Five Strategies for High-Performance Procurement
by Tim A. Minahan -- Supply Chain Management Review, 9/1/2005
The corporate procurement function is no longer all about controlling costs and ensuring supply availability. Five factors—globalization, regulatory pressures, procurement automation, outsourcing, and supply market instability—have both elevated the procurement discipline and increased the supply management challenge. In response, procurement executives are moving to boost their teams’ skill levels, adopt new organizational structures, and employ advanced supply management strategies and systems infrastructures.
To better understand the dynamics in play today, Aberdeen Group surveyed and interviewed procurement executives at 100 global enterprises. Our research, published in a report entitled “The CPO’s Agenda,” found that procurement’s role in strategic operations has increased dramatically over the past five years.1 While procurement organizations are still focused on reducing costs and ensuring supply availability, there’s now a heightened emphasis on contributing to market expansion, product innovation, and regulatory compliance. In short, procurement and supply management are now expected to be major contributors of value across the enterprise. Aberdeen’s research has identified five primary strategies that leaders are adopting to transform procurement’s role from one of cost containment to one of value generation. These strategies, each discussed in detail in this article, are:- Improve supplier development and collaboration.
- Enhance and integrate procurement automation
- infrastructure.
- Adopt low-cost country supply initiatives.
- Transition to a center-led procurement organization.
- Increase amount of spend under management while
improving spend compliance.
1. Improve Supplier Development and Collaboration
Our research found that nearly 70 percent of procurement organizations will have supplier development and improvement programs in place by 2008. Further, 60 percent of those surveyed already have initiatives to involve procurement and suppliers earlier in the product design and development cycle. A number of factors are driving procurement organizations to improve supplier development and collaboration. Foremost among these are pressures to generate year-over-year improvements in supplier quality and performance; to identify opportunities for removing nonvalue-added costs from the supply chain; and to develop and improve capacity, throughput, and other capabilities of key suppliers. Notably, these pressures have intensified recently in response to rising energy prices, inflation, shortages of some commodities, and transportation constraints. The good news is that already existing initiatives in supply rationalization and procurement automation are positioning many companies to drive more collaborative relationships with key suppliers. While fewer than 5 percent of the procurement executives surveyed feel that their companies have fully rationalized their supply bases, more than half report that they are close to having the right number and mix of suppliers. (Truth be told, constantly shifting demand and market dynamics make it unlikely that an enterprise will ever be able to rationalize its supply base perfectly.) Since it acquired Compaq Computer Corp., for example, Hewlett-Packard has more than halved its number of direct-material suppliers and trimmed its transportation carrier base by 70 percent. Evidence also indicates that enterprises are continuing to consolidate a larger portion of their spending with their most strategic suppliers. (Exhibit 1 gives the survey results pertaining to spend consolidation and supplier rationalization.) Such consolidation improves a company’s negotiation leverage with strategic suppliers. It also frees up (and motivates) buying organizations to collaborate with these suppliers to remove nonvalue-added activities and costs while jointly identifying opportunities for improvement.
The procurement executives we surveyed prioritized the following strategies for improving supplier development and collaboration: Improve planning and forecasts with suppliers. Nearly 60 percent of the executives surveyed have initiatives in place to improve the accuracy and frequency of order plans and forecasts with suppliers. These efforts include better coordination between business units internally and more frequent communication of planning and forecast changes with suppliers. Successful completion of these initiatives depends on increased investments in advanced analytics and collaboration tools, including supplier-facing portals and networks. Survey respondents report that these last two tools have improved forecasting, order accuracy, and inventory visibility. And these improvements, in turn, have resulted in reduced inventory levels, better fill rates, and more timely deliveries. Improve supplier-scorecarding and performance-measurement capabilities. Performance measurement has long been the elusive brass ring for supply management professionals. According to the survey, the typical performance measurement activities being pursued include standardizing metrics and procedures across sites and divisions, tracking a broader portion of the supply base, and sharing performance scores with suppliers. Recent advances in procurement automation, data cleansing and classification, analytics, and portal technologies have helped advance the art of supplier