Being the head of procurement is no picnic when business is booming. When the rest of the management team is concentrating on growing the business, procurement risks being seen merely as a tool for cost reduction. Changing your peers’ perceptions of the value that procurement can bring to the business is a real challenge for most CPOs at any point in the economic cycle, but is particularly difficult in the up-cycle. So how do canny CPOs turn this situation to their advantage?
Reducing cost is core to the traditional expectations – and, to be fair, capabilities – of procurement. In times when the overall business is not so good, the procurement star waxes as an integral part the overall cost reduction challenge. This is the down-cycle: a sustained period during which reducing cost is a necessity. Usually the down-cycle is the result of cyclical contraction, such as those seen in the steel and electronic components markets. However, down-cycles may also be triggered in times of growth by aggressive procurement tactics by your customers that keep the pressure on costs – just ask any supplier of hard-discounting retailers like Wal-Mart. Procurement in many industries has become the mechanism by which companies pass the pain of deflationary pressure on to their supply base.
When everyone else in the company wants to save money too, it becomes easier to move beyond just getting a better price. Those who spend the money are more willing to engage around tackling the drivers of complexity, cost and demand. The down-cycle should be a boom time for procurement, when CPOs have the opportunity to build the capabilities to tackle those underlying drivers of spend.
Most of the procurement legends occurred in industries that had severe enough challenges to make this journey worthwhile. The classic examples of this are from the automotive industry, where vehicle makers Chrysler, Ford and General Motors all had different responses to the threat of Japanese competition from companies like Toyota and Honda. Chrysler’s Score programme institutionalised continuous cost reduction in their suppliers; under the late Gene Richter, Ford developed sophisticated sourcing strategies for every spend area; and under J. Ignacio Lopez, General Motors infamously saved a billion dollars in 1992. Whatever their methods, these classic down-cycle stories were all built on the absolute necessity to reduce cost as a strategic priority for the business.
The uphill up-cycle
The up-cycle is very different: the business is focused on growth, and cost reduction slides down the agenda. Any down-cycle success procurement may have had in cost reduction pigeon-holes the function as only able to help reduce cost (oh yes, and ensure supply). Other functions are less willing to invest management attention in addressing what they are buying and how to buy it better. Without their engagement, procurement is limited to just getting a better price without changing any of the fundamentals. Even switching suppliers becomes much harder, which has a double whammy effect on competition between suppliers. In effect, procurement is put back in the cupboard to deal with suppliers and not bother the rest of the organisation as it gets down to “real business”.
But suppliers still hold many levers that are critical to the success of a growing business, such as the capacity to grow, funds for growth, economies of scale, time to market and access to innovative ideas. The key for procurement to survive the up-cycle is to become the channel by which these levers help the overall growth agenda.
There are three plays that CPOs can try to ensure that procurement stays on the top management agenda when the business turns a corner: supplier-driven customer value, growth through acquisition, and value of growth.
THE SUPPLIER-DRIVEN CUSTOMER VALUE PLAY
Although they say you can never be too rich or too thin, not all CPOs are fortunate enough to be in a business where cost remains a top priority during the up-cycle. Particularly in industries where supplier spend as a proportion of sales is low – such as marketing-intensive consumer goods or pharmaceuticals – or where leverage with suppliers is low, a more subtle approach is necessary.
In these cases, other growth priorities are required, such as: securing preferential access to supplier capacity; linking suppliers into the supply chain to increase service; being first in the queue for the best supplier innovations; or reducing time to market. Historically, mobile phone operators have driven their supplier relationships in this way. The value of growth is still real for suppliers, but it can be captured through other benefits.
Non-savings goals require a different form of relationship with suppliers than is required in pure cost reduction. The normal down-cycle challenge of balancing competition between suppliers with the complexity of managing multiple supplier relationships can be relaxed – at least until the next down-cycle. A critical success factor for a non-savings agenda is setting the right goals and measuring results, so that improvement can be driven along different dimensions and relationships with suppliers can be developed in multiple different ways.
THE GROWTH THROUGH ACQUISITION PLAY
Another occasion when procurement directly supports a growth strategy is during and after a merger. In situations where similar companies are being acquired, savings to be delivered by procurement can be up to 60 per cent of the total synergy value from the deal. Even in mergers that are mainly justified on revenue-side synergies, procurement can account for 20-30 per cent of the total value of the deal: usually enough to pay for the acquisition premium.
The programme to capture these procurement synergies often lasts for two years, and gets procurement through a significant proportion of the up-cycle. This is also an excellent opportunity for CPOs to stay close to the heart of the top management agenda while it lasts, since the merger’s (and the CEO’s) success is judged on how well the business was able to capture the promised synergies.
For example, when global drinks giants Diageo and Pernod Ricard acquired Canada’s Seagram Wine & Spirits Group in late 2000, this was a trumpeted as an opportunity for all concerned to build stronger brand portfolios with better distribution into the US retail trade. Implicit in the value of the deal was an assumption that a substantial proportion of spend with suppliers would be saved. The combination of companies gave additional supplier base consolidation opportunities, much like the “value of growth” play (see below).
