The evolution of procurement: How CPOs can drive real competitive advantage, à la Darwin
by PIERRE MITCHELL The Hackett Group
• Despite significant challenges and economic pressures to improve performance, some chief procurement officers (CPOs) still seem satisfied if their procurement organizations simply deliver value through cost savings. But in today’s age of scarcity and volatility, that gravy train has run out of track.
• Our research shows that the best CPOs help their organizations evolve through five major stages, which begin with supply assurance and purchased cost reduction, but then get bogged down at total cost reduction. Why? The real tipping point for procurement organizations occurs in stages 4 and 5, when the focus shifts from being supply-centric to having a deeper focus on internal and external customers.
• At the fifth stage, value management, the CPO’s agenda should be in lock step with the CEO and CFO, focused on issues such as innovation, growth and sustainability.
• While commercial excellence is important, managing contracts and commitments it is also a key accelerant (or barrier) to the evolution.
• To drive evolutionary change, procurement organizations should apply value creation tools to their own organization as well, taking the perspective of a services business. They are also likely to need different organizational capabilities, skills and competencies.
Over the last few years, procurement organizations have been facing a confluence of five major trends that have created what might be called ‘procurement’s perfect storm’.
• Inflationary headwinds are making savings targets harder to sustain as supply markets tighten and become more volatile; at the same time, suppliers have become more formidable and customers continue to push for lower pricing.
• Like someone surrounded by water and still dying of thirst, the scarcity of top-notch talent and information technology in an apparent sea of labor and tools is a major constraint to transforming procurement.
• Poor internal process performance (weak collaboration, policies, process rigor, data management, performance metrics, and so on) distracts people from focusing on the mission-critical tasks.
• Regulatory challenges in the value chain are driving prices up, availability down, suppliers out of the supply chain, and compliance costs through the roof.
• CEOs are asking for more growth, innovation, and brand enhancement (for example, in the guise of corporate social responsibility), but without higher costs.
Volatile commodity markets, tight financial markets and cautious consumers are indeed making their influence felt along supply chains. In addition, environmental issues, product safety incidents, critical part shortages, ethics violations and other supply risks obviously have a negative effect on companies’ reputations and business fortunes.
So, are CPOs sensing these changes and preparing for them? Unfortunately not, according to 2020 Vision: Delivering on the Evolving Value Proposition of Procurement — the Hackett Group’s latest research study drawing from its ongoing benchmarking of procurement organizations at Global 1000 companies.
There’s an old adage that says ‘nothing fails like success’, and most procurement organizations have been happy to simply deliver value by riding the deflationary price environment to meet cost savings targets. Our research shows that the return on investment (ROI) generated by a world-class procurement organization (defined as one that delivers top-quartile performance across a wide range of effectiveness and efficiency metrics) is a compelling 700 per cent, and even typical companies in the study deliver a median ROI of 280 per cent — an almost threefold return on every dollar spent. (This figure is calculated by dividing annual incremental cost savings by the annual cost of procurement processes.)
However, the most successful procurement organizations saw the ‘end of the runway’ of price-centric savings years ago and began re-tooling themselves to take a broader view of the risks and returns of managing global supply properly. The less successful ones are now in an unenviable position of explaining to management why their gross savings numbers (that is, only favorable price variances) are being reported while the firms’ total purchased costs are skyrocketing (for example, from commodities relying on fuel).
If procurement is going to transcend its one-trick-pony status of creating value by beating down purchased costs, it will need all the help it can get. This includes working with corporate contracting, legal, and/or risk management groups to similarly expand the role of contracts from blunt instruments of risk reduction to tangible methods of unlocking value.
Charting a new course
Virtually every procurement organization we have studied evolves its value proposition through five major stages (shown in Figure 1 on page 18) that starts, at the foundation, with addressing business continuity issues by assuring on-time delivery of quality goods and services, and moves through tactical sourcing and transactional purchasing and expediting.
Procurement organizations move up the value chain to focus on reducing first purchased costs, then total supply costs. The former is usually done through cross-functional strategic sourcing teams led by procurement and organized around supply markets. Unfortunately, rather than being true cross-functional supply teams that are extended out to suppliers to reduce overall lifecycle costs, they tend to get implemented as ’drive-by sourcing events’ which then throw the contracts back office and operations groups to figure out how to implement them (see Figure 2).
The real ‘tipping point’ occurs in stages 4 and 5 of the evolutionary model, and this is where world-class firms are primarily focused. While the first three stages of the model are supply-centric, the final two shift procurement’s focus more deeply on to customers — both internal and external. This helps procurement gain the voice of the customer and ‘assurance of relationship’ from the budget owners rather than just looking for assurance of supply. This helps procurement shape both consumption and supply drivers in order to help the broader organization gain more value from its spend.
This is much more than a cursory ‘stakeholder management’ process in a traditional sourcing methodology. Rather, it is about making sure that spend owners are getting what they need from both suppliers andprocurement as a professional services organization. It also tends to be the inflection point at which procurement no longer has to aggressively sell itself, but instead has the business knocking at its door for help in meeting its objectives. At the final stage — value management — the CPO’s agenda should be in lockstep with that of the CEO and CFO (innovation, growth, sustainability, predictability, and so on) and there should be no parallel measurement system for procurement that’s different from that of the enterprise.
