Does Purchasing Generate Value or Expense? Identify Your Value Added!
Thomas A. Crimi, C.P.M.
Thomas A. Crimi, C.P.M., Texaco, Inc. Houston, TX 77402, 713-752-3981, firstname.lastname@example.org
Ralph G. Kauffman, Ph.D., C.P.M.
Ralph G. Kauffman, Ph.D., C.P.M., Univ. of Houston-Downtown, Houston, TX 77002, 713-221-8962, email@example.com
84th Annual International Conference Proceedings - 1999
Abstract. Traditional and strategic concepts of purchasing value added are reviewed. Methods of adding value are presented and discussed. An approach for development of a purchasing performance measurement system and appropriate metrics for measuring results are presented. Considerations in management reporting of value added results are discussed and examples of actual value added achievements are presented.
Introduction. Purchasing has evolved from a clerical function before World War II through a managerial emphasis stage in the 1950s and 60s, and a purchasing strategy stage in the 1970s and 80s, to integration into corporate strategy in the 1990s (Leenders and Fearon, 1997). Not all purchasing organizations have yet made the entire transition to corporate strategy integration but increasing management recognition of the value of the function provides the potential for all purchasing functions to reach that stage. Probably the key underlying reason for the continued evolution of purchasing and for the potential for corporate strategy integration is the gradual but continual recognition by management of the potential for purchasing to add value to the organization and thereby improve its overall operating results.
Traditional Concept. The traditional concept of the value of purchasing was that of obtaining the right materials in the right quantity, for delivery at the right time and right place, from the right source, with the right service, and at the right price (Leenders and Fearon, 1997). Along with this one might add that purchasing was looked upon as a clerical implementer of strategies developed by others in the organization. It also tended to be looked upon as an expense function (or necessary? evil by some), and often was located at a low level in the organization. Its performance measures tended to emphasize specific activities or workload productivity (e.g. number of purchase orders placed), and the focus was on the efficiency of purchasing (e.g. placing the purchase orders at least expense in terms of purchasing salaries and other costs of operating the function).
Strategic Concept. The strategic concept of the value of purchasing views purchasing as a strategic business function integrated within the strategic planning process. Performance is evaluated in terms of end goals and objectives such as quality and supply base management, and the focus is on purchasing effectiveness. Hagstrand (1997) has identified five questions that can be asked to help determine if purchasing is strategically positioned and thinking strategically to add value:
- Is purchasing putting the overall organization first?
- Does purchasing understand the overall organization's direction?
- Is purchasing's contribution visible and valued by the organization?
- Is the purchasing/supply management function positioned at a strategic level in the organization?
- Is purchasing/supply management taking a leadership position in areas where it can contribute?
Leenders and Fearon (1997) have suggested some areas of strategy where purchasing can add value. These include: Social trends and issues, Government regulations and controls, Financial planning with suppliers, Product liability exposure, Economic trends and environment, Organizational changes to facilitate long-term productivity and efficiency, Product or service line additions, deletions, changes, Competitive intelligence, Technology, Investment decisions, Mergers/Acquisitions, Disinvestment, and Time-Based competition.
Methods of Adding Value. A few years ago when Sid Brown was national President of NAPM, he made "adding value" the theme for his term in office. Using a number of the methods he identified in a series of articles in NAPMInsights and Purchasing Today as an outline, we briefly discuss each approach.
Adding value to ourselves can be accomplished both by education and training and through experience. To maximize the potential for adding value we must be selective in education, training, and experience. To receive education, training or experience in the same subject matter or methods repeatedly is obviously less valuable than receiving education, training, and/or experience in a variety of situations, challenges, or subjects. We must seek out new and different challenges and experiences and, above all, must seek those which will keep us up-to-date in thinking, technology, methods, and practices in purchasing and supply management.
Adding value for our companies of course is what many of us would indicate as our reason for existence as purchasing and supply management. Not surprisingly, there is an almost unlimited variety of ways in which value can be added through the purchasing process. Some ways that have been identified include:
From Brown (June, 1995):
- Link purchasing strategies to business strategies
- Develop value-adding supplier relationships
- Sponsor a supplier development program
- Implement a rigorous supplier selection process
- Use cross-functional teams in the supplier certification process
- Establish a formal supplier cost improvement program with emphasis on continuous improvement
- Focus on continued communication improvements
- Focus on internal and external customer satisfaction
- Reach out and propose new and creative ideas
Adding value through research results in improving value in the future. Purchasing research seeks to improve purchasing performance by improving how items are bought or contracted for as well as improving the systems used by purchasing to conduct its activities. Purchasing research involves learning about and evaluating the current and future impact of factors such as purchase market structure, capabilities of existing and potential suppliers, availability of supply and of potential substitute materials, historical trends of price and availability, and security of supply. Value analysis seeks to improve the value received for the purchase dollars expended by focusing on the functionality of the item purchased. The question asked is not, "What is it?" but "What do we need it to do?" If "it" does more or less than what we need, perhaps the value can be improved by modifying the item or purchasing a different item. Value engineering is similar to value analysis but the functionality focus is applied to the development of new products and the parts and materials needed to produce them.
