Capability development

Mastering the perfect storm

Leading procurement organisations are not only surviving today’s tough challenges, but pushing onwards in pursuit of greater value

Summer 2008

by Pierre Mitchell and Christopher Sawchuk

Third, poor internal process performance (weak collaboration, policies, process rigour, data management, performance metrics, etc) distracts staff from the mission-critical tasks at hand. Fourth, regulatory challenges in the value chain are driving prices up, availability down, suppliers out of the supply chain and compliance costs through the roof – keeping many from the safety they seek. And fifth, CEOs are asking for more growth, more innovation, and more brand enhancement (for example, in the guise of corporate social responsibility) but without higher costs.

Successful procurement organisations that have delivered year-on-year cost savings eventually see the end of this runway. Rather than simply trying to hold the gains through hedging and various supply assurance techniques, however, they are looking to evolve procurement’s value proposition in new directions. The question is: where next?

We’ve found that every procurement organisation  evolves its value proposition to the three additional levels of value shown in figure 1 (page 58): total cost of ownership reduction, demand management, and value management. While organisations don’t follow an exactly similar sequence or rate of change, they do tend to broaden their cost reduction focus to attack total lifecycle supply costs within their own inbound supply chains and then out to suppliers’. But the real “tipping point” occurs in the next two stages, and this is where world-class firms are primarily focused. While the first three stages are supply-centric, the final two shift procurement’s focus back more deeply on the customer. This helps procurement to gain the voice of the customer and “assurance of relationship” from the budget owners rather than just looking for assurance of supply. This, in turn, helps procurement to shape both consumption and supply drivers in order to help the broader organisation gain more value from its spend.

This is much more than a cursory “stakeholder management” process in a traditional sourcing methodology led by a cross-functional sourcing team; rather, it is making sure that spend owners are getting what they need from both suppliers and from procurement as a professional services organisation and internal supplier. 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 hidden parallel measurement system for procurement that’s different from the enterprise’s.

The strategic linkages take many forms: supporting post-merger synergy efforts, pushing into emerging markets, ensuring supplier diversity/compliance, tapping suppliers for technology and innovation, and advancing sustainability efforts. These are just some of the platforms that can be used to elevate procurement’s role and fund required capabilities such as improved contract management, market intelligence, supply performance scorecards and knowledge management.

These levels also build on each other and advance at different rates, depending on spend category, budget owner and operating model. If you can develop your model at least annually and also methodically self-fund your new processes, projects and capabilities, you will accelerate your evolution towards world-class procurement performance.

Of course, that is easier said than done. Such an evolution can easily take 5-10 years, since it is not just processes that need to be re-engineered, but also data, policies, job designs, governance structures, performance measures, relationships and – most fundamentally – procurement’s portfolio of business services.

The biggest issue that procurement organisations face in this voyage is misalignment between business requirements that are linked back to business strategy, the procurement strategy and operating plan to execute against those requirements, and the resources and capabilities needed for procurement to execute against the plan. If these are not aligned, procurement activities will be focused on the wrong goals, plans will be unrealistic and execution capabilities will be hampered by underfunded processes, weak information technology support and staff with the wrong skill sets.

A core skill of strong procurement leaders is the ability to find corporate imperatives that will provide their group with a platform for adding value to the business. Some noteworthy ones today are innovation, risk management and CSR (in which we include sustainability efforts). But all three pose significant challenges for procurement organisations.

Platform 1: Innovation

Procurement must innovate its own internal processes and capabilities so that it can help the rest of the organisation to tap the power of supply markets more efficiently and effectively to support broader corporate innovation efforts. Hackett’s recent Innovation in Procurement study showed that while 28 per cent of procurement executives rank innovation as a “top three” priority for procurement, it is a top three issue at the enterprise level twice as often – 56 per cent.

As a result, investments (and performance metrics) and capabilities in innovation management suffer within procurement. Roughly 70 per cent of executives believe there are shortcomings in their ability and approach to fostering innovation, and that they are not yet a partner of choice in this area – and therefore not tapping supplier R&D resources. Similarly, procurement may claim high spend influence numbers – a “quantity of influence” metric – but the “quality of influence” measured by early procurement influence during specification is less than 50 per cent.

The innovation challenge goes beyond just early involvement of procurement and existing suppliers, but also looking to fully engage employees, customers, academics, suppliers in alternative markets and others. For example, Procter & Gamble, with its “Connect and Develop” programme, increased the proportion of its procurement innovations 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, its now-defunct EV-1 electric car programme could have made GM a leader in the “green” vehicle market.

Platform 2: Risk

Risk management remains high on the corporate agenda because of its potential impact on the bottom line, market valuation and shareholder value. Boundaries between companies are increasingly porous, and together with globalisation and increasing market volatility make risk management more complex. And while the increased level of outsourcing to suppliers globally is a tremendous boon to harvesting supply market innovation, it does expose companies to higher levels of external supply risk. These include commodity price fluctuations, increased physical supply chain risks, intellectual property risk, and regulatory and sociopolitical risk. In this context, strategic sourcing and supplier management processes become an even more critical corporate capability.

