Best Practices in Procurement
Introduction
Economic forces and technological advances have combined over the past 20 years
to increase the impact of procurement/supply management on company profitability
and long-term business success. Procurement is now in a position to affect company
profitability faster and more dramatically than any other corporate function.
Companies today are spending more revenue on outside goods and services. Thirty
years ago, the typical manufacturer might have spent 30 percent of company revenue
on outside supplies and services. Today, that number is likely to have doubled
for most manufacturers. Companies have attempted to focus as much as possible
on those activities considered to be "core competencies" - those that are performed
at a higher level internally than externally - while outsourcing other work
to outside companies that are specialists in those fields.
Advances in technology have provided tools that enable thought-leading supply managers to extract maximum possible value from supply. When deployed strategically, technological tools - especially the Internet - increase value for all entities in the supply chain, from raw material supplier to final customer. Advanced information technologies like the Internet have essentially enabled leading companies to integrate their supply chains. In the most advanced cases, these supply chains act more like a single unit than a series of non-aligned entities, which is characteristic of the majority of supply chains.
Leading companies in both manufacturing and service industries have used superior supply management strategies and procurement practices to gain a competitive edge in their markets. Examples include: IBM, Honda of America, Toyota, Harley-Davidson, Wal-Mart, Cisco, Chrysler, Motorola, and American Airlines. These companies and others excelled in at least one area - and usually several areas - of procurement/supply management, including cost management, strategic sourcing, new product development, supply chain integration, technology development, supplier training/development, and others.
The companies are all large companies, but small and mid-sized companies also can develop and employ procurement best practices for competitive gain. The key is to study how to reap maximum value from supply in a particular industry and specific market position, formulate a plan to realize that value, and then effectively execute the plan. The execution stage is the most difficult part, and is where many companies fail for a variety of reasons.
Developing and achieving procurement best practices is never easy. It consumes a lot of time, entails breaking down barriers between internal groups, demands a new approach to suppliers, and requires significant investment in at least a couple of the following areas: people, training, analysis, measurement, technology, suppliers. In manufacturing industries, especially those that produce high value-added products, the investment in suppliers can be large.
The good news is that the payoff for long-term investment in supply management is usually huge. Some manufacturing companies may spend up to 70 percent of sales revenues on incoming goods and services, as shown by numerous studies conducted by the Institute for Supply Management (formerly the National Association of Purchasing Management, or NAPM), Purchasing magazine, and various consulting firms. The entire amount of a reduction in dollars spent hits a company's bottom line, compared to 5 percent to 10 percent of increased sales revenue that may hit the bottom line at a typical manufacturing company.
Unfortunately, if their actions are any indication, far too few companies recognize the tremendous value inherent in their procurement departments and their supply chains. The possible reasons for this failure are many, not the least of which are a high rate of turnover in top management and the pressure on public companies to achieve fast revenue growth in the short term.
Building Best Practices
A critically important factor to consider when discussing best practices in procurement is that no two companies are exactly alike, and there is no simple "cookie cutter" approach to best procurement practices. For example, a company that manufactures a basic commodity product may be best served by employing a supply management strategy that emphasizes low cost, while a company that makes high-technology products may want to create a supply strategy that emphasizes technology development and speed to market. Every company has unique strengths and weaknesses when it comes to supply, and most companies occupy different positions even when serving the same market. It is up to management to determine the best supply strategy, which will dictate the best target areas for development and use of procurement best practices.
It also should be noted that companies cannot always simply copy the strategies and execution of other companies. Best practices often depend on people, suppliers, processes, or other business elements that are specific to a certain situation. Companies that are studying the procurement best practices of other companies should keep this in mind during their research.
While recognizing the differences that always exist from one company to the next, there are some factors that are usually or always present when a company successfully develops and deploys one or more procurement best practices. These factors include:
• Active support from top management — Companies that develop best practices often have top executives who recognize the potential value that lies in their supply chains, and actively support (and fund) supply management efforts. At a minimum, CEOs and other high-ranking executives must have a full understanding of supply value, good relations with their peers at strategic supplier companies, and they must provide the corporate investment needed to develop best practices.
• Deep understanding of cost drivers — It's a sad fact that most companies
aren't even close to having a good handle on what their actual costs are and
what causes them. Companies that have developed best practices nearly always
know in detail all elements of their cost structures and take actions to drive
costs lower all the time. They also continuously collect and analyze data and
other information on the costs of the suppliers that comprise their
supply base.
• Cooperative supplier relations — Leading companies realize that suppliers offer value that is not present in their own companies. These companies integrate strategic suppliers into programs that involve supply, such as new product development, cost reduction, and logistics operations. They also understand that suppliers must achieve profit margins sufficient for them to meet their own business plans and to invest in new technologies, facilities, equipment, and talented people.
