The Delta Perspective January 2010
Driving efficiency through strategic procurement Authors
Javier Alvarez – Partner Lorenzo Campos – Associate Partner Inken Lasar – Senior Associate Delta Partners Intelligence Unit
The successful implementation of strategic procurement can help organizations improve their EBIT margins by 4-8 p.p.
Introduction The global financial crisis has reshaped strategies to increase overall operational efficiency among telecom operators especially in the Middle East and Africa. Operators are required to increasingly focus on an improved bottom-line to ensure funding for future expansion. Such conditions make procurement one of the vital efficiency drivers for operators. Strategic procurement is more than just squeezing suppliers, but it is instead an overall change in the purchase approach. This enables it to make the transition from an ‘adhoc’ support function to a long-term strategic approach. To maximise this shift, it is essential that the approach is adequately supported by analytics and a facilitating environment within the organization. This paper illustrates Delta Partners’ perspective on how the procurement
functions, traditionally seen as a mere administrative and control unit, can be transformed into a ‘change-agent’ for a telecom operator. This can be possible if the organization is willing to transform its existing business models towards a more integrated one for value creation.
Key highlights • Two thirds of all costs of a telecom operator are within the area of influence of a procurement function • Strategic procurement can help organizations improve their EBIT margins by 4-8 p.p. • The successful implementation of strategic procurement depends on three pillars – defining a sourcing model, organizational model and overall governance
What is Strategic Procurement? Strategic procurement consists of applying the correct sourcing strategies for each element within a sourcing category. In telecommunications, the four major categories are Network, IT, Sales & Marketing and General Administration. This involves adopting a long-term approach, the buy-in from the rest of the organization as well as the presence of analytical capabilities and skilled negotiators in the procurement department. Therefore, the key question that needs to be answered is what is the correct sourcing strategy and how does this translate into efficiency improvement? There is no straightforward formula to the correct sourcing strategy – especially since what is applied successfully in one market or operation may not work in another. The most important aspect in strategic procurement is to carefully account for potential sourcing approaches considering the operator’s corporate and commercial strategy, the strategic importance and financial relevance of the item to be sourced and the supplier market conditions. Despite the financial downturn, regional players have witnessed an overall subscriber growth and remain on the lookout for expansion opportunities. However, operators would have to adapt their operating models to the more demanding environment of limited capital, high competition and need towards synergy realization. Limited access to capital Access to capital for expansion plans has become more difficult and expensive due to higher risk-aversion from the banking industry. Only companies that can demonstrate extraordinary market 2
performance, in terms of top line growth as well as bottom-line efficiency, are allowed access. In this environment, CAPEX and OPEX optimization is essential to ensure each dollar invested delivers the highest return. Highly competitive market Similar to comparable European markets, heightened competition and increased pressure on margins across maturing Middle Eastern markets requires increased cost efficiency strategies. In Africa, cost efficiency has historically played a much more important role than in the Middle East. This is due to the higher proportion of low-value users which makes ROI challenging to achieve. Synergy realization After intense consolidation activity in the emerging mobile market sector, driven mostly by strong and committed regional players such as Zain, Etisalat, Orascom, Qtel and MTN, the pace is slowing. Operators are facing a real challenge in realizing cost synergies that were projected in ambitious business plans. In summary, emerging market operators would move away from a time when they were merely focused on expansion to generate shareholder value, to a time when they focus on time-to-market and efficiency improvement. All of these require that the procurement function plays a central role.
How can Strategic Procurement contribute to effective value creation? Strategic procurement is a major tool to conceptualize new business models seeking efficiency improvements. This is achieved by identifying key saving potential areas and driving innovative sourcing models which can enable operators to reinvent their cost structures. For example by turning traditionally fixed costs into variable through outsourcing models. While not all cost categories can be influenced by procurement, typically up to two thirds of all costs of a telecom operator are within the area of influence of a procurement function. Focusing the resources on the most relevant sources of cost, the procurement function can support the operator in achieving
critical efficiency improvements in the short term. This is achieved by direct or indirect manipulation of the key purchase levers of 1. Price of goods and 2. Volume of purchase.
1. Price of goods With the support of other business units, procurement is assigned the responsibility for evaluating, comparing and (re)negotiating prices with vendors across all business lines, based on initial offer and best available market rates.
EXHIBIT 1: SAVINGS POTENTIAL THROUGH STRATEGIC PROCUREMENT - IMPROVE EBIT UP TO 8 PP
Source: Delta Partners Analysis; Note: Cost categories based on benchmarks from MEA mobile players. Savings are from Delta Partners selected projects
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2. Volume of purchase Case Study: A mobile operator that had historically relied on local fuel distributors decided to broaden its horizon by considering international importers in order to reduce its dependency on local players. This helped it to improve security of supply, and bring down overall rates
Following up on each business unit’s needs, procurement should concentrate on requests, centralize relations with vendors and achieve discounted prices through improved negotiating power. In parallel, procurement should also internally strive for enhanced consumption policies and control mechanisms.
