Beyond Cost Savings
By Jose Verdejo Sanjuan and Apollon Fanzeres, C.P.M.
Procurement as a profession has come a long way to get where it is today; in fact, it took years for companies to truly recognize the value it can add. From a business perspective, the most obvious benefits of effective procurement optimization are financial. And in most cases, “old-school” organizations still expect procurement to focus solely on accomplishing such tactical tasks as creating purchase orders, executing contracts and responding to supplier issues.
Only a few understand that the future of procurement starts by moving the focus from transactional procurement to outsourcing operational activities. Although diverse industries are working to develop procurement’s new strategic role, there still are cases where end-user departments acquire needed goods and services without strategically or consciously managing expenditures, resulting in an inconsistent approach and missed savings opportunities.
One example is a U.K.-based global health-care research, development and manufacturing company that, according to a 2006 article published by Institute for Operations Research and the Management Sciences, started optimizing its procurement process after estimating it lost US$80 million-$120 million in procurement savings due to noncompliant purchases outside of contractual agreements. To achieve a more effective and innovative procurement approach, companies must make a considerable effort to change their DNA. Support from the C-suite and efficient execution from the middle-management team are vital to the success of the new generation and strategic role of procurement.
This change in procurement vision mandates a migration from basic price-benchmarking/volume-concentration tactics to more sophisticated activities. One way to accomplish this is by creating a more reliable and credible supply base. Procurement is in the best organizational position to develop a world-class supplier base through adoption of internal processes that include an organizational assessment and identification of overall business needs. This is followed by thorough supplier market research, which eliminates companies that are incapable of achieving the business goals.
Additionally, because operational and financial risk can affect the entire supply chain, the procurement organization must develop a plan to focus on controllable variables by working closely with and integrating selected suppliers. This can be done through such strategies as (1) multisourcing of key materials, (2) continuous monitoring of suppliers, (3) implementation of appropriate technologies and (4) training.
When interacting with suppliers, procurement also can serve as a tool to reduce and deflect unethical and harmful situations that may affect the company’s good reputation. For example, Procter & Gamble instituted a no-deforestation policy aimed at encouraging sustainable-sourcing practices among suppliers following a Greenpeace report about deforestation practices among some of its palm-oil suppliers. By having a supplier code of conduct — and enforcing it — companies can reduce legal and brand risks. Such a policy also supports compliance with the U.S. Foreign Corrupt Practices Act and the U.K.’s Bribery Act 2010.
Other methods in which procurement can demonstrate its value include capitalizing on innovation, negotiating longer payment terms, enhancing revenue and demand management. Here’s a closer look at eight ways:
Managing tail spend with process automation. While the tail is an often-neglected part of spend because of its low-dollar value, it can be improved by implementing relevant technology such as e-catalog ordering, which reduces the amount of labor needed and minimizes the response time to customer.
Capital-expenditure inventory management. Before making capital-expenditure purchases, procurement can verify available inventory of underutilized equipment in other facilities or countries to avoid unnecessary investments. A structured and systematic approach is the best method.
Cross-functional innovation. Procurement can be a key contributor to a company’s innovation process because of its relationships and unique position. It can be instrumental in driving discussions about and identifying future market trends and technologies that would be useful in other internal departments as well as to a company’s future growth.
Working capital improvement. When negotiating, procurement shouldn’t focus only on obtaining the lowest cost to enhance the company’s liquidity. Instead, it can negotiate longer payment terms, thus allowing an improvement in working capital. Conversely, depending on the company’s cash position, procurement can negotiate discount terms related to earlier payment terms, therefore delivering an ROI that is many times greater than regular financial investment instruments available in the marketplace.
Mergers and acquisitions. It’s critical to (1) include procurement as a centerpiece of the combined new entity’s pre-merger activities and (2) determine all supply chain synergies and integration activities to increase shareholder value. Procurement’s role during the four phases of an M&A could include:
- Target identification — identifying targets using industry expertise and assessment methodology
- Due diligence — implementing a due-diligence framework and site-visit toolkit, and looking at long-term commercial impact
- Negotiations — conducting data analysis, deal structuring and negotiations
- Post-merger integration — evaluating spend diagnostics, purchasing-power leverage and perimeter of influence.
Revenue enhancement. Procurement has the capability of providing market insights and supplier information that can support the sales effort of the organization. Additionally, it can structure contracts in such a way as to receive rebates or higher purchase discounts if the spend volume exceeds pre-agreed thresholds.
Demand management. By developing a deep understanding of the demand drivers while working with the final user, procurement can reduce the demand for goods and services — and even reduce the risk of buying useless goods or services.
Specification standardization/harmonization. This (1) results in a reduction in the number of tasks required to acquire a good on a regular basis and (2) helps maintain an image standard throughout the organization.
When a procurement organization’s cost-reduction initiatives are focused solely on achieving price reduction from contracts, potential value-add benefits are overlooked. However, by changing the procurement vision, the function can add value that goes beyond cost savings while assuming a more strategic role within the company.
Jose Verdejo Sanjuan is global procurement director, and Apollon Fanzeres, C.P.M., is chief procurement officer at Laureate Education Inc. in Baltimore.