PHOTO: istockphoto
Reframing procurement’s strategies, priorities and deliverables: Benchmarking performance against ten value levers This article is the first of an exclusive five-part series of articles produced for DILForientering, which will run throughout 2011. It positions the maximisation of value, the minimisation of cost and the balancing of risk as guiding propositions for procurement as a driver of change across the private and public sectors.
6 DILForientering april 2011 Ă…RGANG 48
❙❙
By Jon Hughes, Executive Chairman Future Purchasing, and Professor Marc Day, Henley Business School, University of Reading
C
reating, unlocking, capturing and maximising value at lowest sustainable cost, while balancing risk within acceptable parameters, is the cornerstone of organisational success and the heartland of all strategy and operational practice. It is also a hotly contested area with many different perspectives, both practitioner and academic. In this series of articles, a team of leading consultants and researchers are collaborating to share a wide range of perspectives that hopefully will be of real value to the reader. We will examine the emerging contribution that procurement and major suppliers are making to the value journey; summarise guiding frameworks for value maximisation; highlight a range of interventions for sustaining strategic and operational cost management; identify business models and best-in-class tools for auditing and securing supplier value; apply ‘value at risk’ (VaR) methodologies; and argue for an increasingly international focus on leadership, learning and capability development for all who aspire to become the next generation of chief procurement officers (CPOs).
❙❙
❙❙
❙❙
of the levers, and with a very obvious link to procurement. Reducing risk and cost of capital – by for example hedging raw materials and currencies, optimising inventory and improving working relations with suppliers. Increasing long-term business value – enabling a company to optimise free cash flow generation and minimise the cost of capital, thereby increasing company valuation. Improving transparency and financial communication – in line with analyst, investor and stakeholder expectations (both financial, reputational and ethical). Building trust and confidence – by meeting investor and public expectations, while delivering on forecast results and valued benefits.
Worldwide Collaboration Project on Value Maximisation – A five article series in DILForientering, 2011 Five organisations, well known to many of the readers of DILForientering, are working together on a practitionerfocused project to understand, audit and transform the sources of supplier value. Our work will be shared at a major European conference scheduled for third quarter of 2011.
Over the last decade we have consistently argued that in the private sector, procurement has to demonstrate its impact on shareholder value as a major contributor to business success. Ongoing market globalisation, and more recently the rigours of the financial crisis, have led to tremendous short-term pressure on executives to deliver against major market indices, irre-
spective of business sector. In particular the provision of return on invested capital (ROIC) must be superior to the weighted average cost of capital (WACC). We
ten value levers underpin organisational and procurement performance
Cascading value in the private and public sector Two prime sources provide the intellectual starting point for examining value: Rappaport (in terms of shareholder value, for the private sector) and Moore (public value and social result, for the public sector), as shown at the top of the pyramid in figure 1. These approaches have been our guiding frameworks for evaluating the contribution of procurement practice across ten value levers. Firstly, in the private sector, Rappaport and others have defined six key shareholder value drivers: ❙❙
❙❙
Accelerating free cash flow – providing the funds to pay dividends, buy back shares and support acquisitions. It is one of the financial performance metrics most closely scrutinised by the investor community. Reducing costs – perhaps the most readily understandable and tangible
7 DILForientering april 2011 ÅRGANG 48
Figure 1. Source: © Jon Hughes, Future Purchasing and Professor Marc Day, Henley Business School University of Reading, 2011
About the Authors Jon Hughes Executive chairman and director of Future Purchasing, with 35 years’ experience in procurement change management. His contribution to procurement innovation was acknowledged by the UK’s CIPS with their Swinbank Award. Masters degree in Organisational Psychology from Cambridge University. Email: ejhughes@futurepurchasing.com Web site: www.futurepurchasing.com Marc Day Professor of Strategy and Operations Management at Henley Business School. Former chairman of IPSERA and Visiting professor at Seattle University. 15 years’ experience of consulting, researching and teaching procurement at MBA and doctoral level. PhD in Manufacturing Strategy from Keele University. Email: marc.day@henley.reading.ac.uk Web site: www.henley.reading.ac.uk
believe that effective value creation in line with this requirement should be expressly linked to the overall performance of procurement in its strategies with major suppliers. Secondly, the aftermath of the financial crisis has also put an increasing focus on public sector spend, the need for fundamental reduction of structural deficits and the adoption of new fiscal rules. Moore and others have argued for the maximisation of public value, which has distinct parallels with the case for maximising shareholder value: ❙❙
❙❙
❙❙
Creation of public value – it is hard to measure, but it is the range of beneficial outcomes from spending taxpayers’ money. That is usually strongly contested politically. Public sector effectiveness is the delivery of successful social result in line with that public value. For example a country may spend considerable money on school buildings. What really matters, however, are the cumulative outcomes from that educational spend on a country’s competitiveness and culture. Public sector efficiency is the application of operational practices to achieve more for less.
