Toward World-Class Procurement
By Chet Hirsch and Marcos Barbalho -- Supply Chain Management Review, 11/1/2001
Businesses are never interested in leaving money on the table, right? Well, if you were a shareholder, you would certainly hope not. You typically expect companies to aggressively manage the quality of their goods and services, the prices that they can charge, the service they provide their customers, and their ability to maintain/increase their market share. In other words, you expect business to do what it takes to grow profitably. Unfortunately, when it comes to managing one of the most basic aspects of the supply chain—the sourcing and procurement of goods and services—many businesses fail to see the money that is right in front of them, let alone walk right up and take it.
Several well-publicized success stories over the years have told how companies like Wal-Mart and General Motors have used sourcing and procurement to return value to their shareholders and improve their bottom lines. Despite these successes, many companies have yet to realize the opportunities available to them or have not been effective in their efforts to realize sustainable savings. When you start to investigate the reasons why, a common response from executives and managers is "We are having a hard enough time trying to get the basic job done, let alone focus on strategic initiatives."
Even with well-established enterprise resource planning (ERP) systems and the advent of e-procurement and e-market technology, too many purchasing departments are still mired in inefficient, paper-based processes. There is still heavy reliance on fax machines to transmit purchase orders and on telephones to check order status. Companies have often tried to generate purchasing "savings" by shrinking headcount and the size of the purchasing department. Meanwhile, increasing product complexity, global sourcing alternatives, and shortened product life cycles require companies to put sourcing contracts up for bid more frequently. Yet the actual time required to negotiate contracts remains lengthy.
As they try to cope with these problems, purchasing departments have become very tactical in nature. They find themselves focusing on the day-to-day requirements of managing purchase orders and putting out fires, rather than strategically managing sourcing and procurement to improve shareholder value. By not taking a strategic view of purchasing, companies miss significant opportunities. Depending on the industry, the external procurement of goods and services can represent 40 to 70 percent of revenue. In the consumer products industry, for example, reducing that spend by just 5 percent can represent a 50-percent improvement to the bottom line. (See Exhibit 1.) To attain a similar impact, a company would have to increase sales by 50 percent, reduce overhead up to 20 percent, or significantly reduce staff size. Put another way, the opportunities inherent in effective, strategic procurement—what we call world-class procurement—are tremendous.
Components of World-Class Procurement
World-class procurement is achieved when a company links its supply requirements with market capabilities in ways that create sustainable improvements in cost and performance. It is a holistic approach that combines strategic sourcing and supply management, enabling technologies, and world-class procurement infrastructure and operations (for example, efficient procurement business processes, supporting organizational infrastructure, and modified employee behavior). (See Exhibit 3.)
- A global industrial manufacturer achieved $150 million in annual savings.
- A large telecommunications company achieved $117 million in annual savings.
- A major financial institution achieved approximately $100 million in annual savings.
The first step to world-class procurement is conducting an overall diagnostic of the sourcing and purchasing function. This four- to 10-week process analyzes data extracted from purchasing and accounts payable systems to discover how and where the company spends its money. During the diagnostic, the company also studies its processes for purchasing and sourcing.
The diagnostic is designed to answer some fundamental questions: How much do we spend on goods and services? Where or with whom do we spend it? What are we buying from these suppliers and through what process? Who within the organization buys these goods and services? Why are we buying them? And ultimately, how does our performance compare to that of others across industries? Though these questions may appear basic, it is surprising that so few organizations routinely ask them, let alone have the answers to them on a companywide basis. If they don't ask these fundamental questions, though, excess costs inevitably creep into the organization.
Once the data have been collected and analyzed, the answers to these high-level questions typically raise an extensive list of even more detailed questions. For example, when presented with the analysis, senior management ultimately wants to know things like:
- Are we really spending that much on an annual basis for these different goods and services?
- Why does one operating division buy from this supplier and another operating division from that supplier, when both suppliers provide the same basic commodity?
- Why are employees using different suppliers for these items when we have a negotiated discount with this one primary supplier?
- Why do we have multiple contracts for the same supplier? Why do these contracts have different terms and prices?
- Even though we have done business with this supplier for years, is it really providing us with the best value in the market?
- Do our employees really need so many different models of the same basic product (for example, PCs)? Why can't we consolidate to one or two standard models across the corporation?
