Research

Winter 2011-12

As economic confidence continues to falter, procurement organisations are under pressure to drive costs down rather than pursue strategic supplier relationships

By Rima Evans

A deterioration in economic confidence sparked by events such as the Euro crisis and ongoing fragile global economic conditions have left their mark on the latest CPO Agenda six monthly economic survey.

While cost is an issue that has never gone away, there are signs that economic pressures in certain areas are creeping back.

As a result, the outlook of procurement professionals in this survey, compiled last month, is gloomier than six and 12 months ago, when we reported that activity was focused on growth and value adding rather than cost cutting alone.

Roger Reading, contracts and procurement manager at GHD, based in Australia, who participated in the latest survey, admitted: “The financial conditions are a lot worse now in that solutions applied before may no longer be available to us. We need to dig deeper this time around.”

Reading, who spent four years working in senior procurement roles in the Middle East before taking up his new role in Perth, has also been feeling the effects of regional issues. He told CPO Agenda: “The situation is made worse by the corruption and politics of the Middle East that are no longer cushioned from exposure. This will affect companies a lot quicker this time around.”

Although the causes of a dip in economic confidence are manifold, the effect on procurement organisations is clear.Compared to six months ago, fewer are pursuing the kind of growth activity expected during a period of recovery. For example, 42 per cent of respondents said they are driving the sustainability agenda forward, compared to 53 per cent in May. There has also been a substantial decrease in the number of those investing in areas such as technology. (See chart 1).

At the same time, many indicators of an uncertain business climate are present.  Compared to six months ago, a greater percentage of respondents reported that the pressure to reduce supply costs has intensified; that they are speeding up certain sourcing related projects; that certain investment decisions are being halted; that there is a freeze on hiring new staff; there are staff redundancies; and a cut in discretionary areas of spend. (See chart 2).

James Yearsley, partner in charge of supply chain at Deloitte said: “Not unexpectedly, there is a continual focus on cost reduction. From my perspective, the cost agenda has never gone away since it’s ultimately the role of the procurement organisation to keep driving cost. But the economic climate is less rosy compared to what it was six months ago. Our own Deloitte CFO survey, also an interesting indicator of the economy, showed that CFO confidence has almost gone back to the days of when Lehman Brother’s folded in 2008. Because of what is going on with the Euro, confidence has gone backwards. As a result of that, the type of areas CPOs need to focus on has changed again.” 

Yearsley added: “Six months ago, surveys showed that cost was still critical, but that procurement was looking into other areas as well such as improving supplier relationships, looking to product innovation or joint cost reduction with suppliers. Now it has gone back to renegotiating contracts and pricing terms.”

Indeed, our survey shows considerable increases in the percentage of respondents that, compared to six months ago, have asked for price cuts; renegotiated contracts or enforced pricing terms; and offered earlier payment in exchange for a discount. (See chart 3).

The number of procurement transformation programmes is more or less the same amount as those going on in the marketplace generally, according to Yearsley.

He explained there are two types of programmes taking place: step change transformation, where there is a recognition that procurement is not supporting the business the way it would like, so changes are necessary to bring it more in line with the strategic agenda; and continuous improvement, where there is an expectation that procurement continues to carry out sourcing in a more efficient way and also delivers on other objectives such as engaging with the finance function, SRM and contract management.

Roger Reading said when working in the Middle East his organisation had embarked on a transformation programme “to drive business improvement and lock in more value from projects”, adding that the downturn had simply reinforced the urgency and importance of this work.

The benefits for him included significant technical innovation and savings from suppliers, reduced suppliers,  increased and more rigorous terms and conditions of contract, more reliable, on time delivery, reduced inventory on site, reduced prices of around 30%, and a greater focus on HS&E management. 

Looking to other themes, the survey found that key challenges for procurement for the next 12-18 months are rising prices, commodity price volatility and risk management, which broadly mirror the findings from six months ago. (See chart 4).

When asked in more detail about rising prices and commodity price volatility, the level of concern around them appears to have dropped off fairly dramatically compared to six months ago. In this survey, 76 per cent of respondents reported they were either very concerned or concerned about these issues; in May it was 93 per cent of respondents.

Yearsley said that although on the surface these findings appear contradictory, it could be explained by the fact that organisations felt they were  more in control of managing these areas. “After all, these are issues that are still massively important,’ he said. Indeed, most respondents said they were taking action to plan for rising prices and commodity volatility, the survey showed. The top strategies include: looking for alternative suppliers/capacity (54 per cent); seeking preferred customer status with existing suppliers (39 per cent); and educating business colleagues about issues (34 per cent).

Risk management as an overarching theme is also a critical area, considering the uncertainty caused by economic developments and disruption caused by natural disasters, such as the Japanese tsunami, Yearsley warned.

Reading agreed the situation was “really challenging and the risk of supply failing is a constant worry for all concerned.” Strategies he has employed at his previous organisation to mitigate the risk of supplier failure included providing contracts where none previously existed, locking in volumes and prices and ensuring orders are placed in good time.

