The results are clear. Five years ago, senior executives mainly expected cost reduction from procurement, 3:2 in relative importance compared to value creation. The latest AT Kearney Assessment of Excellence in Procurement study reveals that this gap is rapidly closing. When asked about the future, CEOs are expecting just as much from procurement in terms of value creation as from cost reduction – almost a 1:1 ratio. The world’s leading procurement organisations are already prepared for this challenge and have put in place a number of best practices to address value beyond traditional cost-cutting.
The percentage of companies with goals in value creation through procurement increased from 28 per cent in 1999 to 66 per cent today, according to our study of procurement practices at more than 270 large international companies across 25 industries, the fifth such study since 1992. It found that CEOs see value capture from the supply market as the largest challenge their company faces in procurement.
The function continues to shed its back-office reputation, with 50 per cent of companies now using their procurement expertise to shape and advance corporate goals. Two years ago, only 38 per cent of procurement time was spent on strategic activities. This has increased to 53 per cent currently and is expected to grow to 68 per cent within the next two years.
Procurement has also gained access to the boardroom: two-thirds of companies have at least one senior procurement specialist on the executive management team – an increase from 40 per cent in 1999.
The study shows four key approaches emerging for procurement value creation at leading companies. First, they commit to innovation by involving suppliers in product and service development at an early stage, as well as by systematically leveraging their capabilities across all stages of the product or service lifecycle. Second, they perform value chain optimisation by crafting strategic supplier relationships and by outsourcing non-core activities.
Third, leaders distinguish themselves from others through the application of advanced cost management techniques to influence the total cost of ownership. Lastly, they recognise supply continuity and risk management as strategic issues, requiring management attention and preventative action. Companies willing to fully leverage low factor costs must also be capable of addressing supply risks and helping suppliers to reach a certain level of operational excellence.
These four approaches require a closer organisational alignment, enhanced performance metrics and benefits tracking, more integrated IT support and greater skill sets. The following sections illustrate in more detail what really differentiates the leaders from the followers.
1. VALUE CREATION
Innovation and growth
Companies commit to innovation in order to meet customer demands and reduced product cycle times. Procurement leaders select and develop suppliers based on their potential for future innovation and value creation. Three-quarters of the companies surveyed indicated that they leverage suppliers’ innovation capabilities to generate value and redefine the relationships.
An important measure to foster innovation is the early and frequent involvement of suppliers in the product and service development process. Here, the mass manufacturing industries are significantly leading the way: 53 per cent of automotive companies already involve their key suppliers in the earliest stages of the development phase, whereas on average this is only the case for 20 per cent of all other companies. This number rises to 65 per cent of automotive companies that integrate their suppliers in the prototyping phase, while the other industries lag behind with an average of 37 per cent of companies.
A great example of this is the collaboration of BMW and Hella that developed new “light rings” in the front headlights, enabled by new flexible optical fibre technology. Besides having performance advantages, these new headlights also enable BMW cars to be differentiated further, especially at night, thus strengthening the car’s brand.
Companies that have been ranked as “procurement leaders” in the comprehensive evaluation process of the study show a particular commitment to innovation. Leaders expect innovation from their suppliers and seek their involvement in future products and services. They also give suppliers incentives to focus on innovation and measure the level of supplier contribution to it.
Value chain optimisation
As companies focus on their core competencies, it becomes increasingly important to optimise the value chain and utilise it as efficiently as possible. Concentrating on activities that make best use of company assets helps to fuel growth without investing capital. To achieve this, outsourcing is a widely used tactic. Companies have realised that procurement brings great value to the outsourcing process through detailed supply market knowledge. Sixty-one per cent of companies look for procurement to identify activities to be outsourced and conduct a make/buy analysis. Almost 90 per cent rely on procurement to negotiate, select and contract with outsourcing suppliers.
Particularly advanced in the area of value chain optimisation is the consumer electronics sector. Faced with rapidly changing technologies and seeking volume leverage, the established consumer electronics firms started to source their manufacturing and assembly capacity needs from suppliers such as Solectron and Jabil, which have put themselves together from parts spun off from the electronics firms. Some companies, such as mobile phone manufacturers, even outsource the complete design, manufacturing and sourcing of some of their handsets.
In order to make best use of the value chain, leading companies highly leverage their supplier and partner relationships. Leaders manage their key supplier initiatives using a systematic process, with 72 per cent of leaders and only 33 per cent of other companies implementing cross-functional teams from both companies. More than half of the companies have a scorecard in place to cover performance metrics and service levels, and have regular review meetings with their key suppliers.
