What makes some procurement organisations excel where others struggle to obtain results? What distinguishes procurement organisations that can weather volatile market storms, such as the current financial crisis, from those that are caught unprepared and by surprise? As the 2008 Assessment of Excellence in Procurement (AEP) study – the sixth in a series that dates back nearly two decades – reveals, some organisations are excelling at procurement despite market conditions, ever-increasing customer demands and the fierce battle for talent, to name but a few of the considerations weighing on the minds of CPOs today.
Almost 500 respondents were benchmarked against both their industry and geographic peer groups as well as best-in-class companies, based on a detailed scoring model of leadership practices in eight areas of procurement excellence (see Briefing box, page 49). From this, three key trends emerged in leading procurement practices, each of which are directly linked to the attainment of sustainable competitive advantage:
• Leaders are achieving a broader mandate to drive change.
• Leaders are developing dynamic new value-creation strategies to satisfy ever-increasing customer demands.
• Leaders continue to develop and maintain robust enabling capabilities in performance management, knowledge and information management and human resources management.
This article will explore each of these dimensions in more detail, showing how the practices used by the top 5 per cent of leading companies differ from the rest.
Dimension 1 | A broader mandate to drive change
Our study found that procurement is expected to continue to deliver significant value moving forward, which reflects the high regard for its potential impact on the underlying business compared to other functions. A number of external factors have increased the challenge of attaining (let alone increasing) cost savings, including supply continuity risks, globalisation, sustainability concerns, sharply fluctuating interest rates and inflation, regulatory issues, disruptive technologies and commodity scarcity. The fact that the leaders have continued to show improvement within such an environment makes their achievements all the more interesting.
Since the previous AEP study, followers have narrowed the gap in the percentage of savings achieved through sourcing, as they come to master the mechanics around tools and techniques. However, they are still losing ground to the leaders in terms of the percentage of spend under management. For instance, in direct materials leaders typically control two-thirds of external expenditure – twice that of the average firm. In indirect materials, the proportion is 73 per cent for leaders, 42 per cent for followers. And there are also large gaps in capital expenditure (77 per cent versus 50 per cent) and services (72 per cent versus 52 per cent).
By addressing a larger portion of the total corporate spend, leaders are yielding overall procurement-related savings that are 2.3 times greater than the followers. For a $20 billion company that could represent a 21 per cent advantage in earnings per share versus its competition. Procurement organisations that have demonstrated the ability to deliver these superior results have steadily gained prestige, which in turn has earned them increased responsibilities.
• Aligning with the corporate strategy. In half of the companies designated as leaders in our study, the CPO reports to the CEO or COO (versus 24 per cent for the followers). This close relationship with senior management helps to align procurement strategies with the overall corporate strategy and gives procurement a role in defining that strategy. Although 83 per cent of the leaders’ procurement organisations report that they have medium to high involvement in their companies’ strategic planning processes, only half of the followers are as heavily involved.
• Designing a new organisational structure. Today’s procurement organisation frequently follows a centre-led model that features common policies, approaches and practices for purchasing company-wide. For categories that traditionally represent the majority of spend – direct materials and capital expenditure – half of the leaders in our study employ a centralised model. However, in other less penetrated categories such as marketing, research and development, and legal services, leaders are taking a more flexible organisational approach to deliver the required benefits.
• Increasing strategic focus. Leaders focus their resources on strategic initiatives rather than transactional activities. Eighty-three per cent of the leaders minimise procurement’s involvement in transactional activities, compared with 70 per cent of followers. Almost all of the companies in our study anticipate that their procurement people’s skills will continue to take on more of a strategic bent over the next few years. But although the followers intend to devote 60 per cent of their resources to strategic work within two years, this will only put them at the same level that the leaders achieved two years ago – effectively placing them four years behind on the evolutionary curve.
A North American telecommunications firm undertook a transformation effort several years ago to make itself more competitive. Coming into the initiative, procurement was involved in a mere 30 per cent of the corporate spend and strongly focused on the tactical purchase-to-pay process. In announcing the shake-up, the company’s CEO declared that procurement had a mandate to handle all $9 billion of its annual spend.