8 DILForientering april 2011 ÅRGANG 48
❙❙
Public sector economy is doing all of the above, while minimising the cost of resources.
As an illustration, the UK’s annual gross domestic product is in the region of �2tr; public sector expenditure is c. �800bn; and third party supplier expenditure is approximately half of this. It is easy to see why politicians, at times of severe fiscal austerity, are looking for ways to transform public sector procurement.
Procurement really does make a difference Proving the causal link to show how procurement impacts shareholder value was not conclusively established until 2008 when we assessed the relationship between the two in an extensive research project. It is easy to assume that investing in a top quality procurement team yields positive results across the levers that Rappaport and Moore identify. We decided to test if there was a financial penalty to pay from a misfit between procurement’s role, the prevailing strategic direction of a business and key financial & operational metrics. We set out to assess what the ‘cost’ might be for poor strategic supply management thinking, and what contribution procurement adopts as a shaper of value creation. Our research covered various sectors to provide a clear insight into the way that alignment with the business’s strategic direction builds and leverages value from the supply base. We found poor alignment between a business’s supply strategy and its general strategic direction results in a proven financial and operational penalty. It demonstrates that procurement, when properly aligned with the general strategic direction of the business, plays an important role in harvesting the hard earned rewards of sustained competitive advantage. Three ideal strategic types for procurement emerged, which roughly split the respondents into three equal groups. The first group were value harvesters, where superior performance gets built by leveraging value from mature product and service markets. The opposite were a second equally large group of companies who build value from focusing on new product and service creation. Procurement should act as value catalysts, bringing new ideas from the supply market, as well as performing convention cost reduction roles. The final group, portfolio managers, build supply strategies to deal
with two different types of demand: responding to new market innovations whilst supporting existing products and services. They need a fast follower supply base, but be lean enough to leverage value from mature markets. Our research therefore fails to see a simple ‘one approach fits all’ for alignment, but three options. What did unite them was the need to have a sustained approach to supply strategy roll-out, avoiding the temptation to deviate from the chosen path in the face of pressure from short-term price, cost or relationship turbulence. The key challenge respondents reported was the creation of a real connection between procurement and building for value, whilst still keeping a focus on price and cost.
Successfully aligning procurement with performance delivery In both the private and public sectors, it is essential that procurement initiatives are framed in a way that are aligned to, and expressly connect with, the value parameters described above. Senior management need to understand the true business and organisational impact of procurement, and its centrality to sustainable success. Encouragingly there are now many such case studies across the full spectrum of value, risk and cost highlighted at level C in figure 1. Performance is increasingly being delivered in line with the promise. Here are ten examples: ❙❙
❙❙
❙❙
❙❙
Siemens: Implementing their “60:25:20” plan, i.e. 60% of global spend pooled and aggregated; sourcing in emerging countries increased to 25%; 20% supplier reduction, and over 1,000 measures identified to reduce cost and complexity across product specifications. Toshiba: Slashing the cost of procuring components by ¥1tr over three years. Major shift to overseas suppliers for 70% of their procurement base by value. Procter & Gamble: The “connect and develop” initiative where, over a ten-year period, they are increasing revenue and profit from supplier-led innovation from 15% to 50% with greater externalisation of research and product development. Tesco: The world’s third biggest retailer is reducing the supply chain carbon footprint by 30% by 2020,
❙❙
❙❙
❙❙
❙❙
❙❙
❙❙