- Why is the overall process so slow, and why does it still require so many manual steps?
- Why are we processing so many transactions (orders, invoices, and payments) for such low-dollar-value items?
- How do we ensure that a supplier's capabilities meet not only our current needs but also our future needs?
- What is the quantifiable savings opportunity, and how do we measure these savings?
The output of this analysis points to opportunities for savings and enables the creation of an improvement roadmap. Once the company has a more detailed understanding of what it is paying and knows its actual purchasing processes, it can better identify what best practices to implement. The organization can define its specific categories of spend and develop an improvement plan that targets these categories based on their potential benefit as well as the expected timeline to realize this benefit. Both quick hits and longer-term initiatives can be defined—usually with the goal of funding longer-term projects with the savings obtained from the quick hits.
Getting the MoneyAfter performing the diagnostic, a company then needs to act on this improvement plan by implementing strategic sourcing, efficient procurement business practices, and needed infrastructure changes.
Strategic Sourcing
Typically, the procurement diagnostic reveals large savings opportunities for a company through strategic sourcing. Strategic sourcing leverages the company's total purchasing dollars across each product category or supply stream to those strategic suppliers that offer the best overall value. By doing this, a company can negotiate volume-based discounts with these key suppliers. A competitive supplier can benefit from this process as well. The supplier has the opportunity to increase its savings by going from being just one of many that provide the same good/service to the company to becoming the primary vendor of choice.
Although this may sound similar to vendor consolidation, it is not. Vendor consolidation is the practice of consolidating purchases from several existing suppliers down to a more manageable number. Strategic sourcing, on the other hand, is a more comprehensive process that involves: identifying the business requirements that cause you to purchase a good or service in the first place, conducting market analyses to determine typical costs for goods/services within a particular supply stream, determining the universe of suppliers that best meet your requirements (which may or may not include your existing incumbent suppliers), determining an overall strategy to procure items in that category, and then selecting the strategic supplier(s).
In vendor consolidation, the real driver is cost. With strategic sourcing, however, other factors come into play. Depending on the category being sourced, service, product quality, innovation, and collaboration also will be key criteria in the supplier selection decision. Strategic considerations of the supplier's capabilities will be taken into account as well. For example, if a company is interested in automating processes through e-procurement, whether or not a supplier can provide electronic catalog content or interface its systems into an e-market can become considerations during the selection process. For every category that is sourced, the appropriate criteria must be determined and used to evaluate suppliers.
When deciding whether to source strategically, you need to be aware of the many variables that affect the degree of savings that can be achieved through this approach. Exhibit 4 on the following page shows just a few factors that can determine the level of savings. These factors include overall corporate spend on a given commodity, whether existing contracts are in place, the degree to which this spend is fragmented among different suppliers, and supplier competitiveness and market conditions, as well as the skill sets of the purchasing organization. Though savings will vary by industry, by company, and/or by product category, average savings for those categories that are sourceable typically range from 5 percent at the low end to as high as 15 to 20 percent at the upper end. When these percentages are multiplied across each supply category and the total corporate spend, millions of dollars start flowing to the bottom line.
Efficient Business Practices
In parallel with the strategic sourcing initiative, companies need to streamline their procurement practices for maximum cost savings and efficiency. Consider that the total cost to process a purchase order through traditional manual methods can average $100 or more per purchase order. The primary reason for the high cost is the amount of employee time devoted to all the steps associated with the transaction. Depending on the purchasing process used, the steps to initiate a purchase may include looking up the required item number or description, identifying a supplier, creating a paper purchase requisition, routing the requisition for approval in person or via company mail, waiting for approval, sending the requisition to the purchasing department, faxing the order to the supplier, validating that the supplier received the order, waiting some more, calling to check order status with the supplier, and so on. For low-value, high-volume categories, this overall process becomes very inefficient and costly.
Although many of the purchasing process steps just described may seem to be relics of the 1970s and '80s, they are still alive and well at many companies. For those companies that critically analyze their processes, several improvement possibilities present themselves. A few of these opportunities are embodied in the following questions:
- Why can't approvals be routed automatically via e-mail? Or better yet, why not have the procurement system automatically approve the requisition based on pre-set criteria?
- Why can't orders be securely sent via the Internet, with order acknowledgment and order status provided online and/or by e-mail?