With half of this in services, the announcement was met with some initial scepticism, but as the procurement team was reorganised into two key disciplines – sourcing managers who focus on sourcing projects and category managers who work on day-to-day operations and continuous improvement – and put to work with the business units and the finance function, it began to achieve powerful results. In three years, the procurement group had become involved in 80 per cent of the external spend base and delivered nearly 20 per cent in savings.
Dimension 2 | Dynamic new value-creation strategies
Companies that excel at procurement are extending traditional, time-proven practices such as strategic sourcing, category management and e-auctions to venture deeper into the supply chain to unlock value and even grow the top line. By going above and beyond the basics, initiating supplier collaboration and differentiating themselves through superior approaches to risk management, low-cost country sourcing and sustainability, leaders are able to create new value from procurement.
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• Taking sourcing practices to new heights. Leaders take a highly systematic approach to the application of traditional sourcing strategies, including volume concentration, best-price evaluation and global sourcing, as well as more relationship-orientated approaches such as product specification and joint process improvement, and relationship restructuring.
As shown in figure 1 (below), the gap between leaders and followers is most evident in volume concentration, global sourcing and joint process improvement. There is also a gap in the use of product specification improvement and demand management, although here both leaders and followers leave benefits at the table as a result of their inconsistent application of these levers.
Leaders are creating value by using sourcing and category management methods such as innovation network leveraging, product “teardown” (a common method of analysing competitors’ products), collaborative cost reduction, expressive bidding and price benchmarking, to name but a few, to a far greater extent than the followers (see figure 2 above). They are also better at balancing tried-and-tested and leading-edge procurement strategies.
Coca-Cola Enterprises employed a combination of supply, risk and demand management techniques in its strategic fuel management programme. With a fleet of 28,000 vehicles using some 60 million gallons of fuel annually, the company shifted key elements of purchasing responsibility from its 400 locations back to corporate headquarters in 2002, at a time when gasoline and diesel prices were less than one-third of recent levels. A dedicated cross-functional team developed and implemented a new strategy.
On the supply side, techniques were used to aggregate volumes, evaluate potential fuel sources, craft agreements, develop supplier relationships and use financial hedging strategies. On the demand side, routing improvements, new technologies and the introduction of a hybrid fleet all helped to reduce fuel consumption. Collectively, these changes helped the company to achieve sizeable cost reductions in 2007 while introducing new budget certainty through improved forecasting and compliance.
• Driving supplier collaboration and innovation. While sourcing has long been a cost-centric activity, leaders are redefining boundaries and reaping the benefits of true partnerships. The results achieved are meeting or exceeding their goals at nearly twice the rate of the followers in terms of supplier contributions to product and service innovation and faster time to market.
Leaders use a range of criteria to segment and evaluate suppliers as potential strategic partners. In segmenting its supply base of 34,000 firms, one leading consumer packaged goods company identified approximately 500 potential strategic partners – less than 2 per cent of the total. Only 6 per cent of companies (including the majority of leaders in our study) are deemed truly collaborative, however, employing shared common goals across the value chain to improve existing business and identify new opportunities (see figure 3 below).
• Unlocking value through risk management. Supply risk mitigation is key to leading organisations’ procurement strategies, and frequently a prominent metric for evaluating the function’s performance. Among our study leaders, more than eight out of 10 systematically use internal risk mitigation strategies to ensure supply continuity, develop category management contingency plans, align supply security with their overall business risk tolerance goals, and define, measure and track risk management and supply chain key performance indicators (KPIs).
Volvo’s 3P business unit – which is responsible for product planning, product development and purchasing for the Volvo, Mack and Renault truck brands – has made strong contributions to the Volvo Group’s profitability in recent years. A large part of this success can be attributed to the success with which Volvo 3P has used risk mitigation strategies to help contain costs despite rising prices for commodities like steel, rubber and plastic.
Appointing experts dedicated to market analysis and determining the impact of current prices on Volvo’s costs helped to convince the company to increase its sourcing from emerging markets. Supply guarantees, hedging strategies, disaster planning, continuous risk monitoring and the analysis of “mega-trends” (population growth and the development of alternative energy sources, for instance) were all factored into the division’s successful risk mitigation equation.