Adding value through supplier relationships can range from arranging for a supplier to expedite delivery of a particular to application of supply chain management to multiple tiers of suppliers. As more organizations try to optimize their supply bases by reducing their numbers of suppliers, they find that their relationships with the remaining suppliers have become more interdependent and closer and more cooperative relationships are required. Since most buyer-supplier situations impact multiple functions and persons in both companies, cross-functional teams are frequently used to improve supplier relationships. Teams are useful whether for a one-time quality problem or to administer a supply chain management situation. The keys are improved communication, collaboration, and cooperation between supplying and buying organizations. Partnerships, alliances, and other long-term relationships can add value by increasing the focus of suppliers on your specific requirements be they quality, quantity, delivery, or price. One particular area which can serve as an example is systems contracts. In a recent Purchasing Today article, Etheridge (1998) identified the following potential value-added benefits that can result from systems contracts:
- Utilize the supplier as a consultant
- Reduced inventories
- Access to supplier's inventory
- Marketing supplier capabilities to end users in your organization
Additional possibilities include supplier-managed inventories, supplier-consigned inventories, and supplier integration. Improving the value of your business to a supplier will motivate the supplier to improve their value to your organization. Objectives in supplier relationships should include striving for win-win results that benefit both parties equally.
Adding value through strategic sourcing requires that first of all purchasing knows what purchased items are strategic to its organization. Often these include those that are purchased in the largest quantity or dollar value amounts. Other possibilities include items that are critical to the successful operation of the company and those that are important and difficult to obtain or obtainable from single or limited sources. The strategic sourcing process includes:
- Assess the overall situation for strategic items, identify opportunities, select targets
- Determine value adding strategies for targets
- Develop implementation programs for strategies
- Implement, evaluate, improve
Adding value through customer service requires that purchasing knows who its internal and external customers are. Internal customers are the most obvious but in many situations purchasing can do a better job of adding value if it also knows who are the external customers that ultimately purchase the firm's products and what their requirements are. Customer service can have many aspects including cycle times, delivery schedules, quality levels, services provided, cost, and price.
Adding value as one shops the world emphasizes the fact that purchasing should know no bounds to the markets wherein it seeks to find the best values for its organization. Global procurement opportunities abound. However, the world marketplace is dynamic and often has more dimensions than the domestic marketplace. A source and/or country of origin that may have the best values today may not have them the next time they are consulted. Trade patterns, currency values, supply capabilities, and economic conditions change, sometimes very rapidly. Purchasing must be aware of changes in all the marketplaces in which it does, or considers doing, business.
Although price is not always the most important factor in source selection, cost reduction is always of interest to the procurement process. A recent series of articles in Purchasing Today highlighted a number of ways purchasing can add value through cost reduction. These included:
- Capital equipment purchasing (February 1998)
- Utility costs (March 1998)
- Health insurance (April 1998)
- Raw materials (May 1998)
The first and last of these are not unusual for purchasing involvement. However, utility costs and the cost of health insurance represent two areas in which purchasing has not traditionally been involved. These two items illustrate that purchasing should not limit itself to areas in which it has always been involved in its search to add value to its firm.
Developing a Purchasing Performance Measurement and Evaluation System and Value-added Metrics. (refer to Monczka, Trent, Handfield, 1998, p. 680 for a detailed discussion of this approach)
System development can be accomplished through a five-step process:
- Determine which performance categories to measure
- Develop specific performance measures (metrics)
- Establish performance objectives
- Finalize system details
- Implement and review system performance and measures
The first step is to determine which performance categories to measure. These could include: price effectiveness, cost effectiveness, workload, administration, general efficiency, material status, supplier performance, strategic performance, and total quality management. The particular categories will depend on the specific strategies employed by a company in its overall operations and the resulting priorities for purchasing that flow from those strategies. For example, in some organizations, low cost may be a dominant strategy, while in others maintaining a particular quality level may dominate.
The next step is to develop specific performance measures for the performance categories. Features of the performance measures must include: objectiveness, clarity, not subject to manipulation, dynamic, promote creativity, use available or obtainable data, relate to purchasing and company objectives. One approach to evaluating metrics includes the following criteria: Are they customer-oriented? Can they be used to manage the process? Are they quantitative and do they show trends? Are they timely? Is the data inexpensive to collect? Is the data accurate and reliable? (Hall and Koller, 1998). Another suggestion from the same reference is to employ metrics that measure sub-processes early in the overall process rather than tracking only end-of-the-line performance. The sub-process metrics provide more useful information because they help pinpoint causes of problems that are revealed in end-result metrics.
The third step in developing a purchasing performance measurement and evaluation system is to establish performance objectives through approaches such as: historical data, internally derived comparisons, and competitive analysis e.g. benchmarking. Industry Purchasing Performance Benchmarks from the Center for Advanced Purchasing Studies can be useful in addition to others that you develop for your particular environment and situation.