halving the emissions per case of goods by 2012, and has a highly ambitious goal of becoming carbon neutral by 2050. Chrysler and Fiat: Aiming to deliver $3bn by 2014 through sharing twothirds of their supply base and leveraging the combined $70bn of joint purchasing power. Sony: On track to cut procurement costs by one fifth, with a huge contribution to the company’s annual savings target of ¥330bn. AP Møller Mærsk: Offshored analytical and knowledge-based procurement services to low cost countries and set up a procurement capability in Mumbai for total cost modelling, complex cost analyses and optimising procurement processes. Unilever: Successfully leveraged scale by streamlining their organisational structure, establishing regional sourcing organisations across their geographies and moving to global procurement. Savings well in excess of �2bn and improvement in working capital of a similar amount. Marks & Spencer: Extended supplier payment terms from 30 to 60 days, while implementing supplier financing to enable those suppliers to be paid earlier by the banks. Public sector: In the UK, the newly formed Efficiency & Reform Group is launching strategies capable of securing bankable cost savings in excess of 15% of spend. Fast gain initiatives are already under way, with aggregation of common commodity spend. In the
US, the Presidential Commission for Budget Reform is pushing for a similar cost saving target. In parallel, the National Commission on Fiscal Responsibility and Reform intends to cut more than $200bn from the US budget by 2015, with half these savings coming from Defense, of which half will be from procurement.
Benchmarking sourcing, supplier value management and other value levers It can be quite difficult to assess the overall maturity of procurement from these very short illustrations. Different organisations, in different sectors, tend to be at very different stages in their change journeys, so it can be helpful to understand the different types of sourcing and supplier value management (SVM) initiatives that organisations are actually using. We provide in figure 2 a high level summary of three broad types, together with indicators to tell you whether the primary focus is on tactical sourcing, concentrating on the delivery of contractual value; strategic sourcing, concentrating on the delivery of improvement value; or transformational sourcing, concentrating on the delivery of breakthrough value. We will revisit this theme in the second and third articles in this series. When a content analysis is made of the different types of procurement initiatives and value levers being applied, it also becomes very apparent that the precise balance and mix between them varies in a way that reflects organisational
context and business priorities. Having said that, we have conducted extensive research into these levers and have identified ten generic ones – four focused primarily on internal strategy and realignment (level D in figure 1) and six primarily externally focused (level E). A benchmarking tool is provided in figure 3, both to bring them to life and to enable an assessment of current performance and practices in your own organisation.
A more disciplined focus on risk A simple definition that we have used regularly, of competitive and organisational advantage secured through procurement, is “value minus cost”: drive the value up while reducing the cost. More recently, and particularly through the work of Kairos, we are increasingly emphasising risk management, which will be covered in the fourth article. Indeed, as we write, oil prices closed in on the key psychological level of $100 per barrel; the UN Food & Agriculture Organisation’s Food Commodity Price Index broke through to its highest ever level; and copper and iron ore are at all time highs. While many had hoped that a benign benefit of recession would be a slowing down of the commodity cycle of sharply rising prices, that has not been the case. Commodity led input price inflation is back on a firmly upwards track, so there is clearly a need to develop a much more disciplined and skilled approach. There are at least three critical capabilities that need to be strengthened to mitigate or balance price risk properly: ❙❙
Upgrade commodity risk strategy
different types of sourcing and supplier value management (SVM) initiatives
Indicators
Contract value
Improvement value
Breakthrough value
Activity focus
❙❙ ❙❙
Price focused Securing tactical delivery
❙❙ ❙❙
Cost and value focused Securing performance and value
❙❙ ❙❙
Cost, value, revenue and risk focused Securing capability and advantage
Typical initiatives
❙❙ ❙❙
Quick wins sourcing Contract management
❙❙ ❙❙
Core category management Supplier performance management
❙❙ ❙❙
Business initiative led sourcing Supplier value management (SVM)
Typical deliverables
❙❙ ❙❙
Leveraged price reduction Performance to contract
❙❙ ❙❙
Cost down and value up Top quartile supplier performance
❙❙ ❙❙
Transparency on cost drivers Capability access and innovation
Leadership and resourcing
❙❙ ❙❙
Buyer led Procurement team members
❙❙ ❙❙
Category manager led Cross-functional team members
❙❙ ❙❙