Procurement organisations are trying to anticipate where customers are steering them while at the same time trying to protect themselves from supply risk and deliver cost savings and other benefits. As such, supply intelligence becomes critical. World-class procurement organisations place a higher importance on market analysis and supplier analysis skill sets than their peers, and they also back it up with action, including nearly 36 per cent more hours of annual training.

Yet, few companies have upgraded their capabilities in global risk management, instead continuing with the models that worked in the past. This is a dangerous assumption, since reactive risk management is unsustainable and unacceptable in an environment of ever-increasing volatility. This is why proactive supply risk management is a best-practice area that is being woven into broader supply management processes. Traditional supply market segmentation methodologies used in strategic sourcing and supplier management are now being expanded beyond supply market complexity (itself really a proxy for supply market risk) and spend size to one of broader supply chain risk and overall business impact.

This approach allows firms to get a better handle not only on the business impact that their supply chains can have on financial performance, but also the underlying complexities that are contributing to this risk potential. In the former case, Boston Scientific, a US manufacturer of medical devices, reports a “revenue at risk” figure at the executive management level to provide awareness of the effect of supply chain risk on the business. In the latter, telecoms giant Motorola has used a “complexity index” to help track complexity in both product design and the inbound supply chain. To support this broader and deeper focus on risk, companies wishing to achieve world-class procurement performance should be looking to create a strong supply intelligence capability (see figure 2).

This capability supports cost reduction (through better negotiations or collaboration) as well as better risk mitigation and recovery efforts. Although this capability is hard to build, it can be made more efficient and effective through smart investments in process design, training and technology, whether internal or – as packaging specialist MeadWestvaco and engine maker GE Aviation have done in their supply chains – using outsourcers for certain sub-processes or spend categories.

Over time, procurement will need to work more intensively with executives to help them quantify and optimise the trade-offs between demand-side choices in products, pricing, service levels, and so on, and the resultant risks present in the extended inbound supply chain, some of which need to be hedged in line with the firm’s risk-reward tolerance. This broader involvement in risk management will require overcoming the top five supply risk implementation barriers:

• a lack of senior management awareness and commitment;
• no well-defined process and organisational accountability;
• a lack of tools to support the process;
• difficulty in getting access to fragmented intelligence;
• a lack of funding.

Doing so holds the promise of great financial rewards. Hewlett-Packard’s procurement risk management (PRM) programme has focused primarily on price and availability, but has also reaped impressive financial benefits, with cumulative savings (through 2007) of $500 million on $25 billion of spend.

Platform 3: Corporate social responsibility

To help support corporate social responsibility (CSR) objectives, procurement can take a leadership role in demand management (for example, energy management programmes) and supply management (for example, supplier diversity programmes, ethical supplier certifications and early supplier involvement in “green” initiatives).

In a recent Hackett Group survey, 49 per cent of respondents described CSR as a major initiative sponsored at the board level, while a further 36 per cent said it was among the key issues on their agenda. Nearly two-thirds said CSR was part of their corporate DNA, half described it as part of their brand value, and 41 per cent said their customers expected it. But less than a third believed it provided direct economic value.

Clearly, CSR is taken seriously at the company level, and this mandate is trickling down to the functions, but it is not so deeply embedded at the operational level. While just over half of respondents say CSR is embedded in sourcing processes and policies, only about a quarter say it is a primary aspect of supplier selection. For around half, it’s only a differentiator in supplier selection where other things are equal; and for the rest, CSR is not yet considered when choosing suppliers. »

CPOs can take a leadership position here, but also harness the power of more advanced suppliers, customers and non-governmental organisations to create a platform for change. Quite often, some innovative work has already happened within supply organisations that can be used as a catalyst for better internal recognition, funding and management support for more activity.

Building capabilities to weather the storm

While the “promise of the brand” of a more evolved procurement organisation is compelling, it rings hollow without the capabilities to deliver. A culture of execution is a hallmark of a world-class procurement organisation and requires strong capabilities not only in core processes such as sourcing, purchase-to-pay and supplier management, but also the supporting “operating model” and “resource management” processes that power ongoing transformation. To help firms assess and develop their capabilities in these key dimensions, we created The Hackett Group Procurement Capability Model (see figure 3). It is a diagnostic guide that maps back to the value proposition model and uses four capability levels – reactive, planned, aligned and strategic – that in turn map to the following three major process areas:

• Operating model processes: Specifies the support system for effective core procurement processes. If organisational governance, performance measurement/improvement and strategic alignment are weak, the seeds of success have not been sown.
• Core processes: Includes the “source-to-settle” processes that deliver value, whether these are routine purchase-to-pay processes or high-value activities such as innovation and new product development and introduction support.
• Resource management processes: Focuses on talent and the technology resources that power core processes. Investments in talent and technology need to be commensurate with the value of the processes that use them. Often we find that companies overfund their transactional processes but underfund the strategic ones. Talent and technology must deliver sufficient return on investment (ROI) to deliver value back to the business.