- Is it necessary for the purchasing department to send out the order, or can employees issue it themselves?
Reducing the human touch points throughout the procurement process lowers the transaction cost and decreases cycle times.
Needed Infrastructure Changes
Making these kinds of improvements, however, requires process, technology, and organizational changes to create a cost-effective infrastructure that supports world-class procurement operations. These changes might include eliminating steps that do not add value to the ordering process, implementing an e-procurement system, and changing who has the authority to make a purchase. By initiating these kinds of changes, transaction costs can be decreased by 85 percent or more, which translates to an order processing cost of $6 to $15 an order. Order cycle times can be lowered from weeks to days or even hours. Eliminating manual order entry can drastically reduce errors. Detailed purchasing data can be captured and made visible to enable better management decision making. Perhaps the biggest benefit comes from refocusing the purchasing department away from transactional buying to strategically managing the business.
Keeping the MoneyFinding procurement savings requires detailed analysis to identify the improvement opportunities, and getting these savings requires executing against a well-organized improvement action plan. Often it is institutionalizing the savings, however, that is the hardest part. Achieving world-class procurement is not a one-time initiative; rather it requires establishing a process for creating change and focusing on continuous improvement.
Although process changes, new technologies, and a supporting organizational infrastructure are a means to achieve improvement, they are also essential components for ensuring that savings do not evaporate over time, as shown in Exhibit 5. After just a few years, those companies that focus only on strategic sourcing without other fundamental changes will be right back where they started in terms of cost savings—and wondering what happened. Those that support these changes with complementary organizational, technological, and performance measurement changes will continue to see positive results. There are numerous reasons why savings degradation can occur:
- Management simply changes its focus or becomes complacent.
- Product line or technology changes occur, requiring new suppliers or different supplier capabilities.
- Mergers and acquisitions with other companies bring back overlaps in the supply base, and so on.
Usually the biggest factor in savings degradation boils down to human nature—employees gravitate back to how they operated prior to the change unless appropriate steps are taken.
Sustaining savings requires recognizing the root causes that led to suboptimal purchasing performance in the first place. For example, corporate spend may not be leveraged when purchasing is decentralized. Different corporate divisions or operating facilities may use different suppliers for the same commodity simply because they do not know what other groups are doing. "Maverick purchasing"—the practice of procuring goods/services from off-contract suppliers—can inadvertently occur when employees do not know that corporate discounts have been negotiated with preferred suppliers. (For example, "It is too difficult to find out who are our preferred suppliers, and I can meet my needs better and faster on my own.") Maverick purchasing also may occur by design when employees turn to off-contract suppliers if the "official" purchasing process is inefficient or cumbersome, if they receive poor service from the incumbent supplier, or if there is a lack of metrics/controls to enforce purchasing from the preferred vendors. (For example, "The process is too slow, and I can get a better deal from my supplier anyway.") Meanwhile, the use of manual processes and inadequate systems may mean that data are not readily available to purchasing managers to help them identify these problems. So it is not enough to consolidate corporate spend and negotiate discounts with a group of preferred suppliers; each of the underlying problems has to be resolved as part of the overall improvement plan.
Adopting the Holistic ApproachWorld-class procurement addresses these root causes holistically through the combination of strategy, process, technology, organization, and people elements. As the company builds this holistic approach, it should be aware of the following key considerations in each of these areas:
1. Strategy
When creating an improvement roadmap, it is always helpful to know where you want to go before starting the journey. Accordingly, before embarking on the path to world-class procurement, it's a good idea to begin by developing an overall strategy. At the macro level, the sourcing and procurement strategy should raise and address broad questions such as:
- Are the goods or services being provided of strategic importance to our business, or are they a tactical commodity?
- What purchasing strategy (auctions, collaborative processes, private hubs, industry marketplaces, etc.) should we employ for each category of spend?
- How many suppliers must we have to "guarantee" steady supply and sufficient leverage?
- Is it cheaper to outsource to an aggregator, or can we achieve greater leverage with a third-party consortium?
For categories with large purchase volumes and few suppliers, there may be a high degree of risk to sole-source the procurement of a supply stream to a single vendor, especially if other sources of supply could not be tapped quickly in a time of crisis. On the other end of the spectrum, the initial diagnostic of total spend may identify supply streams where a company just does not have the leverage or purchasing volume required to negotiate any savings. In this case, purchasing from an aggregator instead of directly from the source may be cost justified.
