There is a lot of talk in procurement environments about the role of procurement within companies. Chief Procurement Officers from even large multinationals with billion-dollar procurement budgets ask each other questions like: “Why is Procurement not on the CEO’s agenda?” and “Why is Procurement not strategically important?”
These questions are relevant and valid, as over the past decades a general tendency has increasingly placed Procurement as a strategically important function.
Over the past 20-30 years we have seen an increase in the extent to which a company’s value creation is outsourced to suppliers, as companies increasingly concentrate on core competencies. Often we see that the cost of external suppliers constitutes 40-70 % of turnover in manufacturing and wholesale businesses, while the internal labour costs are often substantially less. Yet we dare to claim without evidence that business leaders to an overwhelming extent have significantly more focus on total internal labour costs than total external supplier costs. In other words; we believe that members of top management focus too much on labour costs and not enough on supplier costs.
Over the past decades, the cash flow of companies has attracted significantly more focus from business owners and managers, which the procurement function greatly influence both through the negotiation of supplier payment terms, but also through delivery and storage contracts with suppliers.
Objectively, it is therefore surprising that procurement executives today ask each other the questions posed above.
It is this article’s claim that there is a general lack of understanding in top management of the potential impact of procurement on total business performance and competitiveness, but at the same time there is a lack of initiative and boldness in procurement to influence top management. This article will highlight some tendencies that underpin these claims.
Point 1: Lack of recognition of how the value chain is structured
Over the past decades there has been an increase in outsourcing, which has meant that the spend value now represents a larger share of revenue, typically 40-70% of revenue in a manufacturing company, where labour costs typically represent 10-40% of revenue. Furthermore, there is good reason to believe that suppliers to a greater or lesser extent influence the level of internal labour costs, as a ‘good supplier’ helps a customer reduce labour costs or increase value creation, while a ‘poor supplier’ increases labour costs.
You can compare the share of top management’s time and focus, which is spent on internal employees (the 10-40% of revenue) and external suppliers (the 40-70% of revenue), respectively. There are no relevant research identified, but it is this article’s claim that top management generally spend significantly less time and focus on suppliers than their costs and potential actually justify. From a pure cost consideration, top management ought to spend more time and focus on managing suppliers and related costs than the time they spend on controlling labour costs.
Point 2: Top management’s one-dimensional cost focus and lack of total measurement
Several studies have shown that the procurement function is predominantly measured and assessed on price reductions and cost savings. These objectives are typically achieved by demonstrating that the procurement function can buy the same service or product at a lower price than before. This is the most important competence in the procurement function; the ability to negotiate a lower price with a supplier, and the negotiation space is thus reduced to an almost one-dimensional price battle.
This method seems to be generally accepted, but is it always the right path to choose? If you take a step back and ask what is relevant to measure in terms of procurement and value creation, there seem to be many other dimensions that should be measured. You may ask, how is value created in the procurement function? Price reduction is a relevant factor, but what about all the indirect costs of a purchased component or the indirect costs a supplier inflict on a company due to e.g. poor after-sales service? Or what about the possible value creation a supplier can bring to the company, for example in the form of flexibility?
The lack of other evaluation criteria than price may be because we have not yet found useful and practical methods for measuring value creation in procurement. It seems obvious to seek inspiration in other functions, such as HR and Customer Service, where there is strong consensus on the relevance of satisfaction measurements in the form of, for example, employee and customer satisfaction surveys. The paradigm here is that, for example, higher employee satisfaction creates more motivated employees, who can create more value for the company.
So why don’t we measure our colleagues’ satisfaction with our suppliers?
The answer probably lies in the fact that the procurement function and suppliers are considered low priority by management, which results in ‘management by autopilot’ and therefore uses the standard method of measurement: cost saving. That is why it is our job in the procurement functions to make visible to top management that there is great value in extending the measurements, so they also focus on other, possibly more value-adding dimensions.
We cannot rely on our busy top management to change their view on procurement. As ambitious procurement leaders, we must prove our value and educate top management to understand the full value potential in procurement, which appears to be huge.
Point 3: Lack of understanding of the R&D potential in the supply chain
Most companies and managements ignore opportunities to innovate and develop in collaboration with suppliers, although there are quite substantial economic reasons to focus more on these. Unilever is a good illustrative example. Unilever spends +15 billion euros in total and devotes 900 million euros to R&D. Unilever suppliers invest about 5-6% of their revenues in R&D, equivalent to 750-900 million euros. Or in other words; 750 million euros that Unilever can have access to if the company upholds the right relationship with its suppliers. This is one of the reasons why Unilever has started its Partner-To-Win program, which aims to work closer with strategic suppliers in the fields of R&D and product development.
If you do not have a good relationship and transparent cooperation with each supplier there is no opportunity to influence suppliers in the direction in which each supplier must innovate/develope, and you are missing out on future opportunities.
Point 4: Lack of skills in business development and value creation in Procurement
Most procurement executives are trained to have a cost focus during their career. The success criteria revolve around their ability to negotiate lower prices – even if it requires a hard bargain with the supplier and might damage the relationship. It can in some categories be the right strategy and approach – for example, in ‘pure commodities’, where there are many alternative suppliers.
But in other categories, which deliver more than just a raw commodity product, the supplier also delivers design, technology, logistics and/or service, and here the cooperation and value creation are considerably more complex. This means that in order to maximise the corporate value of each supplier, using other methods and competences than ‘just’ price pressure is critical. It requires that procurement executives are able to cooperate across the organisation and solve problems in a coordinated process in close collaboration with suppliers. Finally, procurement executives should be able to drive interdisciplinary projects and think in terms of added value in the value chain. This requires a new tool set and new competences from the procurement executives and not ‘just’ the competence to push price.
This article has highlighted a number of points which explain why the procurement function does not have the strategic role in a company it rightfully deserves. Procurement is often a low priority function that most top management teams ‘manage by autopilot’, which only measures cost savings. Therefore, we believe it is procurement’s responsibility to show initiative and make visible to top management that there is significant greater value in developing the procurement function to become a value creating function instead of being ‘just’ a cost reducing function. This requires boldness, smartness and focus but can also catalyst procurement to the top of the CEO’s agenda.
Feel free to share this article with your CEO.