This gets us back to the idea of unlocking value. To unlock value, you have to first define value. If the economic definition of value is utility divided by cost, then procurement’s goal of maximizing supplier spend value should be done by either reducing spend magnitude or increasing the utility of supplier spending to support business objectives. While the first four stages focus on reducing spend magnitude, increasing the utility of supplier spending is where the strategic linkages occur, such as:
• directly supporting revenue uplift efforts;
• supporting post-merger synergy activities;
• pushing into emerging markets;
• ensuring supplier diversity/compliance;
• tapping supply markets for technology and innovation;
• extending lean, six sigma, and other methodologies;
• supporting working capital improvement programs; and
• advancing sustainability efforts.
For example, Procter & Gamble, with its ‘Connect and Develop’ program, increased the proportion of its procurement innovations coming from outside the company from 15 per cent in 2000 to 42 per cent in 2007. And, arguably, if General Motors had invested R&D dollars with its suppliers to advance battery technology in the 1990s, or even outright licensed/bought the fuel cell technology available at the time, its now-defunct EV-1 electric car program could have pushed GM to a leadership position in the current red-hot ‘green vehicle’ market.
These are just some of the platforms that can be used to elevate procurement’s role and fund required capabilities such as improved market intelligence, supply performance measurement, knowledge management, and of course, contract management (CM).
Contract management as virtuous tailwind
In a presentation titled ‘Reshaping Procurement’ that I gave at the IACCM Americas 2008 conference in April this year, I detailed specific ways in which CM helps support the procurement value evolution from one stage to the next. They’re too numerous to list in detail here, but focused primarily on contract visibility, commitments analysis for spend/supply planning, performance monitoring (internally and with suppliers), demand/customer/specification management, and support of the strategic elements cited above.
Yet, as much as procurement may struggle to improve its commercial toolbox, the more difficult and fundamental change is to apply value management not just to the overall business, but to procurement’s own ‘services business’. There is a certain natural psychosis at work here. On one hand, to a forward-thinking supply professional, every business process/function and its associated resources (labor, technology and so on) is a supply market that can have sourcing principles applied to it, and thereby it should need procurement’s help. On the other hand, the most progressive organizations view procurement as a process, and not a department to grow headcount and power. This also goes for CM and is often evidenced when a question such as ‘Where should CM report to?’ gets asked. World-class firms do not spend time debating how the hierarchy is drawn, but rather look to aggressively standardize (without destroying value), automate, and then either push the processes to the ‘end user‘ or to a specialized provider, whether to an external supplier or to itself (for example, via a center of excellence). In other words, to them, the biggest cost is the opportunity cost of wasting time on low value activities while money is on the table ready for the taking at higher levels of value delivery.
This is analogous with the mass democratization of quality management processes within firms. It is already being seen in ‘hands-free’ transactional purchasing, and also now in the realm of CM where end-users can be guided by expert-systems self-service systems that enable flexible assembly of appropriate contract clauses into the appropriate ‘system-of-record’ for contracts. That system will then also feed the critical downstream ‘systems-of-process’ and ‘systems-of-decision’ that will help to transform contract data into contract intelligence.
This process of mass democratization is a bit of an unnatural act for procurement — or any similar function. In fact, this is why there’s a naturally occurring higher turnover at world-class procurement organizations versus their peers. It also requires, displeasing as it may sound to some CPOs, running procurement like a management consulting or equivalent business. As such, it requires relationship managers to use CRM best practices internally and to clinically assemble supply management services that serve the budget owners rather than procurement. This is increasingly being coordinated with other functions under a common ‘business services delivery model’ run by progressive shared services organizations that do as much transformation work as they do transactional work. It results in clearer coordination with all other support functions. This means that procurement, risk management, CM, supplier management, quality, training, and siloed centers of excellence are all working together under one operating model. This becomes critical in supply risk management, where it takes different forms for different aspects of the 5-stage value evolution model and must successfully integrate all types of risk from broad corporate risk, to strategic supply risk, to more tactical buyer-supplier relationship risk.
New capabilities need apply
Finally, this evolution requires not just a different operating model, but also a broader set of organizational capabilities and new skills/competencies for the new supply professional and contracting professional. The skills for the new CPO and the emerging role of procurement client relationship managers are all about managing relationships, change and brand. Increasingly, new CPOs are coming from sales and marketing backgrounds and the key skill is more about selling than buying. This will also prove useful as procurement works at Stages 4 and 5 and helps customer-facing managers and staff to quantify and optimize the trade-offs between demand-side choices in products, pricing, service levels and so on, and the resultant capabilities needed (and risks present) in the extended inbound supply chain.
One thing is for sure, commercial excellence has never been more important to business operations, and procurement needs to evolve its commitment management capabilities if it hopes to evolve its broader value proposition to the business.
In addition to his senior advisory role in Hackett’s Procurement Executive Advisory program, Pierre Mitchell is responsible for leading the firm’s intellectual property development in procurement. He has20 years of industry and consulting experience in procurement, supply chain and information technology. Previously, he was vice president of supply management research at AMR Research and has been recognized as one of the practitioner “Pros to Know” by Supply & Demand Chain Executive magazine. Pierre has led numerous supply chain and procurement transformations at Fortune 500 companies. He was also a manufacturing project manager at The Timberland Company, materials manager at Krupp Companies and an engineer at EG&G.
Getting a more detailed view
The Hackett Group is currently conducting a new open performance study looking at the procurement value proposition and capability assessment that enables companies to assess on a broader evolutionary scale both the value proposition of their procurement service offerings and also the capabilities needed to support them. The study is designed to help procurement organizations quantify the impact of their evolution and also to assess the best practices which could be used to accelerate transformation. Study participants will receive a customized report discussing the study results, and an analysis of significant shortfalls and insights from Hackett on how to close performance gaps.
For more information on the study, please either contact the author or visit: The Hackett Group