Creating and Operating a Viable International Procurement Office
Dick Locke, Principal, Global Procurement Group, San Francisco, CA 94114, 415/695-1673.
82nd Annual International Conference Proceedings - 1997
Overview. International Procurement Offices (IPOs) have been in use for decades. Some have thrived. At least one is handling more than a billion US dollars per year in purchases. Others have failed to make significant impact on their companies and several have closed. This presentation explains some of the important aspects of making an IPO not just work, but thrive.
Company strategy--why are you going international? Companies purchase internationally for two broad reasons. Either they are buying internationally to be able to use the best suppliers in the world, thereby gaining competitive advantage in product design and manufacture; or they are purchasing internationally to match a sales-driven strategy that mandates purchases in a given country. These could be formal countertrade and offset requirements, or a less tangible belief that sales will increase if a company's presence in a country increases.
A procurement office network can make the search for the world's best suppliers more efficient, it can speed up the domestic purchasing department's learning curve, and it can reduce the cost of the supply chain and supplier management.
In the sales-driven case, an IPO can also help. However, it will not usually be locating the world's best suppliers. Countries that must mandate offsets and countertrade usually have a reason, and it is usually that their suppliers are not yet leading-edge. One key cause for failure of an IPO in such circumstances is that its company is used to dealing with excellent suppliers and does not have the overhead infrastructure to deal with poor quality or late delivery. In this case, purchasing is not the best countertrade solution.
Operating Environment--what is happening in global purchasing? As the strategic importance of purchasing is increasingly recognized, purchasing is increasing its role in product design. Leading-edge companies have purchasing people on design teams, and purchasing must have personnel who are technically proficient and who can communicate their proficiency effectively. At the same time, product-life and design cycles are decreasing in many industries. As a result, the first supplier designed in may be the only possible supplier for the life of the product. Resources for locating new suppliers mid-cycle are scarce to nonexistent.
If a company is used to operating in this style, to be effective design needs of new projects and information on world-wide suppliers must travel smoothly and clearly among the world-wide sites of the company. The International Procurement office must have technically proficient people (in a word, engineers) who can communicate effectively across linguistic and cultural barriers.
At the same time, barriers to international trade and purchasing are dropping. Duties are declining under the leadership of the new WTO. Communication is easier, as e-mail is now possible in almost any country that is likely to have the world's best suppliers of a product. The manufacturing, design, quality and, above all, communication skills of developing countries are increasing rapidly.
The result is that there is increasing competition in the procurement channel. IPOs that are trying to show value-added are in competition with other entities in the channel. Historically, the competition has been the reps and subsidiaries of a remote seller that are in the buyer's country. More recently, as US domestic international procurement skills increase, the competition is a buyer who believes that the services of an IPO are not needed. Successful IPOs have learned to overcome these competitors.
IPO functions--what do successful IPOs do? I break the functions down into strategic and tactical, plus a third general category that I call "diplomatic," as distinct from the previous military terms. Strategic functions are those which affect a company's design capability or its skills base. Tactical functions are those that affect the efficiency of the transaction-based supply process, including contracting, ordering, shipping, payment, and feedback. I define this as tactical, but they can have a very large impact on a company's profit. No strategy can be successful without good tactics. The diplomatic functions are those that affect a company's ability to enter into an effective buyer-seller relationship.
Strategic functions--helping make best products possible. The design-related functions are those that increase designers' knowledge of excellent suppliers and suppliers' knowledge of a company's needs. These needs are not just for products, but for quality, cost, flexibility and technology. To do this effectively, an IPO should not simply wait for RFQs but actively cement ties with their company's design centers. An IPO adds most value to this process when it functions in a country where the product group or profit center does not have a design or manufacturing presence. If there is such a presence, members of that profit center are often a better choice than the IPO for this strategic function.
Purchasers operating internationally are often in the front of a company's efforts to understand the workings of another culture. Sales efforts are traditionally handled by a sales staff made up of local citizens, but purchasing often works across national boundaries. Other countries' people's behavior often surprises and confuses the uninitiated. As an example, in some countries it's considered rude to give bad news or a negative response directly. People from countries that are more direct often mistake an indirect or unstated negative response for a positive response. A skilled IPO person can explain the behavior in ways that a domestic buyer will understand.