A major US airline, which owned more than 70 per cent of its own fleet, was faced with a critical question regarding who should “own” two important tasks: line maintenance and heavy maintenance. It launched an in-depth analysis addressing its and the suppliers’ competencies in these areas, in order to determine the most favourable structure. The result was that the airline would handle the line maintenance to keep the turnaround time low, while heavy maintenance would be outsourced to another provider under the concept of “power by the hour” – only paying for the running hours. Improving turnaround time by 20 per cent and cutting heavy maintenance costs by 30 per cent helped to differentiate the airline from its competitors.
Advanced cost management
Companies with successful procurement organisations that have applied an ever-increasing price pressure on their suppliers are now reaching the limit of further cost reduction. Basic cost-saving approaches therefore need to be complemented by more advanced concepts. These advanced cost management techniques are more complex and therefore require greater internal and external collaboration to succeed. This area shows a strong gap between companies leading in procurement and those only following. While leaders apply a portfolio of new techniques to address the total cost of ownership and create an advantage, others still struggle with the basics.
Rationalising specifications, for example, is systematically used by 83 per cent of leaders but only 36 per cent of other companies. Collaborative cost reduction with suppliers, including risk and savings sharing, is applied by 78 per cent of leaders and 31 per cent of the others. Advanced concepts involving strong cross-company and cross-functional co-operation such as “design to cost” – an analysis to achieve an optimised specification and quality – have not yet penetrated procurement organisations and are applied by only a quarter of companies. Lastly, leaders differentiate themselves from followers by constantly redefining the combination of advanced sourcing levers to continuously achieve year-on-year savings.
In order to get the most out of their procurement efforts, many companies need to systematically apply compliance management approaches to ensure that benefits are realised. More than 60 per cent of companies have an IT system in place that enables them to track and report the benefits achieved. These companies are also able to compare the benefits achieved to the benefits identified, and understand the variance. Almost 70 per cent are able to demonstrate the profit and loss impact of procurement.
Compliance management has also been successfully established, with more than 70 per cent of companies monitoring compliance and taking corrective action. However, a “closed-loop” spend management process that identifies, evaluates, addresses and controls all value drivers and potential destroyers and leakages is only in place for 53 per cent of the companies surveyed.
Risk management and supply continuity
While supply chain optimisation, including supplier consolidation, global sourcing and just-in-time, has greatly increased efficiency in recent years, it has also increased supply risks. Almost all companies (90 per cent) have recognised business continuity risks as a strategic issue, and 76 per cent have already implemented processes to scan for and develop response plans to these risks. However, only 40 per cent have actually implemented a procurement strategy that covers business continuity, and more than half of companies do not have contingency plans in case of supply discontinuity for all or most of their categories.
Over the past few years, there have been an increasing number of new important risks affecting corporate operations. While more than 60 per cent of companies still see traditional risks such as government regulation and legal decisions as important, this number has significantly decreased from our previous study in 2003. Emerging risks, strongly connected to the world moving closer together – theft of intellectual property, terrorist attacks, security threats to employees and assets, and so on – concern an increasing percentage of companies, today almost 30 per cent.
The strong reliance on suppliers through single sourcing and lack of contingency plans for critical parts and components results in lost production and revenue if an important supplier falls victim to any occurring risk. Future supply disruptions may also occur because of disruptions at transit “chokepoints”, as many important sea routes need to pass geographically and politically unstable bottlenecks. Companies therefore need to prepare contingency plans covering risks at supply locations as well as important supply chain nodes.
The dramatic increase in sourcing from low-cost supply markets such as China, eastern Europe and India is also connected with high risk, as it has not been matched by knowledge and understanding of these markets. Companies are chasing offshore sourcing savings but they are not effectively evaluating the risks or cultivating the necessary skills associated with overseas sourcing efforts.
By 2009, 72 per cent of companies say they plan to source from China – a rise from less than 30 per cent in 1999. Fifty-nine per cent plan to source from eastern Europe by 2009, an increase from a third five years ago. And half of the companies surveyed plan to source from India in 2009 – nearly a threefold increase.
Yet companies surveyed indicate that they are not prepared to effectively manage increased sourcing from low-cost countries. Just 41 per cent make emerging market skills and language capabilities a high priority for their sourcing organisation. Only 53 per cent have category strategies that include a clear understanding of supply chain and logistics costs when comparing emerging market alternatives. And just 39 per cent have formal plans in place to increase their supplier base from global sources.
Leading companies have set up international purchasing offices (IPOs) with multi-functional capabilities to develop suppliers in quality management, production technology and other areas. By contrast, the followers set up IPOs just to source the materials or services, which are not always up to the expectations of the rest of the organisation.
2. ORGANISATIONAL ALIGNMENT
In order to implement the approaches mentioned, the procurement organisation must have the necessary mandate and capabilities. Aligning the organisation means defining and communicating the accountability and authority for policy, strategy, execution and management of procurement to deliver value from external purchases. It also means ensuring that appropriate linkage exists with other company functions to embed procurement capabilities into key business value creation processes.