“We experienced a number of key suppliers going bankrupt, but the major risk was local traders and we worked to reduce the reliance on these suppliers,” Reading said.

Yearsley added: “Because of what has happened in the past three years, people have looked much closer at their suppliers and understood what their contingency plans are. Recent events, such as those in Japan, have brought to the forefront just how strong those contingency plans are. But with what’s going on in the economy, there’s a reshuffling of the deck in terms of: ‘How robust are our supply bases?’”

In fact, confidence levels in processes for evaluating suppliers at risk, mitigating this risk and dealing with the consequences of supplier failure have risen, the survey shows. Whereas six months ago, 43 per cent of participants said their processes were either very good or good, this increased to 56 per cent in the latest findings. Fewer respondents also rated processes as either average or poor compared to six months ago.

According to the survey, the most common action to reduce risk of key suppliers failing is cutting the number of single-source arrangements (54 per cent), which mirrors findings from six months ago. However, a greater percentage  of respondents in this survey indicated they are or are considering switching to more stable suppliers. (See chart 5).

More robust evaluation methods may explain the surprising finding in the latest survey that although concern about the prospect of key suppliers failing in the next two quarters is considerable – 34 per cent said they were either very concerned or concerned – this represents a more positive outlook than in the May survey, when 46 per cent said they were either very concerned or concerned about this issue.

This might reflect the fact that organisations now feel better prepared, having done all the necessary work to head off that risk, said Yearsley.

However, he warns: “It’s absolutely critical in these times that organisations are continuing to evaluate the financial health of their supply base. That should be an ongoing process. As a result of what happened at Lehman, people have implemented more robust processes of managing this. The challenge is that we continue to make sure these processes are as robust as they were three years ago.”

What sensing mechanisms are procurement using to evaluate suppliers at risk of failure? The biggest number of respondents said they used market intelligence, such as newsfeeds (57 per cent); followed jointly by monitoring supplier’s business performance and financials closely and stepping up communication with key suppliers (both 55 per cent); and feedback from frontline staff in the organisation (43 per cent).

“These are all very valid,” Yearsley says. “People are making more use of newsfeeds to get more up-to-date feedback of what their suppliers are doing. What I have seen a lot more of in the marketplace, around the concept of communication with key suppliers, is people thinking about who the different groups of suppliers are – strategic, operational or tactical – and how to engage with those different groups. There has been a big move to looking at that, understanding the particular different suppliers and putting the relevant communications mechanisms and improvement mechanisms in place. As part of that supplier relationship management, getting feedback from frontline staff is key.”

Increasingly, adds Yearsley, organisiations are putting together supplier information management ‘hubs’ that bring together information from a variety of sources, in a format that can be shared.
“Procurement professionals pull information from multiple places, whether they go to suppliers, stakeholders or customers, or look in to their systems to pull out performance data or whether they are having to understand different project teams that may might be carrying out continuous improvement activity with a supplier. Trying to get all of that in a format is something that everybody is thinking about at the moment.”

While economic uncertainty is not likely to dissipate in the short term, a key challenge for procurement will be how to understand and manage the unpredictability, says Yearsley.
“However, many organisations have put in place a lot of work around risk management. Their systems are pretty robust.”

73 percent of respondents say pressure to cut costs has intensified

A greater percentage of respondents have also reported they are switching to cheaper products and services or targeting a bigger percentage of external spend.

Transformation programmes among procurement are still going strong, however, the survey highlights. A slightly bigger percentage of respondents said they are either embarking on or planning a change programme compared to six months ago. (See chart 6). 

The top drivers behind this include: increasing efficiency (65 per cent); achieving greater alignment with the business (65 per cent); and achieving cost savings (61 per cent). (See chart 7)

Yearsley commented: “These things go in waves and in the past year procurement functions realised they needed to step up their engagement with the business. That’s not going to go away now since businesses are trying to drive that as much as possible. Improving the efficiency agenda of procurement is perhaps a wave that is also coming back now.”

Key challenges for 2012

The biggest procurement challenges in the next 6-12 months, according to James Yearsley

• Their ability to understand the economic markets
• Working with their leadership – CFOs, CEOs and so forth – with a view to understanding the implications for the business and the types of deals they need to put in place with suppliers to protect their supply to customers.

“As a result of what procurement has had to go through in the past two or three years I think procurement is far better placed than it was to meet those challenges,” says Yearsley. “Having said that, the potential forthcoming challenges in the economy might be greater than they have been. There will be more unpredictability.”

Soundbites

What the CPOs are saying

• “We want to find more secure countries to do business with and not be so dependent on China.” Divisional senior vice president, aerospace and defence.
• “A difficult point is that everyone is holding on to their money for longer to milk extra time.” Purchasing manager, public sector.
• “I’m feeling quite confident. We managed the Japan situation and other issues quite well.” Senior director, IT/high tech/telecoms.
• “We cannot employ temporary staff.” Participant from the public sector.