Guest blog post provided by Milan Vyas
There has been transformation in the Procurement function over the past decade. From the starting point of the traditional buy-sell, transaction-based purchasing, the practice has moved through stages of change that redefines most aspect of the business.
A typical Purchasing Function is limited to the transactional job of collecting information about the requirements of user departments and carrying out commercial checks and balances to finally procure the product & service based on cost reduction only and focused on supply continuity.
The strategy is to shift the company’s focus from the current “transaction” oriented independent buying of goods and services to a “product” oriented strategic approach.
A Paradigm Shift in the Procurement Function
As companies seek to discover ways to increase overall excellence and competitiveness, a new source of value has emerged – Strategic Sourcing. Strategic Sourcing is a proven approach to understanding and delivering significant cost reduction based on Total Cost of Ownership (TCO), building a sustained value – creating relationship with the suppliers and category spend reduction in order to create and sustain a competitive advantage.
What is Strategic Sourcing?
The fundamental objective of any organisation is lowering the cost of goods manufactured. This can be achieved through reduction in prices of purchased products & services and reduction in their specific consumption. Strategic Sourcing does exactly the same by addressing the total cost.
Strategic Sourcing is a comprehensive process aimed at obtaining maximum advantage on cost, technology, process and quality, by leveraging the company’s buying power with select suppliers, conducting best price evaluations, sourcing globally and conducting company/supplier joint process improvements.
It is defined as: “A disciplined, systematic process for reducing the total costs of externally purchased materials, products and services while maintaining or improving levels of quality, service and technology”.
The Strategic Sourcing approach is designed to:
- Drive reduction in total cost of acquisition of goods and services
- Drive a thorough understanding of both the supply market and internal company requirements
- Developing in-depth understanding for knowledge based buying
- Building sustained value creating relationships with suppliers
- Deliver significant earnings to bottom line
The process of strategic sourcing starts with spends analysis and category management, which identifies, consolidates and standardises information from a wide range of data sources.
The Evolution of Procurement’s Value Proposition
Are we witnessing the dawn of a big shift in the way strategic procurement is done? Category management has been the only credible procurement strategy since the late 1990s, and that may be about to change. The techniques devised in strategic sourcing and category management strategies to choose suppliers and build strategic partnerships are due for an overhaul.
Today’s uncertain and volatile markets make agility and change inevitable as well as essential.
Many business leaders have ambitions to improve profitability by reducing costs. But to do so, they must also reshape their supplier relationships, aligning their supply chain with a more progressive strategy and securing a competitive advantage. So what are the new realities?
Procurement professionals need to get savvy. Their professional credentials will be measured by their ability to influence, persuade, and provide vision. Their mindset must be strategic, global, collaborative, and, above all, commercial.
Today reducing cost is no longer enough. Successful companies must seek high-impact performance improvements. According to A.T. Kearney’s latest Assessment of Excellence in Procurement (AEP) study, more senior executives are asking their procurement functions, and specifically their Chief Procurement Officers (CPOs), to deliver value well beyond cost reductions. Indeed, the AEP finds that the importance of value creation in procurement is growing twice as fast as the importance of cost reduction.
Today procurement professionals are under considerable pressure to deliver value-adding business performance, and it is no longer enough to build a supply management capability that is efficient, demand-driven, or even transparent. Procurement must offer the organisation something that is value adding: a new supply management where the strategic scope of procurement’s value is delivered via innovation, a networked function, and focus.
This demands full alignment with the corporate strategy, and integration internally with stakeholders and externally with the supply base. Procurement must be the function that is continually challenging ways of working. It must look to ensure that it helps its internal business stakeholders to achieve their goals and targets while, at the same time, taking the opportunity to challenge total cost and facilitate “customer of choice” benefits, such as access to innovation and, of course, the management of risk. Most critical of all is that procurement must be aligned to the corporate focus, addressing the key question for any business: “What is value to the customer?”
The customer never buys a product. By definition the customer buys the satisfaction of a want, which in economics is defined as value. In essence, value is utility; that is, the total satisfaction derived from a good or service.
Value management relies on multiple streams of information from inside and outside the organisation — both internal and external perspectives are necessary. Today procurement holds information regarding customers, competitors, demand, offers, costs, and production constraints. These data are all used in value management, and this places procurement in a strong position to make this aspect of business their own.
Procurement was once a transactional function focused on supply continuity. Strategic sourcing transformed CPOs into credible business contributors. Now, CPOs have the chance to transform again – to use strategic supplier relationship management (SSRM) to deliver something more than cost reduction, something that drives competitive advantage – strategic value. Yet delivering strategic value across the supply chain will require a change in mindset: from confrontational, one-on-one negotiations on cost reduction to collaboration – both internal and external.
What and Where Is Strategic Value?
Many CPOs have rightly concluded that the key to unlocking the next level of value is to complement their category-focused strategic sourcing efforts with a supplier-focused approach.
The above figure illustrates models of supplier interaction that form a pyramid because they rely on a solid base in category-driven transactions. With some suppliers, it’s also possible to use strategic sourcing projects to optimize total cost of ownership. An even smaller subset of suppliers deserves SSRM value projects that use more intense supplier cooperation to gain more substantial advantages for a specific business unit or product. Lastly, the top of the pyramid represents those few cross-enterprise relationships that interact across many business units or products and multiple dimensions – you may buy from, sell to, innovate with, and sometimes even compete with these suppliers.
Turning Supplier Collaboration into a Core Competency
To drive strategic value creation systematically, your procurement organisation needs to develop a key competency in supplier collaboration.
Indeed, the first step for CPOs is to lead the function through an understanding of how a collaborative approach compares and contrasts with traditional sourcing (see figure). What happens when you move from transaction to relationship-based philosophies? Which traditional strategic sourcing success principles can help you in the move? Many CPOs, for example, enforce the use of deep analytics to inform the process before engaging a supplier. Good. The analytics are important in developing a structured approach to identify value creation opportunities.
Turning supplier collaboration into a core competency will not be easy. But when properly structured as an initiative to develop a key capability, it will not be insurmountable (no more so than developing strategic sourcing capabilities was 20 years ago).
Now Is the Time…
Now is the time to push your CPO to become a strategic contributor to your team, accountable for tapping the supply base’s energy to help achieve your company’s strategic objectives. Obviously, these objectives go well beyond cost reductions. As key industries continue to consolidate, the first-mover advantage of learning to collaborate with winning suppliers will be crucial to success. The CEO’s job here is to understand and articulate the vision—and task the CPO with specific strategic objectives over the next two to three years. These objectives may include:
- Growth: Create incremental revenue growth.
- Risk: Demonstrate a significant reduction in enterprise risk, covering all potential relevant risk categories such as brand, catastrophes and commodity pricing
- Value chain: Optimise the value chain around the corporation’s core, differentiating capabilities, using supplier relationships to maximise benefits for all involved
- Structural capabilities: Demonstrate advances in select areas, such as a sustainable competitive cost advantage, improved agility or responsiveness, gains in corporate social responsibility, or other structural capabilities essential to the future strategy.
Clearly, the objectives will vary depending on your strategy, position, and industry. The suppliers you collaborate with, and the results you achieve, will also be unique. What must not vary, however, is the philosophy of collaboration. In the past few decades, the procurement function has grown from a function of lesser importance to one important enough to a have a chief officer. The next step in the quest for value creation is collaboration.
And the time to take that step is now…
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