real-time, I can verify the status of a shipment by directly consulting the blockchain, whether I am on the side of the supplier or the customer. This feature ensures transparency and trust throughout the supply chain process.

In this scenario, the delivery note may be electronically forwarded to the system for maximum transparency. To keep track of the shipment worldwide, a Global Positioning System (GPS) monitoring device could be utilized. This instance of blockchain usage is often referred to as supply chain traceability, and it plays a crucial role in the application of blockchain technology within procurement processes.

Automated smart contracts are capable of executing digital duties on their own. They’re particularly useful for overseeing purchase agreements, ensuring that all involved parties adhere to the specified terms and conditions.

How do companies approach using blockchain in procurement?

Beginning the integration of blockchain into procurement involves identifying areas where it can offer the most value. Once these spots are pinpointed, a company may opt to collaborate with a reliable technology provider, or alternatively, embark on constructing their own customized blockchain system.

A company could develop a private blockchain if it had the right experts. Or, it might use a ready-made product from a company. Here are the key steps involved in the process:

Step 1: Process identification and platform selection

A business is embarking on exploring the application of blockchain technology within its procurement process. This exploration may lead to utilizing blockchain for various purposes such as managing purchase orders or contracts. Additionally, the business might also look into employing blockchain in areas like inventory management, compliance, and auditing, where it could potentially bring added efficiency.

The task at hand is to discover a suitable platform, technology solution, or vendor. Among the permissioned platforms are Hyperledger Fabric, R3, and Corda. Public blockchains encompass Ethereum. When choosing, a company takes into account their technical competence, cost, security concerns, compliance with regulations, and the parties who need access to the network.

Step 2: Development and testing

After locating an appropriate technology, it’s essential to proceed with its implementation. Regardless if we find a pre-built solution, it still needs to be thoroughly tested to ensure the smart contracts function correctly.

Step 3: Integration and training 

After establishing a smart contract procurement process, it should be disseminated to both teams and potential suppliers. By incorporating blockchain technology into procurement, both companies and their suppliers can utilize the same software platform. Consequently, it’s essential that suppliers are adequately trained on the new systems and procedures as well.

What are the benefits of smart contracts in procurement?

Smart contracts can streamline procurement processes and lead to financial savings by minimizing the requirement for external verification and simplifying the resolution of conflicts.

• Trust and transparency: Blockchain transactions are immutable. This means they cannot be easily changed. A blockchain creates a reliable, transparent set of records that all parties can view. 
• Efficiency and cost savings: Automation and digital tasks get rid of manual delays and inefficient paperwork. They reduce costs and free up time for procurement teams to work on other matters. 
• Fewer intermediaries: Smart contracts and automation can replace manual checks and validation. For example, a procurement manager doesn’t need to check a delivery note and release an invoice for payment; a smart contract can perform this task. 
• Dispute resolution: If there is a disagreement, a supplier or a company can quickly check blockchain records for the status of a shipment or payment. 
• Decentralized marketplaces for blockchain procurement: Blockchain-powered decentralized marketplaces may become important in procurement. They offer a transparent and secure place for buyers and sellers to connect. These marketplaces can help companies save money and promote fair competition. Buyers can compare prices and supplier ratings on a marketplace. Suppliers get access to a bigger market to sell their products and services.

In previous times, finding suppliers often required extensive research followed by sending out bids for contracts. On the other hand, a user of a modern, decentralized marketplace can easily search for new suppliers and gather information about them. Furthermore, instead of initiating the process by inviting suppliers to bid, a buyer could simply post an opportunity and receive prompt responses from potential sellers.

What are the challenges of using blockchain and smart contracts in procurement?

Blockchain and smart contract technologies are relatively novel, and there’s currently a lack of established industry guidelines for businesses to adhere to. These intricate technologies are being continuously refined, while the regulatory landscape is also developing.

As a researcher delving into the realm of blockchain and smart contracts for procurement purposes, it’s crucial to be aware of several significant hurdles that must be addressed:

• Standardization and interoperability: There are many blockchain networks. Often, these networks use very different technologies or programming. There aren’t really standard protocols and frameworks yet. This makes it difficult for a company to choose the right blockchain or software. For example, a company might choose Corda or Ethereum. However, later, if Hyperledger’s technology becomes the industry standard, the company might find it hard to work with suppliers using other platforms. 
• Compliance and regulation: Smart contracts can enforce terms and conditions. They could replace traditional paper or document-based agreements. However, it’s not clear how legally compliant they will be. Also, regulations are different in every country. This makes cross-border transactions complicated. 
• Cost and technical complexity: Smart contracts and blockchain technology are quite new. Development work can be expensive, and experts can be hard to find. 

Smart contract issues like bugs and vulnerabilities can pose threats to a business. For instance, a fault or security lapse might result in monetary losses or harm to the company’s standing.