This has led to a realignment of the procurement function in many industries. In some automotive companies, procurement has been merged with the engineering function. In the high-tech sector, procurement is responsible for the functional design, contract manufacturing, supply chain and quality management of certain system components.
To address corporate synergies, the centre-led approach has established itself as the most common procurement organisation structure. Today, 68 per cent of companies are using such an approach, up from 42 per cent in 1999. It is used to help drive a company-wide adoption of common policies, approaches and practices. These procurement functions have been set up across more than three-quarters for category, spend and supplier management, as well as target setting and performance management.
3. CAPABILITIES
IT and knowledge management
Many advanced techniques require the use of sophisticated information and knowledge management tools. These tools have specific functionality for procurement use, but they also cut across many functional areas and help to facilitate collaboration. Leading companies have found a way to fit these key IT components together into a complete system solution for category management. The amount of IT support in the different stages of a product greatly varies between the leading companies and all others. The phase of product development lacks strong IT support, and this is connected to the low involvement of procurement at this stage.
For example, product lifecycle management tools are applied by 26 per cent of leading companies, but by only 12 per cent of others. For the strategic sourcing phase as a key component of strategic procurement, more tools are available and applied. This includes market analysis, e-RFX and internet negotiations/auctions, supplier selection and contract creation. Nevertheless, leaders are way ahead of other companies, with 48 per cent of leaders and only 17 per cent of the others using IT tools for market analysis.
The tactical execution of procurement is widely supported through IT, but not consistently by most companies. While 90 per cent of companies have automated at least a part of their requisition-to-pay processes for one of their spend categories, only 28 per cent have full automation for all four categories of spend: direct, indirect, capital expenditure and services.
Performance management is the fourth and last part of the procurement cycle. This consists of closed-loop spend management, contract management, supplier performance management and savings tracking. While most companies are aware of the importance of these areas, the tracking possibility is strongly influenced by the underlying IT structure, which is not always satisfying in scope. Spend management provides the basis for any procurement performance management, and IT support is only implemented for 69 per cent of leaders and 45 per cent of followers.
Processes and measurement
Having the right strategies and approaches is not enough: execution also requires the right formal processes and measurement techniques. Procurement leaders understand the importance of consistent quality across the entire process. Looking at outsourcing, for example, 56 per cent of leaders and only 37 per cent of other companies monitor supply market changes using a formal process; 83 per cent of leaders conduct a make/buy analysis formally, compared with 59 per cent of the others; and 94 per cent of leaders recognise the importance of, and have established, a formal process for tracking and reporting the performance of any outsourcing activities, whereas this is only the case for 62 per cent of all other companies.
Procurement leaders also measure a wider set of key performance metrics, which greatly increases their chances of improvement in those areas. For example, while 94 per cent of leaders measure quality, only 70 per cent of other companies do. While 89 per cent of leaders use compliance as a procurement metric, only 70 per cent of others do. Leaders are also measured on the amount of supplier contribution to innovation. In addition, leading companies align and agree upon metrics with other functional areas.
Human resource management
Without the proper skill sets among its procurement employees, the organisation cannot achieve goals in value creation. Leading companies are now challenged with attracting and retaining people to execute the advanced strategies, which increases the “war for talent”, as these individuals are in high demand generally.
The talented individuals must possess a strategic mindset with strong business focus, enabling them to work with and impact business processes, stretching from product development/engineering/new services development through manufacturing and sales, customers and after-sales service. All companies see their talent base as important, with 81 per cent of companies planning to upgrade the skills of their procurement staff.
While traditional procurement skills such as sourcing methodology, supply market analysis, supplier cost analysis and negotiations are valued highly by almost all companies, non-traditional skills required for new approaches are mainly valued by procurement leaders. For example, 89 per cent of leaders versus 64 per cent of others train for project management; and 94 per cent of leaders train for operational improvement techniques versus 28 per cent of others. Procurement leaders also value more highly general business skills such as finance and accounting – 89 per cent of leaders train for these skills, compared with 52 per cent of others.
Overall, leading companies do a better job of developing and tracking the skills of their procurement employees.
4. SUCCESS
The efforts and investments of leading companies into procurement are strongly rewarded. Leading procurement organisations outperform their counterparts in generating savings and driving those savings to the bottom line.
Across all spend categories, leaders earn average annual savings that are about twice as high as the savings of other companies (see figure 2, below). The largest gap is in services, where leaders reach average savings of 9.8 per cent over two years, while others only achieve 3.6 per cent. Procurement leaders also achieve success at the bottom line: they all outperform their industries in net income margins every year.