In addition to cultural skills, companies can learn from other countries' manufacturing and purchasing techniques. JIT and kanban came from Asia, ISO standards from Europe, and SPC from the United States (where we didn't use it until recently). Some price differentials from South Asia, such as a 20% differential on purchased products that are 90% material can only be explained by more effective purchasing techniques. Staying abreast of world leading-edge skills is a vital strategic function that an IPO is positioned to help.
Diplomatic functions--explaining the buyers. The functions that I call diplomatic include not only explaining foreign behavior to domestic buyers, but explaining puzzling buyer behavior to foreign sellers. For example, if people in a country believe it rude to give bad news directly and bluntly, there must be a countervailing rule that stops people from putting others in a position where bad news must be given directly. A buyer from a country where people pride themselves on being frank, open, and honest may offend a person from the other country. Good IPOs can explain behavior in both directions.
The presence of an IPO in a country also shows that a company is making a long-term commitment to buy there, and gives the excellent suppliers access to business opportunities.
Tactical functions--making it happen. "Tactical" functions sound less important than "strategic" functions, but in many cases, unless the IPO can provide tactical support, the strategy will be of no benefit. The supplier's products may be excellent, the designers' relationship may be excellent, but if the products can not be ordered, delivered and paid for effectively and efficiently, there will be no benefits to the relationship. There are a wide range of services that an IPO can provide to make the relationship happen.
To make the IPO most effective, IPOs should place purchase orders in the supplier's country or region. The order directs the supplier to make the goods available for Ex works pickup by the buyer's freight forwarder at the supplier's factory, for delivery to the buyer in its own country. (In the US, delivery is often to a customs broker at the port of entry, but many other countries permit customs clearance at the buyer's site.) Placing orders in the seller's country has several benefits:
- it reduces the legal complexity involved in international purchases because a purchase becomes a domestic transaction in the seller's country. Contracts and POs become simpler.
- it makes it easier to avoid using expensive agents and subsidiaries in the buyer's country
- it increases the power of the IPO to negotiate prices when the order is discretionary to the IPO. This works effectively when there is a world wide commodity product and there are minor price differentials from region to region. A network of IPOs gives a buying company an opportunity to maximize business in the lowest-cost regions.
- it gives the buying company increased control of the logistics process
In addition to orders, the IPO should be the vehicle for sharing forecasts with suppliers. The longer lead times associated with ocean freight (eight days to three weeks to the US from East Asia or western Europe) create an additional cost of doing business with a remote supplier. Sharing forecasts is an essential step to keep lead times under control and to maintain flexibility.
Another major tactical benefit that an IPO can perform is currency management. The IPO can hedge currencies (a task that baffles many large-company treasury departments) for a reasonable period of time. Depending on purchasing forecast accuracy, this period could be from 3 months to a year.
The IPO can also perform source inspection during the initial stages of business, although this should drop off rapidly. An excellent supplier will have adequate process controls in place to assure perfect or nearly perfect quality, but there are often initial misunderstandings that inspection can catch.
The IPO also helps avoid the "one more shipment" syndrome, during which a buyer puts off making a long trip to a poorly performing supplier as long as possible. An IPO person can be at the supplier within hours, at low cost, to see what is really happening and to get it fixed.
Locations--where should you put an IPO? If a company is looking for the best suppliers in the world for its important purchased items, ideally it should put an IPO in the country or countries that are best in the world at building that product (or will be best soon). However, a major practical issue involving expense and staffing can cause this to be a less than optimum solution. It's much better to put an IPO into a country where the buyer has a legal subsidiary or joint venture already. This reduces the overhead expense of legally forming a company, getting permission to hire people, paying taxes, etc. It also makes hiring good people much easier. If a company has a factory, a sales office, a distribution center, or a service center in the country already, it becomes a much more attractive career choice for a potential employee. More opportunities for advancement and promotion exist, and the IPO can draw on existing staff talent.