The next step in the system development process is to finalize system details such as reporting frequency, conduct education and training, and determine exactly how system output will be used. The final step is to implement the system and review its performance and the performance of the metrics adopted. A pilot test may be useful in implementation and the system may require update and modification over time.
Management Reporting of Value Added. For purchasing as a function to benefit fully from value-added activities, company management must be aware of the results and the results must be acceptable and believable to management. Because in most organizations most purchasing results are accomplished with the cooperation of other functions, one approach is to involve all affected functions in determining what, how, and when results will be reported to management. If cross-functional teams are used, the teams should determine the reporting. This approach means that purchasing will not receive all the credit for value added but it will assure cooperation from others who are vital to achieving future added value. As reporting of results is developed, management should also be involved for their input on what they want to see. Hall and Koller (1997) suggest using metric status charts that contain key information for each metric.
Examples. Following are a number of particular situations in which one of the authors has been involved where value has been added by application of a number of the approaches discussed in this paper. The value-added benefits are listed for each example.
- A supplier alliance which provides a number of services and products that had previously been separately obtained from multiple suppliers.
- Favorable commodity and service pricing
- In-house (buyer's house) supplier engineering rep to coordinate between supplier and buyer organizations
- Advanced access to supplier's R&D technology
- Reduced buyer administration costs in purchasing
- Reduced buyer field administration costs
- Operational process improvements in buyer's site operations
- New technology, dedicated personnel
- Improved communications, problem resolution, facilities
- Operational process improvements
- Reduced engineering administrative time
- Increased exposure to new technology
- Improved communications
- Use of in-house technical support
- Procurement of material and related services as "bundles."
- Incorporated guaranteed service obligations from supplier
- Assistance during loading
- Analysis of operating data
- Unit optimization
- Minimum guaranteed hours of technical service on-site
- Supplier-provided monthly service reports
- Supplier-run tests and results reporting
- Alliance to provide specialized capital equipment
- Purchase cost savings
- Longer-term warranty
- Free equipment loaner program as needed
- Committed cost reduction initiatives by seller and buyer
- Equipment standardization
- Reduced parts inventories, fewer models
- Explore/implement reduced manufacturing cost
- Expand contract coverage multinationally
- Quality initiatives
- Measurable distributor performance
- In-depth training for equipment installation, operation, and maintenance
- Annual joint meeting to review performance
- Developed process for future alliances
- Centralized service program through distributors
- Alliance for MRO materials using an integrated supply agreement
- Leveraged materials and services
- Combined materials management functions with inventory, warehousing, delivery, and invoicing activities
- Included manpower, warehousing and sourcing services
- Saved approximately 15-17% the first two years
- Leveraging equipment, materials, and technical services, additional savings of 20% were achieved
Keys to success in value-added initiatives include a number of factors most of which must be present if objectives are to be achieved. Some of these corporate best practices that drive world-class supplier processes include:
- Leadership by senior management that advocates accountability
- Vision based not solely on goals but also on value-add to corporation and individual operation
- Appropriate infrastructure to provide sustainability of results
- Recognition of those who role-model business inclusion
- A corporate culture that supports and promotes a change environment
Bates, Russell, "Cut Out Costs: Utilities," Purchasing Today®, March 1998, 12-13.
"Adding Value to Ourselves," NAPM Insights, April 1995, 1.
"Adding Value for Our Companies," NAPM Insights, June 1995, 1.
"Research - Allowing Us To Add Future Value," NAPM Insights, July 1995, 1.
"Adding Value Through Supplier Relationships," NAPM Insights, August 1995, 1.
"Adding Value Through Strategic Sourcing," NAPM Insights, September 1995, 1.
"Value Through Customer Service," NAPM Insights, December 1995, 2.
"Adding Value as One Shops the World," Purchasing Today®, January 1996, 2.
Purchasing Performance Benchmarks, various publication dates for 26 industries, Center for Advanced Purchasing Studies, Tempe, Arizona
Etheridge, J. Don, "Pump Up the Value," Purchasing Today, July 1998, 10.
Hagstrand, Allen P., "Are You Truly Adding Value?" Purchasing Today®, August 1997, 4.
Hall, Ian, and Betty Koller, "Benchmarking Put To Work." Purchasing Today®, March 1998, 48-50.
Leenders, Michael R., and Harold E. Fearon, Purchasing and Supply Management, 11th ed., ", 1997
Monczka, Robert, Robert Trent, and Robert Handfield, "Purchasing and Supply Chain Management," South-Western, 1998.
Ransom, Cheryl, and Fred Gaudios, "Cut Out Costs: Health Insurance," Purchasing Today, April 1998, 12-13.
Thorn, Candy, "Cut Out Costs: Capital Equipment," Purchasing Today®, February 1998, 6.
Zande, Dave, "Cut Out Costs: Raw Materials," Purchasing Today®, May 1998, 8.