However, while rationalising the manufacturing and distribution network inside the newly merged entity, many issues that added complexity to the business were also considered. It was therefore possible for procurement to table and agree with marketing colleagues a series of measures that reduced the overall complexity of the packaging portfolio, further reducing the cost to suppliers. Under “normal” circumstances in such brand-driven companies, it would have been extremely difficult for procurement to gain agreement for such opportunities, but the need to secure the value of the deal broke some of the usual constraints.
THE VALUE OF GROWTH PLAY
The first line of defence for a CPO during the up-cycle is persuading peers that continuing pressure on prices is integral to the growth strategy. By capturing the “value of growth” in the supplier base, the business has additional funds with which to further accelerate growth.
If the rest of the management team can be persuaded of the value of growth play, the logic is compelling. As your business grows, so do your suppliers, particularly in direct materials for industries that deal with physical products. This changes the underlying cost for the supplier to manufacture and distribute their goods, because their factories and warehouses are more utilised. In other words, they are spreading their fixed costs over more business, so their unit cost falls. Even if they invest in additional capacity, there are still economies of scale.
One of the best examples of using the value of growth play to turn up-cycle procurement to overall strategic advantage can be seen in some of the larger, more price competitive retailers such as Wal-Mart, Tesco and B&Q. These retailers use procurement as an integral part of their growth strategy, to fund new store openings or additional price reductions for consumers. The combination of using the classic procurement skill of understanding the dynamics of supplier costs with the negotiating clout to change supplier pricing policies can be irresistible for most suppliers.
Capturing the value of growth is actually essential to the retailer strategy: if the retailer does not capture it, the suppliers may use the retailer’s hard-won growth to subsidise business to competitors. This combination of growth and differential supplier pricing can reduce the price paid by retailers so far below the normal market price that there is a real competitive advantage for the retailer. They have created a virtuous circle where they use the consummate cost capabilities of procurement to capture the value of growth from suppliers, and use the money to fund more growth while hampering the competition.
Thriving in the up-cycle
Some CPOs are tempted to get out of procurement while the going is good, and move functions when they sense the bottom of the cycle. However, the up-cycle offers opportunities for forward-thinking CPOs to lead their function into a new space. Whichever play is available to you, the following five priorities will help you position the procurement function to maintain a place on the top management agenda – and avoid watching the business grow from the inside of a cupboard.
1. Find the appropriate hook into the top management agenda. It is essential to establish a clear link with top management between the company strategy and how procurement can help to drive it, so that procurement has a mandate to play a role that supports growth. It often helps to use a different language to describe the procurement value proposition, moving away from “savings” and towards “funding growth”, “value creation” or “competitive advantage” to resonate with the overall strategic agenda. For example, at one fast-growing healthcare products manufacturer, where procurement spend was a low percentage of the overall cost base, procurement made a breakthrough with top management by offering to offset the effects of wage and property cost inflation across the company, thereby ensuring that the company kept the value of its own growth.
2. Use the positive growth story to create and share value with suppliers, and to secure privileged access to capacity and innovation. Growth is valuable for suppliers as they reap scale and utilisation benefits in their operations, and this should continue to be shared or captured to avoid your efforts to grow potentially benefiting your competitors. Suppliers are also important engines for growth, both as sources of competitive advantage (such as accelerating time to market or accessing market-leading ideas), and also as potential sources of preferential access to capacity.
3. Reposition procurement with stakeholders as a channel for total supplier value. Functions that consume strategic goods and services, such as marketing, R&D and IT, need a procurement function to help align the supplier base to their strategy. So, procurement should tailor its language and value proposition for each key function, and organise itself to build internal relations and get involved in the many day-to-day decisions that affect procurement. For example, talking with marketing about “savings” or “leverage” in the context of their creative agencies will not secure influence over how to structure the supplier relationship. In anticipation of future down-cycles, use this influence to limit the additional complexity costs created through the proliferation of specifications.
4. Shift the emphasis of the procurement organisation away from centralised buying to be closer to internal stakeholders. Physically position procurement people close to the stakeholders, to maximise their chances of involvement in day-to-day discussions. This probably means moving away from a central or lead buying model designed for maximum leverage over suppliers. If necessary, use the top management mandate to ensure access.
5. Do not assume that the good times will go on forever. All good things come to an end, so avoid making commercial commitments that would tie you to a course of action that would be undesirable when the cycle turns. A critical part of successfully navigating the up-cycle is preparing for the next down-cycle. In addition, having organised procurement with explicit interface roles dedicated to each stakeholder not only ensures influence over key decisions in the up-cycle, but positions procurement to influence the drivers of cost and demand in future down-cycles.
Being well prepared for the up-cycle can lift procurement from being pigeon-holed as useful cost cutters into critical contributors to the growth agenda, and the role of CPO into one that is valued in all parts of the economic cycle.
Although for many companies the value of procurement is not as crystal-clear and focused in the up-cycle as it is with discounting retailers, there is always competitive advantage that suppliers can deliver with the appropriate shepherding from an up-cycle-tuned procurement function.
Hugh Baker (
baker_hugh@bah.com) and
Simon Harper are principals in Booz Allen Hamilton's global operations practice, based in London
