This article originally appeared in Forbes.com
Procurement represents the lion’s share—as much as 80%—of overall costs in some industries, and companies like Wal-Mart and Apple have demonstrated that procurement leaders are cost leaders in their industries, with a clear edge over rivals. Nowhere is the pressure to improve procurement as intense as in Asia-Pacific, both for domestic companies and multinationals that rely on the region as an important source of goods and services. Companies in developing countries like China wrestle with operations that have bloated during high-growth years. Those in developed countries like Australia struggle to shore up margins as top-line growth slows. Firms in all parts of the region deal with rising and volatile input costs. When we recently interviewed 60 business heads and chief procurement officers (CPOs) throughout Asia-Pacific, 90% agreed that volatility is here to stay.
Leadership teams have dutifully set aggressive targets for reducing input costs and usually in short time. Despite their best intentions, however, many executives tell us they are simply ill-prepared to meet their goals. They readily admit that their companies rely on procurement capabilities that are no better than their competitors—and sometimes worse. Still, our interviews helped us identify those procurement organizations in leading companies across the region that stand out. A 5% cost performance gap and contribution to revenues is what sets apart good from great procurement organizations when compared with their industry peers.
The majority of executives we interviewed described procurement operations that lag global best practices. That spells trouble for companies headquartered in Asia-Pacific as well as MNCs that source extensively from the region.
Our study found that procurement teams in Asia-Pacific often lack organizational support and prominence, tend to focus on short-term activities, rely on inadequate demand management processes and struggle with underdeveloped supply bases. For example, more than half of the CEOs interviewed feel their supply base is underdeveloped. Moreover, they lack systematic supplier management processes, reliable data systems and strong procurement talent. In fact, only 40% are satisfied with their procurement talent.
Fortunately, they can learn from the best. Even companies that are woefully behind can catch up by adopting the practices of what we refer to as “4th-Generation” procurement: using the procurement function as a way to add value to the business year after year, boosting the bottom line by keeping costs from mounting. With dedicated effort, a continuous improvement culture and complementary capabilities, we’ve seen companies repeatedly achieve 3% to 4% savings year over year, following initial savings of 8% to 12%.
What does 4th-Generation procurement look like? Our work with clients and our study of procurement capabilities in Asia-Pacific identifies the criteria that raise companies above their rivals.
Leaders tackle procurement from an organizational standpoint, choosing a mandate and structure to maximize procurement gains. LG Electronics moved from managing its procurement according to product line to managing it according to manufacturing stages. Hence, it could buy a common part for washing machines and refrigerators. It also reorganized 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 $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 minimize costs and maximize value, it implements regional category strategies, taking a total-cost-of-ownership approach. Then it systematically manages its suppliers through 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 $5 billion by the end of 2014.
4th-Generation procurement companies rely on customized, dynamic dashboards that provide integrated and transparent data for both direct and indirect spending, highlighting performance gaps. With seamless access to centralized 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 the effectiveness of the P&L, companies with 4th-Generation capabilities establish pull-based demand management with enforced compliance and formalized 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 manage performance through well-defined KPIs and incentives. A key factor in the success of Royal Philips Electronics’ procurement organization: linking it to decision makers throughout the company. Whenever a key person in procurement is being recruited, stakeholders throughout the company are consulted.
Finally, to stay on task and sustain 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.
These procurement leaders have set strong examples for others to follow. As a starting point, if you’re running procurement, it’s worth asking a few key questions. Is the procurement function prominent enough? Are you the preferred customer of vendors? Are IT systems helping to continuously identify improvement opportunities? Companies that can answer these questions have a head start on this critical area of business.
Ray Tsang is a partner in Bain & Company’s Shanghai office and a leader in the firm’s Performance Improvement practice. Amit Sinha is a partner based in New Delhi, and Gerry Mattios is a principal based in Beijing.