Executive director led Business leader team members
Figure 2. Source: © Jon Hughes, Future Purchasing and Professor Marc Day, Henley Business School University of Reading, 2011
9 DILForientering april 2011 ÅRGANG 48
benchmarking procurement transformation against ten value levers Little evidence Value lever 1 Business alignment and stakeholder engagement
1 Not started
1 Value lever 2 Structure, governance and operating model
Not started
Value lever 3 Leadership, people and team strength
Not started
Value lever 4 Process excellence and technology
Not started
Value lever 5 Category and supplier value management
Not started
Value lever 6 Reform of the supply chain
Not started
Value lever 7 Outsourcing, offshoring and LCCS
Not started
Value lever 8 De-Risking the supply chain
Not started
1
1
1
1
1
1
1 Value lever 9 Product, process and relationship innovation
Not started
1 Value lever 10 Ethical sourcing and CSR
Not started
Early days performer “Moving forward” 2
3
Improving performer “Real acceleration” 4
Procurement strategy in outline only. Stakeholders are interested, but we tend to be involved in operating plans quite late. Not closely integrated with key business metrics. 2
3
4
Organisational structure of procurement still evolving. Some misalignment locally, regionally and globally. Project reviews take place, but need for better governance. 2
3
4
Mixed capabilities and competence across the team. Need to strengthen procurement leadership. Some training under way, but primarily covering functional skills. 2
3
4
We have 50% or less adoption of processes in category management, supplier management and P2P. Compliance varies. Spend access and knowledge transfer difficult. 2
3
4
Quick wins completed, but focus still primarily on price down, consolidation and leverage. In early days of wave planning cycle. Full category planning not yet done. 2
3
4
Our supply chain is neither particularly lean, reliable nor agile. A few tools are being used, but there is no guiding vision such as ‘operational excellence’ or ‘lean’. 2
3
4
Less than 20% of outsourcing/offshoring potential exploited. Processes not well defined. Access to international procurement office and Asia sourcing under way. 2
3
4
Sourcing and SVM teams focus on risk, but not in a systematic manner. Not integrated into enterprise risk management. No real line of sight on value at risk. 2
3
4
Category and supplier management are being used to leverage supplier relationships, rather than access capability. The focus is price not innovation. 2
3
4
Formal procurement and ethical policies are in place. We are aware of responsible sourcing, but have not really done very much. It is not a strength of our business yet.
5
6
Best in class performer “The benchmark standard” 7
8
Approved procurement strategy, plan, targets and metrics. Reviewed as part of the planning cycle. Business leaders sponsoring initiatives impacting categories and suppliers. 5
6
7
8
Organisational changes have been made. Well on way to operating as “one procurement team”. Programme management and project planning have been strengthened. 5
6
7
5
6
7
5
6
7
5
6
7
5
6
7
5
6
7
5
6
7
5
6
7
9
10
9
10
9
10
9
10
9
10
Our business model has changed fundamentally to embrace open innovation. 40% + innovation and revenue growth is coming from proactive supplier input. 8
Well-defined programmes for compliance with global codes e.g. Dow Jones/FTSE 4 Good Index. Transparency building with suppliers and some auditing has taken place.
10
Balancing of commodity and supply chain risk is driven top down through strategy, policy and well-focused initiatives. We are expert in procurement and commodity analytics. 8
Our core procurement processes now emphasise innovation as part of business requirements. Suppliers are involved in incremental innovation and adaptation.
9
61% + of outsourcing/offshoring potential exploited. Using this supply base to transform our competencies and capabilities. Product localisation and R&D centres in place. 8
We are adopting a value at risk approach to volatile commodity management and are strengthening sourcing, commodity and supplier management to include risk.
10
Lean strategy and operational excellence are central to our business, with close integration with major suppliers. Supplier value auditing drives ongoing step change. 8
21-60% of outsourcing/offshoring potential exploited. Tools such as outcome based contracting in place. Substantial staff resources on the ground in growth markets.
9
Very significant penetration of addressable expenditure across full range of sub-categories. Supplier value management fully impacting top 50+ suppliers. 8
Lean thinking and operational excellence adopted by senior management. Business is competent in at least three core approaches, e.g. lean, cost innovation, SVM.
