Saving Procurement from Itself

It’s time for chief procurement officers to stop relying solely on functional depth
and start increasing functional breadth.

The emergence in the 1980s of strategic sourcing — a concept in which

procurement leaders take a holistic approach to their organization’s supply chain
and constantly seek to improve purchasing behavior — was a defining moment
for procurement, with the potential to transform it from a primarily
administrative function to a powerful new force for competitive advantage.
Today, however, this reinvention has stalled in many businesses.

Many chief procurement officers (CPOs), chasing short-term stretch goals and
facing a lack of interest from other functions, no longer seek to influence the
supply chain or strive to tackle the underlying drivers of cost and value. They are
increasingly focused inward, implementing sophisticated ways of improving
procurement itself but neglecting coordination with the wider organization.
Indeed, CPOs have been successful in refining their function. Innovations of the
past five years, such as e-procurement, e-auctions, spend analysis, and
procurement outsourcing, reflect this attention.

But focusing on cost reduction leaves untouched the significant potential for
creating value generated when procurement engages the rest of the business
and its suppliers. In today’s business environment, many companies are finding
top-line growth elusive. To generate revenue and eliminate costs, they are
devising complex business models that will require more sophisticated skills from
procurement leaders. It’s time for those leaders to step up to the challenge:
Procurement is uniquely positioned to reach out across the organization and the
supply chain, pursuing cost reduction, but also emphasizing collaboration,
innovation, flexibility, and resilience.

Broadening the Procurement Agenda

Too often, management invites procurement to participate only after decisions
have been made and detailed contracts need to be negotiated and drafted. For
procurement to be considered more than a functional tool for other
departments, CPOs need to build influence and credibility with their internal
management colleagues by showing that what they do adds real value. By
engaging with peers — that is, by taking a cross-functional approach —
procurement can influence the decisions that impact value all along the chain.
There are several key ways for CPOs to accomplish this.

Develop a close working relationship with finance – but try to avoid reporting to the
finance function. Chief financial officers (CFOs) want procurement to
demonstrate clearly how it contributes to value generation. In fact, translating
procurement results to the bottom line will continue to be one of the toughest
cross-functional challenges CPOs will face over the next five years. To succeed,
they must design a procurement performance system that reflects the CFO’s
definition of profitability, but that requires finance to look at inputs rather than
outputs. The CPO and CFO should meet regularly to review how procurement’s
efforts are affecting budgets. Armed with that up-to-date information, the CFO
can make the best use of the value created by procurement, and the CPO gets a
little well-deserved recognition.
The Lego Group, the world’s fifth-largest toymaker, introduced this collaboration
as part of its supply chain transformation. It established a purchasing
performance management forum that includes regular meetings between the
CPO and CFO (monthly if everything goes according to plan, and weekly or bi-
weekly if issues have arisen) to ensure that results hit the bottom line. In the case
of one initiative to change packaging, such meetings enabled the team to break
down consumption by plant and identify the sources of gaps in performance.
Working together, they were able to ensure that in the next month, orders were
made at the right quantities and savings leakages were minimized.

However, a recent study by CPO Agenda makes clear that CPOs have their work
cut out for them: An online survey of more than 200 CFOs, vice presidents, and
directors of finance in North America revealed that only one in five believed
procurement’s ability to provide “timely and accurate spend data” was excellent,
whereas one-third believed this ability to be poor.

Manage cross-functional trade-offs. CPOs must also measure the efficiency of the
organization as a whole and enforce cross-functional decisions. They must
ensure that the interests of the whole enterprise are taken into account when
deciding to invest in inventory, and manage the inevitable trade-offs that arise
from tensions among the company’s key functions.

The Spanish clothing company Inditex is a perfect example of how procurement

trade-offs within the value chain have led to success. Its most famous
brand, Zara, competes with other mass clothing brands, but rather than inducing
customers to buy a lot at once, Zara gets them to buy often. Whereas most
fashion brands launch new collections no more than four times a year, Zara rolls
out 16 new collections annually. Reducing costs through large-scale purchases
would undermine its strategy. Instead, procurement contributes to the brand’s
success by ensuring supply network flexibility; it is the kind of feverish pace that
requires speedy decisions and strong cross-functional teamwork among
procurement, design, manufacturing, logistics, and sales. Having a procurement
department with the ability to step up and synthesize cross-functional
requirements in an aligned operating model is key to Zara’s success.