scorecarding and performance measurement. As part of their performance-measurement programs, some companies, such as Daimler-Chrysler and MEDRAD, have created formal channels to receive, evaluate, implement, and measure results of cost-reduction or improvement suggestions from suppliers. Daimler-Chrysler has recorded more than $1 billion in savings from supplier-suggested improvements. Similarly, medical-imaging company MEDRAD recorded nearly $500,000 in improvements during the first year of its program. Improve use of sourcing, procurement, and planning automation. Procurement executives reported increasing adoption and integration of automation in their source-to-pay operations—all of the activities associated with initiating the supplier relationship through procurement and payment. Overall, automation can extend procurement processes and intelligence across the enterprise while simultaneously improving coordination and control of spending and execution. Create dedicated supplier improvement teams. Procurement leaders such as Cessna Aircraft Company, Delphi, and The Toro Company have dedicated cross-functional teams that focus on supplier improvement. These teams incorporate Six Sigma, lean, and other statistical process control and improvement techniques in their supplier relationships. The benefits of these efforts include increased standardization and automation of transactions and processes, elimination of redundant testing and processes, and vendor-managed inventory programs. Other leaders, such as Ford Motor Company and Nortel Networks, have used their buying clout to negotiate favored trading terms with material and part suppliers. They then share their preferred pricing and availability with their contract manufacturers and other supply partners to lower costs across the supply chain. One Fortune 500 distributor that we interviewed offers a good example of team-based collaboration. This company has created a dedicated, cross-functional vendor-relations team, consisting of procurement, sales, marketing, contracts, payables, distribution, and IT. The team meets with the company’s strategic suppliers each quarter to scrutinize processes and performance and to identify opportunities for improvement. The group also has established a formal vendor scorecard consisting of metrics that are of interest to both the company and its suppliers. These metrics center on order and shipment accuracy, payment terms compliance, error tracking, and timeliness of response. Scorecards are shared with suppliers via a Web-based portal and are used to identify and prioritize waste-reduction and improvement initiatives. Increase procurement and supplier roles in new product development. More than 60 percent of manufacturers in our survey are working to involve procurement, suppliers, and other relevant stakeholders earlier in the product-development process. The Toro Company, for example, has made procurement a key participant in product development. In particular, it has established new product-development sourcing teams that co-locate sourcing and commodity managers (most of whom are degreed engineers) with product engineers. These commodity experts collaborate with engineers from design concept through production build. They ensure that innovative, technology-leading suppliers are being used and that sufficient capacity exists to support intended production. The sourcing teams also work to meet or beat target and “should-cost” goals. Toro has integrated its new-product-development program with its e-sourcing initiative. Under this approach, each costing and sourcing program uses the project management, sourcing, and analytics capabilities within the company’s e-sourcing platform. The e-sourcing tool allows Toro to involve multiple functions in the sourcing process, quickly cost various design and bill-of-materials scenarios, and incorporate supplier-performance and total-cost scores into design and sourcing decisions. Early supplier involvement in product development also allows procurement and suppliers to suggest new technologies, manufacturing methods, and processes that add value and competitive advantage before product design is locked down. Involving procurement in design also advances initiatives to meet or exceed target cost models. And it helps ensure sufficient supply capacity and quality to support proposed designs at volume production levels. Related Aberdeen research found that product-development costs for companies that involved suppliers and procurement groups at design inception and development were 18 percent lower than those that delayed such collaboration until the product-prototype phase. Early involvement also yielded 10- to 20-percent improvements in time-to-market cycles, enabling these early movers to capture greater market share and profit margins.
2. Enhance and Integrate Procurement Automation Infrastructure
The leaders are transitioning from tactical and fragmented investments in automation to more cohesive and integrated source-to-pay platforms. Over the next three years, they’re planning to invest in such solutions as full e-sourcing platforms, supplier or transaction networks, optimization-based sourcing and analytics tools, and supplier-performance-measurement and contract-management applications.
- Supplier or transaction networks.
- Full e-sourcing platforms.
- Optimization-based sourcing and analytics tools.
- Supplier performance measurement.
- Contract management.