• Sourcing from emerging markets. Despite the potential risks, a focus on cost and margin improvement sees companies continue to source from emerging markets. To a far lesser degree, they are also emphasising these countries in pursuit of supply chain efficiency, additional capacity and even a cost-effective option to home-country environmental regulations. Eighty per cent of the AEP study participants are active in emerging markets, as are all of the leaders.
These leaders demonstrate that potential obstacles around emerging market sourcing (including quality, sustainability and intellectual property rights) can be overcome by actively engaging with and investing in suppliers. The ability to manage risk – through supplier process auditing, process risk assessment, high-quality data reporting and analysis, and the placement of key procurement executives in offshore locations – gives the leaders confidence that their emerging market sourcing activities will bring cost improvements without introducing excess risk.
• Sustainability and corporate responsibility. These have emerged as significant issues for the procurement function and are now factored into most companies’ corporate goals. However, there is still a long way to go until these goals are formally embedded into procurement strategies. Finding the right balance between economic viability, environmental awareness and social well-being is a significant challenge, but a competitive advantage can be gained by companies that locate intersection points for all three.
More than two-thirds of our study leaders are aggressively working with their suppliers on the sustainability challenge by defining and sharing their new requirements, employing supplier scorecards and KPIs, and extending their requirements and monitoring into emerging markets.
Sustainability leaders are differentiating themselves in a number of ways, be it through reductions in energy use and waste, taking on a holistic, future-orientated focus (Procter & Gamble and BASF), extending sustainability outward to the extended enterprise (Coca-Cola, Unilever and Newell Rubbermaid) or organising around a centre-led approach rather than reacting to local markets (Dow Chemical, Bank of America and Hilton Hotels).
For Wal-Mart, sustainability has broad economic and social components, including healthcare, economic opportunity and the quality of life of the people who make the products it stocks. The company’s commitment to sustainability centres on three aggressive goals: to be supplied 100 per cent by renewable energy, to create zero waste, and to sell products that sustain natural resources and the environment. The key focus areas for its sustainability efforts include paper, packaging, textiles, jewellery, electronics and chemical-based products – categories selected based on a combination of consumption and the volume of product sold.
Wal-Mart helps its suppliers to develop goals and set expectations, assist with knowledge around sustainability practices, and evaluate and manage results. Suppliers are expected to “do right” by workers and the environment, examine the entire product lifecycle in order to develop sustainable merchandise and significantly increase energy efficiency throughout the supply chain, especially in the area of logistics and shipping.
Key scorecard metrics include greenhouse gas emissions produced during manufacturing, the product-to-packaging ratio, packing cube utilisation, recycled material usage, renewable energy use at supplier facilities and raw material recovery rates. The involvement and commitment of the world’s largest retailer toward sustainability practices throughout the supply chain will accelerate the rate at which many companies come to adopt sustainability-focused practices.
Dimension 3 | A robust set of enabling capabilities
As procurement’s influence continues to expand, leading companies are introducing robust metrics to measure the function’s achievements. More than 80 per cent of the leaders in our study measure actual (versus just identified) benefits, perform audits of procurement benefits, examine the function’s impact on profit and loss, and track productivity performance indicators. Leaders have been twice as aggressive as followers in measuring procurement’s effectiveness in the areas of risk management, supply chain security, sustainability and innovation.
Leaders are using a similarly comprehensive approach to measure supplier performance, examining factors beyond cost savings and service-level KPIs and holding two-way evaluations. While 81 per cent of leaders are using supplier scorecards, only 39 per cent of followers are. And whereas 23 per cent of followers conduct two-way supplier evaluations, leaders are nearly three times as likely to do so.
• Fruitful use of technology. Despite the fairly widespread use of e-procurement tools and enterprise resource planning systems, few companies have fully implemented standard transaction processes across all of their spend categories. While more than half have standard operating processes for their receipt-to-payment, approval-to-order and requisition-to-order processes, less than a fifth report deploying these tools across each of the four major spend categories: direct materials, indirect materials, services and capital expenditure.
Leaders have taken spend visibility to the next level, linking systems to product development and product lifecycle management tools to further improve control and influence procurement decisions earlier in the design and decision-making process. With more than 70 per cent of costs determined during the product development phase, procurement’s involvement at this phase is crucial. Leaders are improving their business intelligence capabilities with respect to spend management, using techniques such as predictive modeling at a much faster rate than followers.