IPOs are quite possible to regionalize. One or two can cover Western Europe. An IPO in Singapore or Hong Kong can cover SE Asia. In attempting this, be cautious about relations between the people (not necessarily the governments) of the countries involved. Taiwanese can usually work comfortably in China, for example, but unresolved problems make it difficult for Koreans and Japanese to work in each other's countries.
Staffing--whom should you hire? In order to be strategic, an IPO needs engineers. In order to be competitive with other channel alternatives, the staff must also be oriented toward marketing themselves. Everyone must have a good perception of the quality and quality improvement process, and everyone must speak the company's main language. Cultural sensitivity is vital.
A company should try to avoid using expatriates if at all possible. Typical expatriate benefit packages are often 200% of the base salary, and the cost will be difficult to get internal customers to pay. If the company has a factory in the supplier's country, a person transferred from the factory is the best alternative. If there isn't a factory, it may be necessary to put an expatriate in place for a year or two to train local people.
To make an IPO a long-term success, a company should develop a realistic plan to have at least a five-person office within three years. This is particularly important in the group-oriented countries of Asia, where being part of a functioning team is critical.
The IPO manager in a country should report on a solid line basis to a senior purchasing executive of the company. There may be a requirement for a dotted line reporting relationship in the IPO's country, but the IPO manager's goals and tasks should be directed by headquarters purchasing. Local logistics support is also helpful.
In addition to IPOs, it's very beneficial to develop an "IPO sales staff" in the buyer's country. This staff will be alert for opportunities, keep abreast of key R&D projects, and keep IPO and buyer behavior on track.
Systems--what do you need? To perform their tactical role of placing orders, an IPO will need some systems support. There are two general ways to do this. Most multinationals have a well-developed internal order system in place, and the IPO can use it. A buyer places an internal order to the IPO and the IPO places a purchase order to the supplier. A simple system converts the IO to a PO. A newer approach is to use the power of telecommunications so that an IPO person can obtain access to the suggested order files at the buyer's site. The IPO person becomes an off-site tactical buyer. A period of trust building is often necessary before this will be accepted.
The IPOs will need to be on the company's e-mail system and, if they place purchase orders, will need to have the support of an intracompany invoicing system.
Funding--how do you pay for this? There are three generic ways to fund such an operation. The first is a mandated, central funding that is charged to a company's profit centers whether they want it or not. This has merit for a startup only, but it's better to have an IPO charge users, and only users, of its services. If the use of an IPO is optional, rather than mandated, then the IPO is more likely to perform services that its users find valuable. I believe it's best to have a negotiated annual charge for the services that are strategic, and a transaction-based fee for tactical services. Markups on purchase orders are an ideal transaction-based fee.
These markups must be less than other intermediaries (such as the supplier's representatives in the buyer's country) would charge and less than a buyer perceives it would cost to do the work him/herself. The markups must also be large enough to enable the IPO to grow and be a pleasant place to work. The seller's representatives and subsidiaries create a high pricing umbrella, generally charging 5-10% for multi-million (and multi-tens of million) dollar deals. Successful IPOs operating at this business level have expense/volume ratios of 1-2%.
It's a complex problem for an IPO to devise a plan of transaction-based charges that are low enough to obtain buyer participation on big deals, and high enough to fund the IPO on small deals. No buyer would voluntarily pay 2% of a $40M deal. That would be $800K, enough to pay for multiple trips to visit the supplier. Such charging plans can be devised, however.
There is another problem: the perceived tactical value added by an IPO drops over time. The supplier becomes routine, the buyers become more experienced, the seller's country becomes more internationally attuned, and buyers and sellers become more comfortable dealing with each other. To respond, the IPO in a maturing situation should either find new products, new functions, or focus on strategic benefits.
Is an IPO for you? I believe an IPO is a good strategic and tactical solution. Strategically, the IPOs belong in countries that are producing technologically advanced products and are culturally difficult for buyers to operate in. Tactically, they help anywhere where there is a cultural, language or time-zone gap. I believe that if a company has a legal presence in the supplier's region, a history of hiring and keeping good people there, and as little as $10-20M annual purchases in the region, it should have an IPO.