The Business Times

Adding value through better procurement

Adding value through better procurement

Fourth-generation procurement can help businesses keep mounting costs in check.

  • min read


Adding value through better procurement

This article originally appeared in The Business Times (Singapore) - subscription required.

As we mentioned in the first of this two-part series, our candid interviews with 60 executives throughout Asia-Pacific helped us see where they feel they're lagging in procurement capabilities, at a time when such mounting pressures as cost volatility make it more important than ever to catch up.

Fortunately, they can learn from the best. We call it fourth-generation procurement—using the procurement function as a way to add value to the business year after year, shoring up the bottom line by keeping costs from mounting. Based on our work with clients and our study of procurement capabilities, we've identified the criteria that raise companies above their rivals and found winners for each of the six important enablers: organisation, processes, tools and systems, P&L effectiveness, talent and Results Delivery®.

Leaders tackle procurement from an organisational standpoint, choosing a mandate and structure to maximise procurement gains. LG Electronics moved from managing its procurement according to product line to managing it according to manufacturing stages. Hence, it could buy the same part for washing machines and refrigerators. It also reorganised reporting structures—now all procurement team members report to a head of procurement—and gave procurement a seat at the table in top executive meetings. The savings mounted. Procurement's impact on the bottom line is estimated at US$30 billion from 2008 to 2012, and it remains a key factor in LG's continued success.

Winners focus on the critical processes they need to get right: category management, vendor development and the quality of information. For example, they rigorously evaluate suppliers and contracts, always conducting a total-cost-of-ownership analysis. UK-based mining company Rio Tinto, with major operations throughout Asia-Pacific, works with internal customers to identify short and long-term needs and develops expert knowledge of supply markets, vendors and value levers. To minimise costs and maximise value, it implements regional category strategies, taking a total-cost-of-ownership approach. Then it systematically manages its suppliers through predefined key performance indicators (KPIs) and common objectives. Along with other initiatives, Rio Tinto's procurement operation will contribute to the company's expected cash cost savings of more than US$5 billion by the end of this year.

Fourth-generation procurement companies rely on customised, dynamic dashboards that provide integrated and transparent data for both direct and indirect spending, highlighting performance gaps. With tools and systems that provide seamless access to centralised global information, Ford Motor Company's procurement managers quickly see and adapt best practices. They may note, for example, that a global supplier of headlamps has a production facility in Asia that faces quality challenges at a higher rate than its facility in Europe. With this comparison in hand, the company can actively work with the supplier to improve its record and meet global standards for all its facilities.

To boost P&L effectiveness, companies with fourth-generation capabilities establish pull-based demand management with enforced compliance and formalised budgeting for all categories. At one leading retailer, an advanced category management toolkit allows the company to see the direct effect of its sourcing decisions on the bottom line - a first step in alerting it to the need to make adjustments.

Leaders make a serious point of investing in talent. They establish procurement as a grooming ground for leadership and cultivate the right mindset. At Royal Philips Electronics, stakeholders throughout the company are consulted whenever a key person in procurement is being recruited. Leaders also manage performance through well-defined KPIs and incentives.

Finally, to stay on task and deliver results, forward-thinking firms establish risk teams that track and manage all transactional and strategic risks. For example, to make its savings stick, Dow Chemical implemented a system of feedback loops. Supply managers routinely sit down with business unit managers to review supply management performance and jointly determine ways to improve.

Road to procurement excellence

Our experience helping companies has taught us that the path to achieving fourth-generation maturity differs for each company, based on the sophistication of its existing operation, its unique objectives and the industry or market dynamics. We've also learned that while it's possible to reap above-average results by improving the six enablers, companies with fourth-generation capabilities share one common characteristic. Their procurement organisations work in tandem with the business. It's carefully choreographed down to the last detail.

To get there, companies work on three key initiatives:

  • Spending transparency: The first goal of any procurement organisation is to ensure it has a complete and accurate picture of its spending, that all information is continuously maintained and the database is accessible for procurement professionals across the organisation. Bringing full spending visibility under one roof leads to higher rates of compliance, to the point that maverick spending becomes almost extinct.
  • Going beyond savings delivery: The goal is to identify the full savings potential and the steps that can be taken to capture those savings. To this end, leaders analyse category and cost structure, as well as the supplier landscape for each category. They conduct category workshops to verify findings, develop initiatives for each category and estimate the savings potential of each initiative. The results can be impressive. Fostering competition among a broader supplier base and sourcing from best-cost countries allowed Rio Tinto to save 50 per cent on the cost of truck pads and to source truck trays that are 40 per cent cheaper than it previously paid.
    As part of this process, successful companies look for quick wins and assess initiatives on an ease-of-implementation basis. The right moves can lead to initial savings of 8 per cent to 12 per cent. For example, one PC company saved more than US$20 million in its first year - and identified US$250 million annual savings across multiple categories - by tackling five areas. It controlled demand by revising purchasing policies and deferring some purchases. It invested to better understand its markets and suppliers, which helped it effectively negotiate prices. The company consolidated volume, designed to cost and developed integrated systems for total cost of ownership.
  • Sustainability: With procurement savings identified and with the right steps in place, the next move is to ensure the savings stick year after year. Companies focus on three areas.

First, they establish corporate and cross-functional interfaces. For example, procurement needs to work closely with the business, operating towards common targets and motivated by common KPIs, all managed through a rigorous process that incorporates feedback from internal customers. As required, companies make organisational changes to help them meet customer needs.

Second, companies refine core procurement management capabilities. In our experience, category management and supplier management are the two most important processes for achieving sustainable results.

Finally, they design their organisations for sustained results. For example, they organise for identifying and quickly making the most important decisions - and at the right level.

We've found that companies following this approach can save on procurement year after year. After those initial cost savings in the 8 per cent to 12 per cent range, the best players typically deliver 3 per cent to 4 per cent cost reductions per year.

Some companies sourcing in Asia-Pacific are dealing with the fallout of rapid growth and others with the challenges of a cooling economy. Both situations require companies to build world-class procurement organisations that control costs better than rival firms.

Executives are candid about their shortcomings in this area. They lag behind global best practices in everything from supplier management to business intelligence. But for those who choose to improve, advancing to fourth-generation procurement begins with a single step: performing a basic diagnostic to learn, in important detail, where you're starting from and what you stand to gain by taking the journey.

The writers are respectively a Bain & Company partner based in Kuala Lumpur and a Bain & Company principal based in Beijing.

See the first article in this series: Why procurement in Asia-Pac needs overhaul


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