While e-sourcing tools have been around for more than a decade, and with most users reporting high levels of satisfaction with them, it is astonishing that nearly a quarter of companies in our study are not using them at all. Leaders hold, on average, more than five e-sourcing events per business day – a rate four times greater than that of the followers. “Power users” are approaching 1,000 events per year, including more than 50 annual advanced events such as collaborative optimisation or “expressive bidding”.
Contract management tools are also being embraced by leading companies. However, the biggest wave coming may be the use of collaborative workspace tools that support best practices in category management for those organisations that have dispersed or global footprints, mirroring the use of product lifecycle management tools by engineering and manufacturing functions.
An advanced source-to-pay system helped pharmaceutical company F. Hoffmann-La Roche succeed during a recent three-year procurement transformation programme. A single, global automated reporting system was created for both direct and indirect spend that helped it to achieve 3.5 per cent annual cost savings and more than 90 per cent compliance for indirect spend, automate more than 60 per cent of its overall procurement, and establish spend visibility over more than three-quarters of its direct and indirect spend.
• Winning the fierce battle for talent. Leaders realise that continued success depends on their ability to attract and retain the right people. They are working with universities and using internal transfers, as well as external agencies, to attract talented staff into procurement to a much greater degree than the followers. In order to retain this talent, leading companies rotate high-potential employees through different functions and geographies, offer substantial training, continuously monitor compensation levels and employ non-monetary rewards to supplement more traditional incentives.
Increased activity in emerging markets has created some new talent management challenges, including the availability of skilled people, knowledge of local markets, and language and cultural issues. Leaders are finding success by locating procurement executives closer to their supply bases – setting up international purchasing offices to more closely reflect the organisation and supplier footprint – and using executive recruiters to identify the best regional talent while also promoting international experience as a training and development opportunity.
An accelerated recruitment programme helped to transform the procurement organisation at Royal Mail, the national postal service of the United Kingdom, in just nine months. In the course of this project, Royal Mail turned over 60 per cent of its incumbent procurement team, adding people from traditional competitors in the shipping business as well as from a range of other industries. Performance-related pay became the norm and a robust training curriculum was introduced. As procurement became more professional, it rose from a department that attracted little interest from employees to a destination of choice. As a result, its overall performance rose disproportionately in comparison to other followers in our study.
Any benchmarking exercise only becomes of value when participants start to translate their individual findings into actions and ultimately into tangible results. A number of companies that participated in this latest AEP study have already significantly improved their performance compared with their results from previous studies. Some have used it to help raise awareness of their department’s capabilities at the senior leadership level and create the business case for change.
Frequently, CPOs use the results to “rally the troops” and reflect where their organisation is en route to fulfilling its potential. Others have taken action on specific issues that the findings made more visible, such as a lack of data transparency or more complex shortcomings in organisational alignment with other functions.
Such examples demonstrate that with a strong desire to reach leadership status, rapid improvements are achievable. Those followers that have been determined to improve, with a clear destiny in mind, leadership support and a comprehensive transformation programme in place have advanced disproportionately.
BRIEFING:
About the research
The 2008 Assessment of Excellence in Procurement research study was developed and conducted and the findings analysed by a global team from AT Kearney. This study, the sixth in a series dating back to 1992, included input from almost 500 procurement and supply chain executives across 28 different industry sectors. They were drawn from around the world, with 50 per cent coming from Europe, 38 per cent from the Americas and 12 per cent from Asia-Pacific.
Participants completed the survey online, with more than 600 evaluation points spanning eight dimensions: supply management strategy; organisational alignment; sourcing and category management; supplier relationship management; operating process management; performance management; knowledge and information management; and human resource management.
The 18 survey leaders, spread across four continents and 12 industries, represent the top 5 per cent of respondents and are defined as those companies with a) the top overall scores, and b) above-average overall performance in all eight dimensions and strong, world-class performance in at least three of them.
Wolfgang Steck (wolfgang.steck@atkearney.com) is a vice-president and Simon Rycraft is an associate in the procurement and analytic solutions practice of AT Kerney in London