• Culture of continuous improvement — Companies that have achieved best practices in procurement do not stand idle and admire their accomplishments. At all levels, they seek to learn from others and to continuously advance their practices and processes.
• Cross-functional approach — To function at an optimum level, supply management must include not only the procurement group but other corporate functions that can add value through interacting with suppliers, such as technology, logistics, manufacturing, operations, distribution, and research and development, to name a few. The use of cross-functional teams became a common way to involve other departments in supply management over the past decade, but too many companies deploy teams without first developing a sound strategy for how these teams will enhance value.
• Appreciation of advanced communications technology — While technology by itself will do nothing to improve procurement/supply management operations, intelligent deployment of advanced technologies within the confines of a superior supply strategy can reap great value — value that not only is untapped, but often is completely invisible to even trained procurement eyes. Far too many companies view technology use in procurement as a best practice unto itself. These companies don't truly understand that technology's value is wasted unless it is part of a sound supply strategy. Technology is a tool, not a strategy. When technology is not used correctly, it can cause a lot of damage to supply operations.
• Investment in procurement/supply management — Leading companies invest in training and development programs for their own personnel and often for suppliers. They also invest in communications and other technology. These factors should not be viewed as elements that will automatically lead to the development of best practices in procurement/supply management. But one would be hard-pressed to find a company that has achieved best practice that does not exhibit all of these traits.
Perhaps the most important factor in maximizing supply value is active support
from top management. Support does not necessarily mean involvement of the chief
executive in day-to-day operations. A valid case could be made that the CEO
should not be involved in day-to-day supply management; however, it is critically
important that the CEO and the executive management team:
1. Understand the potential value of supply to company success
2. Recruit and/or develop the best available supply management talent
3. Provide the necessary funding for supply management, even (or especially)
in tough business climates
4. Show internal personnel at all levels that they are fully committed to excellence
in supply management
5. Interact with their counterparts at key supplier organizations on a regular
basis
Without top management support, no company is able to develop and execute best practices in procurement. But with sufficient top management support and subsequent investment in procurement/ supply management operations, the other necessary elements for success often are created as a result.
Other Factors that Effect Best Practices in Procurement
Critically important to best practices in procurement is the development and use of systems and methodologies to measure performance of suppliers, systems, and employees. Performance measurement goes hand-in-hand with continuous improvement. It is astonishing that many companies simply do not measure the performance of suppliers or the performance of internal groups that interface with suppliers, yet they claim to operate supply programs that are based on continuous improvement. Without a formal, consistent system of measurement, you can't know if you've improved.
Perhaps equally astounding is that many or most companies know few details of their overall spend, which, approaches 70 percent of sales revenues in some manufacturing industries. Far too many large companies have not analyzed their spend across business units, divisions, or facilities. Spending practices of the typical company also do not make full use of buying leverage, supplier expertise, or numerous economies of scale that result from coordinating the spend across the corporation. Companies that achieve best practices in procurement have in-depth knowledge of how they spend their money, usually on a global basis.
Related to knowing a company's spend is the structure of the procurement/supply management organization. All too often analysts and industry media tout either a centralized or decentralized procurement structure as "the answer" for a company's supply needs, with centralized structures deemed appropriate for companies that provide commodity products or services, and decentralized structures for technology and high value-added products and services. But, the reality is much more complex. There really is no single answer to how a company's procurement operation should be structured. Each situation demands its own analysis, because each situation is different, even within the same company. In practice most companies that have achieved one or more best practices in procurement use both structures, depending on the details of different business situations. But common elements are a strong procurement/supply management group and a position on the strategic business team for the head of procurement.
Supplier Relations: Cornerstone of Best Practices
Historically, the procurement function was viewed as a low-level, back-office operation that existed solely to beat up suppliers for lower prices. "Three bids and a cloud of dust" is an expression used by many veteran procurement professionals to describe this traditional approach to supplier relations. The traditional approach to suppliers was price-based, confrontational, surface-level, short-term, and extremely short-sighted.
Today, innovative supply managers realize that, once they have selected the best suppliers, mutual cooperation can pay big dividends for both customer and supplier. While all companies want to pay the lowest possible purchase price for goods and services, leading companies have realized that purchase price is only one element of total cost, and that it's critically important to establish continuous improvement programs with strategic suppliers.