As procurement moves beyond the tactical buying value proposition to total cost of ownership reduction, and ultimately to demand management and value management, it is building the capabilities that will allow it to execute against increasingly sophisticated and aggressive strategies and plans.

The importance of a good operating model and resource model can’t be emphasised enough. In the Six Sigma parlance of “DMAIC” (define/measure/analyse/improve/control), they spend too much time on how to best control processes, but not enough time answering questions such as:

• Are we working on what spend owners value most?
• Are we measuring procurement, the supply chain, spend categories, suppliers and employees in an integrated way to align to these broader priorities?
• Are we using a broad continuous improvement toolbox, or is it a strategic sourcing methodology hammer looking for a nail?
• Are we investing enough in the right approaches and resources to accomplish this?

When organisations do try to break through their performance plateaus, they’ll often ask questions such as “how can I own more spend?” and “what’s the best organisational structure for procurement?” These are the wrong questions. Procurement service delivery/operating models should be tuned to business needs, not force fitted and seeking to own all those who are doing procurement-related processes.

This is not to say that there aren’t some emerging organisational trends. For example, increasingly procurement has four main “service lines” (or sub-functions) reporting to the CPO:

A customer management function to manage spend owners and ensure they get the best value from both procurement and from the supply base. This is organised around the customer (eg, regionally and/or by business unit).

• A sourcing and supplier management group to deliver the core value of supply management services (usually through a centre-led type model).
• A purchase-to-pay function to deliver transactional excellence (increasingly through shared business services delivery organisations at a global or regional level).
• A performance excellence group that focuses on the operating model and resource management areas such as metrics, methodologies, training, systems, benchmarking and other such transformational capabilities.

The first two areas are critical to ensuring alignment with the spend owners, and the payoff is compelling. Companies that have a high involvement of procurement during enterprise-level planning and budgeting processes achieve a 6 per cent higher operating margin relative to the industry average, whereas those that have only low or medium involvement underperform their industry average by 26 per cent. This is because they have full demand visibility and bring their (and their suppliers’) whole arsenal of capabilities to bear, rather than scrambling to salvage some minor gains from late-stage negotiations. We call this “quality of spend influence”, as opposed to “quantity of influence”, which is measured only by being involved in the tendering process. An innovative method of early influence is performed by BD (Becton Dickinson – a global medical technology company). As part of its annual worldwide procurement conference, it invites dozens of stakeholders to take part, in order to ensure joint planning and alignment. Indeed, of the 120 staff who typically attend, half are from outside the procurement organisation.

Once procurement gets this early involvement, it can help the business to figure out the optimal way to source and manage the processes in question. Issues that can be resolved more effectively will include:

• in-house versus external supplier;
• onshore versus offshore versus nearshore;
• skill sets required relative to existing talent;
• information required relative to existing IT capabilities;
• understanding the relationship between technology and talent (both of which are supply markets unto themselves), because we feel the “knowledge management” intersection between them has the potential to help overcome the crises that both individual areas face right now;
• organisation model (eg, local v corporate v shared services).

We call this “business process sourcing” (ie, how to best source processes with the best talent and technology) and believe that it is a critical area where procurement will either take a forward leadership position or else be relegated to late-stage sub-processes. If nothing else, procurement should certainly be looking to do this within the procurement organisation itself, where outsourcing and offshoring levels have lagged behind other functions such as IT, HR, and finance.

*****

Procurement must help the business to understand that the greatest ROI comes from greater alignment and delivery along the value evolution model – beyond price/cost savings towards harnessing supply market power to wring maximum value from spend. It must also be deliberate in how it builds its service delivery model and the capabilities to deliver on the “promise of the brand” of the new procurement function. By doing so, it will move beyond the “batten down the hatches” response to the perfect storm to take control in search of the competitive advantage that exists in today’s global supply markets.

FURTHER RESEARCH:

Getting a more detailed view

The summary view of the capability model presented in this article is diagnostic, rather than prescriptive. Business strategies and culture, as well as critical challenges and talent shortages, will determine short-term and long-term priorities in individual cases.

A more detailed version of the capability model is available to companies that would like to plot themselves against their peers as part of Hackett’s Procurement Value Proposition and Capability Assessment, which is currently under way. The study will also draw from Hackett’s functional benchmark data to provide additional performance insights. 

For more information on the study, please either contact the authors or go to www.thehackettgroup.com/expertise/procurement.jsp#PerformanceStudies

Pierre Mitchell (pmitchell@thehackettgroup.com) is a director and Christopher Sawchuk (csawchuk@thehackettgroup.com) is procurement practice leader at The Hackett Group, a global strategic advisory firm, based in Miami