Positive results by short-term actions and tools can be taken to the next level with the support of a strategic procurement function focused on the improvement of overall sourcing and purchasing processes. Based on Delta Partners’ experience, it was observed that the potential for value creation ranges between 4 - 8 pp of EBIT margin for a typical emerging market mobile player (As shown in Exhibit 1).
How do organizations implement Strategic Procurement? The successful implementation of strategic procurement is built on the three pillars of: 1. Sourcing Model 2. Organizational Model and 3. Governance Structure (As shown in Exhibit 2). 1. Sourcing Model
Case Study: Backed by Delta Partner’s advisory support, a MEA mobile operator was able to reduce its network CAPEX by 35%, through centrally renegotiating network elements. This was based on a competitive bidding process and closure of a framework agreement for the forthcoming years.
A robust sourcing model is essential for the overall success of strategic procurement since it is required for each of the four main categories of telecommunications - Network, IT, Sales & Marketing and General Administration. In order to procure different items under each category, the sourcing model needs to delve deeper into the aspects of spend analysis, supplier relationship management, and category plans. 1.1 Spend analysis The first step towards a strategic approach in the procurement function is the achievement of transparency across the organization on what is bought by
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whom, the type of approvals required and its regularity. It is essential that the procurement unit possesses people with an analytical profile in order to perform regular spend analysis and reporting. For instance, just by installing transparency about spend, and channeling every purchase order through the procurement department (empowered for the entire negotiation process), a mobile operator was able to reduce annual OPEX spend by 2%. 1.2 Supplier relationship management The next step in the sourcing strategy is to research available sourcing options in the supplier market, which can either be from local or international vendors. A detailed assessment of the
Case Study: Whilst supporting a MEA operator in the bidding process and selection of preferred vendors in the region, Delta Partners helped create a platform that could achieve annual savings of 30% and 15% on SIM and scratch card purchases respectively.
different supplier options should be undertaken, weighing various criteria, such as price, lead time, quality, on-site support and long term conditions, amongst others. Here, procurement personnel should use their creativity in exploring alternative supply options. A supplier pre-qualification process to ensure they comply with requirements aligned with procurement strategy and policies is also necessary. 1.3 Category plans The implementation of a successful sourcing strategy is also based upon effective category planning. For all the items within the four categories – i.e. Network, IT, Sales & Marketing and General administration, the elements of vendor strategy, relationship, price structure, payment terms and delivery terms play a critical role. This entails being clear about source of purchase (such as original equipment manufacturers, wholesalers or retailers), use of one/multiple suppliers, short or long-term basis, credit terms or cash and decision on delivery period. As a rule, the overall framework needs to contain all the items requested from
the suppliers as part of the provided quotation, along with a long-term outlook of annual volumes as well as re-negotiation cycles. This needs to be formalized in writing and made known to respective procurement employees.
2. Organizational Model The introduction of strategic procurement within an organization has to be carried out in a phased approach. Firstly, a capable and empowered procurement organization needs to be put in place. Most modern organizations choose the category management principle, whereby each procurement employee is responsible for a certain category. However, strategic procurement is not necessarily linked to a certain organizational model. Regardless of the operators’ set-up, procurement employees should be specialists with strong experience in the area and possess not only sound quantitative and analytical skills but also the ability to communicate and negotiate effectively. Above all, integrity is a non-negotiable
EXHIBIT 2: IMPLEMENTATION OF STRATEGIC PROCUREMENT
Source: Delta Partners Analysis
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requirement. In order to be effective, the procurement organization must be empowered by the company’s management. Empowerment is done by choosing an adequate reporting level within the organization which is most likely the Chief Financial Officer (CFO). However, this is not a hard and fast rule and should be adapted to local market conditions. For example, in an emerging market, where a quick network rollout was required, a mobile operator appointed the Procurement Director into the Executive Committee as a
C-level executive, i.e. the CPO (Chief Procurement Officer). This reflected the importance the organization bestowed upon procurement as a crucial function especially when time-to-market was critical.