By casting procurement in a major role and ensuring it is highly integrated with

all of the other functions, Zara has created a strategic advantage that has proved
exceptionally difficult for others to replicate. The traditional model of retail
procurement is a back-end service function that merely sources fixed designs at
the lowest cost, usually irrespective of the delivery lead time. To copy Zara would
require top management to recognize purchasing as a strategic function that
supports the company’s competitive objectives. Because this operating model is
embedded in the company’s culture, the best way to copy such a strategy is to
start from scratch.

Collaborate on the joint supplier–customer value chain. Through sharing data

down the chain and forecasting methodology up the chain, preferred suppliers
and retailers for some large categories can create a win-win. Procurement can
play an important role in facilitating this flexible working partnership.
The procurement function at a major northern European food retailer, realizing
that both retailers and suppliers incur costs and lose revenue opportunities in an
effort to optimize margins, decided to think outside the box to identify joint
improvement opportunities with its supplier. The company understood consumer
behavior at the retail level, but it lacked its supplier’s in-depth, product-specific
knowledge and a true end-to-end understanding of costs. Together, they took
steps to find mutually beneficial areas of improvement: establishing a common
value chain that clearly detailed all costs and revenues for both players,
highlighting joint strategic areas to focus on options for improvement, analyzing
opportunities to improve profitability and enhance revenue, and establishing
implementation plans and benefits sharing.

Procurement’s role in this process was to bring economic insights to the table to
help build a picture of the joint value chain and to facilitate the necessary
decisions internally. They moved from looking at price, to total internal costs, to
value chain costs. Not only did this help the retailer and its supplier to identify
areas of revenue enhancement, but it enabled them to eliminate costs.

Gain preferential access to innovation. The supplier network can generate many
sources of competitive advantages. Procurement needs to find ways to facilitate,
not hinder, such advantages. Translating the company’s vision into an end
product is the domain of innovation, production, and business development, but
procurement can play a critical role in evolving the supply base to deliver that
vision and evaluating the trade-offs when considering new ideas or suppliers.
Jeff Hawkins, inventor of the Palm personal digital assistant (PDA), saw this
potential. Most competitors attacked Palm’s market leadership in the late 1990s
with extra features and memory, but Hawkins, rather than using his in-house
innovation team to compete head-to-head on functionality, asked procurement
to engage the supplier base on innovation. Procurement adapted its role to
become a channel for great ideas coming from suppliers. One of these, IDEO,
helped Palm understand that simplicity and aesthetic appeal would win out in the
marketplace over improvement in functionality alone. The supplier and the Palm
team worked for almost three years to develop the next-generation PDA,
launching the Palm V in 1999. Consumers were so enthusiastic that they paid a
much higher price for the sleek, lightweight Palm V than for rival gadgets.

Design network resilience. By engaging suppliers, procurement can increase

network resilience by ensuring greater flexibility in times of discontinuity. Lower-
cost supplier networks and longer supply chains are often less resilient by nature.
Resilience needs to be inherent in the design and, with the help of colleagues,
can be appropriately weighed against cost. When they get involved at the supply
chain design stage, procurement can work with other functions to balance the
needs of low cost and resilience in the supply network. This is particularly
important now that global sourcing is becoming commonplace and supply chains
are lengthening.

Such engagement proved crucial for Toyota when a major fire at a supplier’s
factory in February 1997 halted the supply of a critical valve. Toyota plants, which
build more than 14,000 cars a day, had only four hours’ supply of this valve as a
result of its just-in-time operation. Not being able to replace the part would have
resulted in huge losses and damage to the brand. Fortunately, Toyota’s
procurement department had designed its supplier base as a network, so that if
one node went down, other pathways were in place to secure the necessary
components. Toyota had its production lines up and running in four days when
experts had predicted it would take weeks. Procurement worked successfully
with other functions to keep costs low without sacrificing resilience.
Procurement is at a crossroads. Its increasingly common inclination to focus on
reducing the price it pays for goods and the cost of its own operations has
certainly benefited organizations, but the returns on these efforts are
diminishing. When procurement has moved beyond its traditional role, fulfilling
the promise of its earlier reinvention, companies have prospered. Keeping the
attention of colleagues is the CPO’s responsibility, and it will not be easy.

Procurement leaders must constantly strive for the kind of breakthrough thinking
that benefits their colleagues’ functional and strategic agendas. They must avoid
the temptation to look only inward, and instead broaden their reach and take a
seat at the strategy table.