The strategy should also drive tactical requirements. The tactical questions that need to be addressed may include:
- Does it make sense to purchase any items through suppliers' Web sites instead of through internal procurement systems?
- Are there some supply categories that we definitely expect to "e-enable" and others where we will continue to use traditional manual purchasing methods?
Again, it is important to understand the functionality and cost trade-offs (for example, the use of supplier Web sites could preclude capturing detailed spend data). Defining these strategies at the outset is vital; trying to resolve them while in the midst of implementation will undoubtedly slow progress.
2. Process
We have already seen how purchasing processes that are inefficient can be both time consuming and costly. Though a common goal is to standardize these processes as much as possible to make them more efficient, it quickly becomes evident that standardization is not as easy as it seems. This is because sourcing and purchasing processes must be established to support very different spend categories with very different requirements.
For example, a company could employ a variety of different purchasing processes for a relatively standard commodity such as office supplies. Among the options, employees could actually drive to a local superstore, thumb through a paper catalog and call an 800 number, fill out a paper purchase order and fax it to a supplier, utilize a supplier Web site, or use a corporate e-procurement system to place the order from a desktop PC. The purchasing process will be more complicated, however, for customized items, such as a telecommunications network switch or a service like management consulting. Even when these goods or services are purchased on a regular basis from the same company, their requirements may differ from purchase to purchase. In these cases, the process may be lengthy because of the requirement of issuing detailed specifications, confirming understanding of the specifications, developing a price tailored to the situation, and so forth. It's important to note that all of these activities take place prior to the actual issuance of a purchase order.
When examining the different process alternatives available to the various spend categories, companies must understand the "as-is" state and develop a vision of how they want the process "to be." Although a company may choose to continue to use manual processes for some categories, it should always strive to make the process more effective. Whenever improving the process can be cost justified, a company should strive to eliminate inefficient processes and replace them with technology-enabled automated processes.
3. Technology
Using technology effectively is at the heart of driving and sustaining world-class procurement. Though much of the hype surrounding e-business seems to have faded with the demise of so many business-to-consumer dot-coms, business-to-business (B2B) purchasing transactions continue to grow because the business case remains compelling. The combination of ERP systems with e-technologies such as e-procurement, e-markets, and B2B auctions enables powerful procurement improvement opportunities. These range from reduced transaction costs, to shorter cycle times, to better order and data visibility, to improved collaboration with suppliers.
Technology alone rarely is the solution, of course, and this is especially true with the latest e-technologies. e-Procurement systems and e-marketplaces are built with relatively new technology. This means that, although they can offer tremendous benefits here and now, it's important to understand what the technology does well today vs. what it will do better in the future. Companies can avoid many of the pitfalls of implementing new technology by working with a partner who has experience with what works well and what does not work well for implementations. Companies that choose to implement new technology without any help risk increasing the implementation time and cost and reducing the technology's effectiveness.
PricewaterhouseCoopers recently surveyed 50 top e-procurement implementations to identify the critical success factors. We consistently heard that successful companies focused both on traditional procurement improvement opportunities and on the new management challenges that resulted from the new technology. One of the key findings of the survey was that the successful companies focused on strategic sourcing before implementing an e-procurement system. This helped them avoid exerting extra effort on those suppliers that they may not do business with in the long run.
The best companies also met the tough new challenges brought about by e-procurement, including supplier adoption of the technology and catalog content management. Supplier adoption is the process of enabling electronic transactions with selected suppliers. It is not enough for a company to be able to send electronic purchase orders. If the order is to be filled, the supplier must also be able to receive it. Putting this capability in place will involve changes to the suppliers' systems and processes. And though the suppliers may recognize the ultimate benefits of these changes, they will also likely incur costs to make them happen. These costs may include allocating employees to the effort, making changes/upgrades to their IT hardware or software, and paying a transaction fee to an e-marketplace to receive their orders electronically. Closing the loop with the integration of the invoicing and payment processes can represent additional changes. To make e-procurement effective, suppliers need to be fully engaged and support the overall program.
e-Procurement systems require robust electronic catalog content (including part numbers, descriptions, units of measure, prices, digital pictures, and other information) so that employees, on their own, can clearly identify and select the appropriate items they need to purchase. Developing this robust content is a challenge. A company must first create the content, then standardize it across suppliers, and manage it for accuracy. Finally, it must make sure the content remains user-friendly. Sources for this content typically are either internal corporate or supplier legacy systems. The initial data extracted from these systems usually reveals the large task at hand: the need to correct out-of-date information, incomplete item data, and truncated descriptions and cryptic abbreviations due to system field length limitations, and so on. Even with the assistance of third-party content factories, converting these data into robust information (which includes things like short item descriptions, long descriptions, and digital pictures) becomes extremely time consuming.