3. Governance Structure An adequate governance system is vital to reap benefits from strategic procurement, as strategic procurement is often oriented at achieving savings, and can conflict with the interests of the
business units. An escalation process to senior management needs to be considered and implemented to address such conflicts. The governance system should also include mechanisms to manage the relationship with suppliers. In this way, new trends and potential issues can be detected as early as possible and new sourcing models can be designed to react accordingly. Rather than strictly looking at P&L effective cost reductions that compare to last year’s spend, procurement needs
Illustrations of Strategic Procurement Best Practices • Target pricing: Instead of using a competitive RFP process, a mobile operator shifted to the ‘target pricing
model’, setting its suppliers a price target for a certain product category, leading to maximum transparency. This price target was derived from overall world market price, accounting for a ‘mark-up’ to reflect additional costs (Example transportation, distributor margin etc.). The overall savings achieved was estimated to be around US$ 1 Mn per annum • Reverse auction: Standardization of P&S request, maintaining price as the only variable to compare suppliers
against. Reverse auctions can also be conducted over the Internet, further reducing time and effort. For example, a MEA operator identified new integrated site maintenance providers through a competitive reverse auction process, leading to 40% cost reduction • Volume bundling: Centralized procurement at Group level allows for standardization of Products & Services (P&S)
across all operations as well as quantity discounts. A mobile operator who bundled its CAPEX at Group level was able to reduce network CAPEX by 35% • Sourcing of different components: In some situations, it might be preferential to source different components
from different suppliers instead of the whole and centralized package. This can lead to the most competitive offers from different sources. Furthermore, a global sourcing framework that caters to the operator’s footprint, can further contribute towards significant savings • Preferred supplier: Electing a preferred supplier using a pre-defined set of parameters ensures quality control as
well as helps to obtain preferential rates. Mobile operator was able to get a EDGE upgrade for free from a vendor in return for the award of the exclusive contract for 3G network roll-out in a European country • Discount by vouchers: In certain instances, an operator can negotiate for discount vouchers from the vendor at
the time of placing a large order. These can then be used in subsequent purchases • Long-term contracts/ versus spot buying: For volatile supply markets (e.g. fuel), it might be beneficial to enter
into a long-term agreement with a fixed price for a certain period to hedge against expected price increases • Outsourcing: Delta Partners supported a mobile operator in outsourcing its call center function to an external
service provider, resulting in savings of around 10% of operating costs, alongside increased service quality • Backwards integration: If the product/service procured is of high importance for the operator (e.g. content
providers), close co-operation with a specific supplier or even backwards integration might be a viable strategy
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its own savings calculation methodology to access true savings. This should be auditable and supported but at the same time adequately incentivize the employees. Delta Partners has developed its proprietary savings classification methodology, accounting for different type of savings depending on the nature of the effective purchase process. Hard savings: This includes savings registered against historical spend data and thus directly reflected in the P&L account. Soft savings: These include cost reductions which cannot be calculated using historical data and therefore do
not create a direct impact on the P&L accounts. However, they minimize the negative impact to the bottom-line that a higher expenditure for a certain item would have caused. Example. Price reductions through negotiations during the purchase of a new item. Cost avoidance: This includes cost reductions that have been achieved as a result of changing product specifications (scope changes) due to the involvement of procurement function. Registration of cost avoidance implies a negotiation process between business users (responsible for the request) and the procurement department (responsible for the purchase).
Conclusion Since the global financial crisis surfaced over a year ago, MEA telecom operators have slowed down their aggressive expansion plans due to limited availability of funding. Meanwhile, the need to establish synergies and the presence of increased competition in existing markets continues to exert pressure on margins. In this environment, strategic procurement has proven to be a powerful lever in order to improve overall efficiency. Mobile operators that have consciously invested in the re-orientation of their scattered purchasing units, changing their pure operational spot buying approach into a long-term, integrated strategic one, usually creating a centralized group function as driving force are bound to succeed. Delta Partners has had significant exposure supporting operators across emerging markets in the establishment of a strategic procurement function. Based on its experience, savings of up
to 4 to 8 p.p. in operating profit (EBIT) can be achieved by those operators that succeed in this process. They take the initiative to transform the procurement function into a “change agent” that works hand in hand with business users to redefine traditional operating models for value creation. Operators willing to adopt strategic procurement within their organizations need to concentrate on three key dimensions: • Definition of strategic sourcing models for key procurement categories, which requires detailed spend analysis and the development of detailed category plans as key inputs to select the most appropriate strategy • Creation of a capable and empowered
procurement organization wherein each procurement employee is responsible for a certain category such as Network, IT, Sales & Marketing and General administration
• In-depth review of the procurement
organization and the definition of a governance model that covers both procurement specific issues as well as the interaction with business users to ensure integrated decision making. Organizations would also need to develop long-term partnerships with suppliers, by enhancement of market intelligence through rigorous supplier research, clear vendor prequalification criteria and periodic evaluation & feedback mechanisms As the world begins to look beyond the current crisis and take the first steps towards recovery, operators mastering strategic procurement will be able to resurge stronger, leveraging this sustainable competitive advantage to strengthen their position in an increasingly tough environment in emerging markets.
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