10
We have 76%+ adoption of e-enabled processes in category management, supplier management and P2P. Compliance is excellent, as is knowledge management. 8
Large numbers of cross-functional category team projects under way. On track to achieve forecast savings and big improvements in supplier performance. Credibility building.
9
Well recognised externally as a leading function. Real credibility in the eyes of top management. Sophisticated capability building in place, such as academies and coaching 8
We have 51-75% adoption of processes in category management, supplier management and P2P. Compliance is good, as is online access to information, toolkits etc.
10
Really cohesive procurement structure, with single lines of authority and reporting. Welldeveloped steering groups, governance and project reviews, internally and with suppliers. 8
High quality professional procurement leadership team in place and actively engaging the business. Investment plan approved for talent management and learning.
9
Very clear linkage, business strategy, goals and procurement initiatives. Closely integrated into the planning cycle. Active sponsorship from CEO down. Tied in to MBOs.
9
10
Acknowledged leader in the field, as measured by indices/investors. Central to our business value proposition. Reputational and sustainable sourcing a business strength.
Figure 3. Source: © Jon Hughes, Future Purchasing and Professor Marc Day, Henley Business School University of Reading, 2011
❙❙
and create dynamic, organisationwide action plans – with a starting point most definitely being a forward analysis of risk – the classic VAR calculation – so that you are looking forward into the future rather than in the rear view mirror. Strengthen commodity governance, build stronger collaboration with finance and do more reviews: The accountability for commodity price risk management lies squarely with procurement, but it must be integrated with the currency responsibility of finance. The two are interdependent with currency fluctuations having a
10 DILForientering april 2011 ÅRGANG 48
❙❙
huge impact on commodity prices. Apply innovative analytical tools: There is a huge return on investment in stronger analytics. Alas, far too many companies still have a limited understanding of the cost drivers behind major commodities, and have not integrated the well-developed tools of fundamental / business cycle analysis with technical analysis / contract timing into a dynamic contract strategy embracing the full range of hedging strategies and financial instruments.
From strategy to operational execution Jack Welch of GE famously commented, “The key isn’t having a strategy, it’s getting it implemented.” This is partly analytical (breaking strategy down into clear targets, precise milestones, designing, tracking and review mechanisms etc.) and partly behavioural (stakeholder engagement, influencing skills, selling the procurement value proposition etc.). This will also be a theme we will examine throughout these articles, with the final one concentrating on the talent agenda of people and capability. There will also be a European CPO Forum later in the year examining our key
themes in a highly participative conference setting, and we look forward to meeting some of you at that time. / References½ Bundgaard, T., Hughes, E.J., Vammen, S., Hvid-Jørgensen, L. (2008). Equipped for a Bumpy Ride: Developing a More Disciplined and Skilled Approach to Managing Cost Risk. CPO Agenda, Autumn, pp.18-26. Day, M. and Lichtenstein, S. (2008) Exploiting the Strategic Power of Procurement, Henley Business School, University of Reading, UK. Day, M. & Lichtenstein, S. (2006) Strategic procurement: The relationship between procurement practices, strategic orientation and their impact on organisational performance. Journal of Purchasing & Procurement, 12, pp. 313-21. Day, M., Magnan, G. M., Hughes, E. J. & Webb, M. (2008) Strategic supplier relationship management. Supply Chain Management Review, 12, pp. 40-48. Gallery, C., Brock, D. (2006). Charting Your Financial Impact: Procurement’s Contribution to Sustainable Shareholder Value. CPO Agenda, Winter, pp.19-23. Hughes, E.J. (2005). Pulling Power: Making Strategic Sourcing a Core Competence. CPO Agenda, Spring, pp.31-36. Hughes, E.J. (2009). Refreshing a Core Process: Category Management as a Cornerstone of Procurement Excellence. CPO Agenda, Spring, pp.18-26. Moore, M. (1995). Creating Public Value: Strategic Management in Government. Harvard University Press. Rappaport, A. (1986). Creating Shareholder Value: A New Standard for Business Performance. Simon & Schuster.
11 DILForientering april 2011 ÅRGANG 48