3. Adopt Low-Cost-Country Supply Initiatives
Companies will double their spending with offshore suppliers by 2008, according to our study findings. Pressed to further reduce supply and delivery costs and to help penetrate new markets, procurement executives are developing strategies and procedures to identify, assess, and manage low-cost-country suppliers. Today, it’s not a matter of if your company will source globally but how best to do so. The attraction of low-cost countries is obvious: Materials and products from countries like China, Singapore, and Malaysia can be manufactured at prices 30 to 50 percent less than in the United States. Related Aberdeen research finds that companies are still reporting cost advantages of 10 to 35 percent from low-cost-country suppliers—even after factoring in logistics and tariff costs. Considering these factors, it’s not surprising that use of foreign suppliers will double in the next three years. Indeed, by 2008, offshore sources will account for 27 percent of the typical company’s supply base. Not surprisingly, more than 86 percent of manufacturers list low-cost-country sourcing (LCCS) as a top initiative for the next three years. Having applied strategic sourcing within domestic regions, most manufacturers are now looking to offshore sources for their next wave of savings. Many initiatives in this space are being driven from the top, specifically from executives who were influenced by peers, rivals, and board members touting the benefits of LCCS. Alcoa is a good example. “Our CEO wants us to be an industry leader in LCCS,” said one procurement executive. “There is also a growing awareness in our organization that we have already achieved some of the easy, early savings from leveraging, and we need to be looking into new ways to save money. LCCS are an appealing opportunity.” A growing number of companies also view LCCS as a way to reduce logistics and inventory costs and help their companies penetrate new markets. For instance, Procter & Gamble (P&G) redoubled its LCCS initiatives in 2000, when A.G. Lafley took over as CEO and accelerated the company’s move into new global markets and product segments. Lafley pushed P&G to serve “all the world’s markets.” So, the consumer products giant restructured and started to compete in immature and undeveloped markets. For example, P&G established a purchasing operation in China, recruiting and training Chinese employees in professional purchasing practices. The company also invested in developing the capabilities of the local supply base, funding equipment and training for Chinese suppliers. The key to P&G’s success: LCCS was managed as a company strategy, not as a procurement strategy. Increasingly, procurement executives are becoming acutely aware of the challenges and risks associated with LCCS. These range from basic language, culture, and time-zone differences to intellectual property protection, currency fluctuations, geopolitical unrest, and supplier “on-boarding”—the whole process of getting a supplier ready to do business with your company. The leaders are organizing cross-functional teams and are leveraging technology, external information, and service support to address these issues.
Along with the initiatives described above, procurement executives are taking the following steps as part of an LCCS strategy:
Access supplier intelligence services. Nearly 70 percent of procurement executives plan to rely on external information sources to identify and assess capabilities, constraints, and financial viability of suppliers in low-cost countries.
Prepare to automate sourcing and procurement processes. All respondents to the survey viewed adoption of sourcing and procurement automation as a component of their LCCS strategies. (Indeed, in related Aberdeen research, e-sourcing users reported that these tools increased and improved their ability to negotiate with offshore suppliers.) However, Aberdeen’s most recent investigation into LCCS practices (“Low-Cost Country Sourcing Success Strategies,” June 2005) suggests that many low-cost markets remain too immature to sustain the use of procurement automation. Aberdeen anticipates that the use of procurement automation will increase with improvements in technology infrastructure and user skills in these regions.
Access third-party intelligence on tariffs, trade rules, and landed costs. Material and manufacturing savings can quickly be undone if a company doesn’t fully understand the transportation, handling, and tariff costs associated with moving product to the manufacturing site or end market. To illustrate, Ingersoll-Rand estimates that transportation, duties, taxes, and other cross-border logistics costs range from 13 to 24 percent of the basic price of imported materials and parts. Calculating such “total landed costs” requires an understanding of the following: the continually evolving harmonized tariff schedule; transportation, drayage, and handling costs; and cross-border regulations. Companies increasingly will look to third-party information services for assistance in ensuring accurate landed-cost calculations. Establish an international purchasing office (IPO) in the country or region where low-cost country suppliers are located. The Aberdeen study found that larger companies were more inclined to set up their own IPOs because they have the spend volumes to justify such an investment. Larger firms also were more likely to hire regional supply market experts. Meanwhile, more than half of the mid-size firms either use or plan to use external service providers for in-country support of supplier assessment and management.
4. Transition to a Center-Led Procurement Organization
By 2008, 75 percent of the companies surveyed will have shifted or will be in the process of shifting to a center-led structure. Procurement executives are aggressively moving toward centralization as a way of maximizing spending, standardizing procedures, and driving efficiencies. At the same time, they’re supporting the unique requirements of individual business units and regions. Key strategies applied in making the transition include securing executive support, adopting a closed-loop procurement systems infrastructure, using cross-functional teams, improving training, and recruiting new hires with business, engineering, and finance degrees.