Because of the amount of work involved with both content management and supplier adoption, companies have to recognize and plan what they can and cannot do with their own resources.
4. Organizational Structure
Another key factor in achieving and sustaining world-class procurement is the company's organizational structure. In most cases, how a company has organized procurement and supply chain management largely determines whether or not costs are being minimized.
The impact of the organizational structure is most clear when a company has decentralized purchasing responsibilities to individual operating companies, divisions, or plants. When this occurs, it is common for each organization to source its needs from those local suppliers that it believes provide the best cost, quality, and service. The larger the company is and the more locations it purchases from, however, the more decentralized purchasing allows savings to evaporate with every purchase. Many companies learned long ago that consolidating their purchasing power across companies, divisions, and facilities increased their leverage for a given commodity and could result in significant savings. And yet, too many companies still have done nothing about it.
This is not to say that decentralized procurement execution is a bad thing. Decentralized purchasing is attractive because local employees usually know what they need, when they need to order it, and why they need it far better than someone in headquarters thousands of miles away. However, the local employee cannot see how many other divisions or facilities are buying the same item. Because strategic sourcing involves looking across the entire company to identify total spend by category, someone needs to manage procurement from a centralized perspective to identify common opportunities. Successful companies have implemented different ways to do just this, such as using centralized sourcing groups with vendor selection/management responsibilities or implementing cross-company procurement councils. The key is to ensure that if decentralized purchasing takes place, these purchases are made with approved suppliers using corporatewide negotiated contracts.
5. People
Finally, world-class procurement cannot be achieved unless the employees of the company are ready to make the journey. The company must get buy-in not only from those whose jobs revolve around purchasing but also from those employees with the occasional purchase requirement. As Isaac Newton observed about inertia, an object at rest tends to stay at rest—and this unfortunately holds true when you ask employees to support an agenda for change. Though there will be many employees who rejoice at the prospect of more efficient processes, reduced cycle times, better data, and the opportunity to save the company money; there will be an equally loud chorus of:
- "Tell me again, why do we have to do this?"
- "I've been doing business with my supplier for years—and besides, the sales representative is my golfing buddy!"
- "You mean I have to use my PC and learn some new software?"
A strong ongoing change management program is an integral part of world-class procurement. Once corporate executives are firmly committed, the program should start with clear, companywide communications about the initiatives that are going to take place. These initial communications, preferably issued by senior corporate executives, need to specify the importance, expected improvements, business case for change, impact on employees, and rollout timing. The program also needs to consider training requirements to bring their people the needed skills and proficiency levels. Remember that the transformation of purchasing away from managing the execution/fulfillment of purchase orders toward more strategic sourcing can require increased analytical expertise and a talent for supplier negotiation.
Because sustaining benefits requires measuring benefits, key performance metrics have to be implemented and managed to ensure lasting change. The best negotiated contract from the best supplier ultimately means nothing if you can't measure and enforce contract compliance across the corporation. Metrics need to be designed from the outset and adopted through official policies, procedures, and division/department performance plans to drive savings.
Although world-class procurement can bring significant savings to a company's bottom line in a relatively short amount of time, a commitment to long-term change is essential. After the company achieves initial success, an ongoing focus will assure long-term sustainability. By first conducting a thorough procurement diagnostic, a company can start to find the opportunities or "see the money." By beginning to strategically source spend to key suppliers, a company will start to "get the money." And by developing strategies, improving processes, implementing technologies, preparing employees, and creating organizational structures that support the process, companies will "keep the money coming."
| Author Information |
| Chet Hirsch is a principal consultant and Marcos Barbalho is a partner with PricewaterhouseCoopers' Supply Chain and Operational Services consulting practice. |
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