Key to this process is selecting the right suppliers. The importance of supplier selection and supplier relations to long-term success cannot be overstated. Once the best supplier group is formed, innovative companies have used various methods to spread intelligence through their supply base. A good example is Harley-Davidson Motor Co., which for several years has used "supplier councils" to effectively cross-pollinate supply intelligence through the company's supply base. These councils meet several times a year, coordinated by Harley's purchasing group, and discuss key strategic initiatives. Council members often criticize Harley's practices and critique new processes or technologies, all in an effort to produce the best possible solutions for all companies involved, including suppliers. Some suppliers share detailed cost information with Harley, something that is unthinkable to most suppliers. Harley-Davidson's use of supplier councils to share intelligence is an example of a best procurement practice.
Best Practice: Cost Management
Managing and reducing the entire spectrum of costs associated with running
a business is one of the most important — if not the most important —
job of an industrial procurement organization. Unfortunately, far too many organizations
confuse total cost reduction with purchase price reduction; there is a world
of difference. Purchase price is the amount of money paid for a product or service.
Total cost is the sum of all money spent to perform a specific action or series
of actions, and includes purchase price plus the costs of all other activities
needed to perform the action or series of actions. In many cases, purchase price
is only a small fraction of total cost.
Companies that have achieved a best practice in cost management not only measure
and see clearly all costs involved with producing and delivering a product or
service, they also help their suppliers do the same. They realize that suppliers
will not make the long-term effort to seek out waste and reduce costs if they
have little or nothing to gain. Companies that achieve a best practice in cost
reduction usually work closely with suppliers to closely examine all processes
involved at both companies, and then attempt to reduce those costs. Some companies
share savings with suppliers, thereby creating a very strong incentive to reduce
costs.
Companies that have achieved a best practice in cost management in recent years
include Honda of America, IBM, and Chrysler — at least prior to the merger with
DaimlerBenz. Perhaps the program that best exemplifies how to manage costs is
the SCORE program that was pioneered by Chrysler several years ago under the
direction of renowned procurement leader Thomas Stallkamp, who currently serves
as CEO of MSX International, an engineering firm in Michigan.
Much has been discussed about SCORE - the program's name is an acronym for "supplier
cost reduction effort." At the heart of SCORE was the sharing of savings with
a supplier when that supplier identified an area where costs could be reduced
and proposed a method to realize that savings. The program took at least a couple
of years to gain momentum, but when it did, enormous cost savings resulted.
SCORE led to Chrysler being the most profitable car maker in the world at the
time.
Keys to the success of SCORE were some of the foundations discussed earlier:
Support from top management, use of technology, supplier involvement, and a
cross-functional approach. SCORE became a company-wide process of continuous
cost reduction, and the typical objection that suppliers have to cost-reduction
initiatives - that it degrades their profit margins - was stood on its head.
SCORE actually increased suppliers' margins because they shared savings with
their customer. Suppliers also could use techniques and knowledge revealed through
SCORE in their interactions with customers other than Chrysler, furthering bolstering
their businesses.
Chrysler's SCORE program has been widely accepted as a best practice in cost management/cost reduction, but the vast majority of companies have not been willing to accept SCORE's key elements — sharing savings with suppliers, and company-wide implementation of the program.
Key Performance Indicators
Unlike best practices in many other business disciplines, it's difficult and
actually misleading to specify a key performance indicator for any of the various
procurement/supply management activities. Each company has a unique supply situation,
and the optimum supply strategy will result from an intensive and continuous
study of their particular situation, and by developing a long-term strategy
that will maximize strengths while minimizing weaknesses.Although there is a
danger in seeking and relying on KPIs as a guide to developing
procurement best practices, there are some examples of what leading companies
have done in specific areas of supply management, especially cost management.
Dave Nelson, the current chairman of the board of directors of the Institute for Supply Management, is perhaps most qualified to quantify what can be achieved in cost management. Nelson says that the majority of manufacturing companies can remove about 25 percent of the cost for procured parts and related services over a six-year period. This is achieved by continuously examining processes to removing redundancies and other inefficiencies, and by showing suppliers how they can remove costs from their own processes. This reduction in costs is not achieved overnight; most successful cost reduction programs are loaded heavily on the back end. Major cost savings aren't realized until well into the program, because it takes time to ferret out waste and eliminate it. However, it also should be noted that such cost savings are not a one-time occurrence, such as buying a commodity at a low price because of market conditions. The wasted cost that is eliminated in such efforts is eliminated forever, and companies benefit every following year from a reduced cost base.
Reference
For detailed examples of best practices in procurement: The
Purchasing Machine, How the Top Ten Companies Use Best Practices to Manage Their
Supply Chains, co-authored by Nelson, Patricia E. Moody, and Jonathan Stegner,
published by The Free Press, 2001.