Leverage technology to accelerate center-led procurement. Web-based automation empowers an enterprise to extend source-to-pay activities to the desktops of frontline employees. At the same time, it enforces compliance with standard procedures and contracts. Advanced workflow capabilities embedded within these tools can also be used to configure unique processes or controls at the divisional or local level. In fact, many enterprises, such as Corning and ExxonMobil, view automation as a key enabler for transitioning to a center-led organization and adopting enterprisewide process standardization and controls. Establish common goals and incentives. To foster support across business units, procurement leaders have set multiyear sourcing and commodity plans that map closely to the financial and performance goals of the business. These plans address organizational structures, services, and commodity strategies, and they project their respective financial and operational impacts. Unfortunately, fewer than half of all procurement organizations use formal, multiyear plans. Instead, most rely on one-year plans. And 16 percent of companies lack any formal procurement plan at all. Recruit new talent. Automation has freed up procurement to focus on more strategic tasks like supplier development. But many enterprises are learning that buyers often lack the domain expertise or skills to drive these strategic activities. In response, executives are recruiting new talent, particularly those with graduate degrees in supply chain, logistics, procurement, and finance. Candidates with engineering degrees now are much in demand. (Exhibit 3 shows the educational requirements for new hires set by the procurement executives surveyed.) Provide ongoing education. Leaders such as Motorola and John Deere have worked with university graduate programs to provide continuing education to existing team members.
Industry leaders are putting more spend and categories of spend under procurement’s oversight. That’s a wise strategy because Aberdeen research shows that each new dollar put under procurement’s control yields a 5- to 20-percent savings in total spend. Organizations that bring an increased amount of spend under procurement’s management—and do so in a consistent and integrated manner—outperform their peers in cost savings, supplier integration, operating costs, and compliance. (Exhibit 4 compares these best-in-class organizations to the average companies.) These firms also reported greater contribution from procurement to enterprise value in the form of product and process innovation, faster time-to-market cycles, expansion into new markets, and improved profitability.
Leading procurement executives have prioritized the following strategies for increasing the amount of spend under management:
Improve access to timely and accurate spend data. The success of any supply management program depends largely on the ability to access, organize, and analyze spend data. Timely, accurate, complete, and detailed spend data offers invaluable intelligence on spending patterns, compliance and performance ratings, inventory status, and part attributes. Such insight helps identify savings opportunities, drive compliance, and develop sourcing strategies. Accurate spend data can also arm procurement executives with the facts they need to secure budget and policy changes to drive supply management initiatives.
Market the value of procurement to the enterprise. A common attribute among procurement leaders is their ability to communicate cost, performance, and process improvements to stakeholders across the enterprise. Leaders such as MetLife and ExxonMobil have regular meetings with functional and business unit leaders to review plans and results. Other companies use newsletters and workshops to communicate improvements in spend management and to secure buy-in from other areas of the organization.
Secure policy changes and mandates to foster adoption and compliance. Without backing from senior executives, the procurement group often lacks the clout to increase spend under management and drive compliance. Unfortunately, less than a quarter of companies surveyed hold business unit leaders accountable for spend compliance targets. And less than 20 percent of procurement executives reported that their CFOs provide sufficient backing and policy support to drive compliance. Procurement leaders have secured the support of senior leadership and of business unit/functional leaders to get more spend under procurement’s control and to drive compliance.
Improve visibility and control of contract compliance. Procurement executives have prioritized investments in contract management systems to communicate approved contracts to stakeholders, track and control compliance against contract terms, and analyze and report on contract performance. Such visibility and controls are a critical part of effectively sourcing and managing service contracts, which typically have complex pricing, payment, and service-level terms.
Leverage pricing and performance benchmarks to get support and monitor improvements. The surveyed executives view access to pricing and performance benchmarks as critical for measuring their performance against peers, defining optimal negotiation strategies with suppliers, and securing executive and stakeholder support for procurement initiatives.
Time to Get Moving
Notably, some procurement leaders such as ExxonMobil, Hewlett-Packard, and Procter & Gamble have organized procedures, resources, and systems so that they can pursue all of the spend management strategies in an integrated and coordinated fashion. But while it’s not necessary to take on all five initiatives at once, it is critical to get moving on the procurement transformation. In fact, the strategic initiatives described here are interrelated. So progress on any front is likely to bring improvements on another.
Endnotes
1For more on the report, see www.aberdeen.com, and search for “CPO’s Agenda.”
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