Category Archives: Procurement Innovation

Remember the Dangers of Centralized Buying

In an effort to combat the inflation across the board, I’m hearing a number of consulting firms emphasize the need to leverage your spend across the board, which is good advice. However, I’m worried about how some firms might be interpreting this advice. I’m getting signs that some firms, not yet as advanced in Supply Management as they need to be, are interpreting this as a need to “centralize”. While this has been the common historical response when a firm needs to obtain spend leverage and Supply Management for the categories in question are decentralized, it’s usually the wrong one. What needs to happen is the firm needs to move from decentralized buying straight to center-led buying and skip the centralization step and the growing pains that will result.

When you centralize, you lose:

  • local opportunities
    while a national temp labor agency can offer you better rates across the board, sometimes a local agency that is 10% more is actually 40% cheaper because you don’t have any travel expenses for local resources
  • local knowledge
    and sometimes a local buyer has a better understanding of the ups and down of commodity or service pricing in a region than a buyer on the other side of the globe and knows that she can spot buy a better price 80% of the time
  • (some) control over supplier performance
    as a centralized buy will typically be with one or two international suppliers who will not only have a lot more weight and leverage, but distributed production; in comparison, if buys are more local, they are typically with smaller suppliers where the buyer has the dominant position in the relationship and more control over quality and the production schedule

In addition, when you centralize, you can pave the way for organizational conflict as a result of:

  • the divergence of subunit goals
  • conflicts of preference between the central units and remote units
  • the lack of subunit inclusion
  • higher costs of certain purchases on the corporate contract as compared with local costs from a local supplier

However, a center-led purchasing organization will work with each subunit to insure that the best buy is made every time. Sometimes that will be through amalgamation of volume to obtain leverage through a larger contract with an international supplier (where costs are high) and sometimes it will be through the provision of best practices to each unit, which will secure the best rates in their region. You only get leverage where it exists to be found.

An Idea for Aligning the Non-Competing Finance and Procurement Agendas

About two weeks ago, in What Competing Agendas, SI pointed out that, where Finance and Procurement are concerned, there are no competing agendas. Furthermore, as far as the doctor is concerned, whomever said that the dynamics and sometimes competing agendas between finance and procurement are widely known doesn’t get it. At all. Remembering that the ultimate goal of any organization is to derive value for the stakeholders — employees, customers, and shareholders alike — both organizations are trying to find the right balance between cost cutting and value generation to meet the company’s goals and shareholder return. Just because Procurement is always spending while Finance is always trying to cut spend doesn’t mean that the departments are in opposition. Finance knows better than any other department that companies have to spend money to make money, as long as the money is being spent wisely, and a good Procurement organization has better spending as its ultimate goal. There is no competing agenda.

However, since Finance and Procurement sometimes speak a different language, because Procurement hasn’t learned to Speak the Language of the CFO, the agendas aren’t always aligned. And while they both plot a route to the same goal, the routes barely intersect. And any good financier as well as any good sourcerer knows that taking two planes from New York, New York to Mumbai, India with one routed through Frankfurt, Germany and the other routed through Sydney, Australia, is wasteful. Thus, the agendas have to be closely aligned for optimal performance.

But how do you align the agendas?

One idea could be to use balanced scorecards as a shared framework. Back in the early days, SI ran a post that asked if you need a Chief Strategy Management Officer. Back in 2006, CFO Research Services published a short paper that summarized the highlights of their annual executive conference in New York, New York. Part of that report was a mini-paper on aligning the finance function to strategy execution based on a presentation by Robert S. Kaplan, co-developer of the balanced scorecard and co-author of Alignment: Using the Balanced Scorecard to Create Corporate Synergies with David P. Norton.

At the conference, Kaplan discussed various approaches for aligning the finance function more strategically with the goals of business units and corporate leaders, including:

  • the use of balanced scorecards as a shared framework to run the business, guide the operating agenda, and evaluate progress against strategy
  • the use of activity-based budgeting to link the strategic planning capability of Balanced Scorecards with the operational budgeting mechanism of a time-driven ABC (activity-based costing) model

And, as I suggested in my original post, I think it’s a great idea. And I still see no idea why it can’t work for Procurement. In the process of creating a balanced scorecard, Procurement and Finance will have to agree on budgets and savings / avoidance targets, payment terms, working capital objectives, inventory turnover, and a host of other supply management issues. And by scoring themselves on the same metrics, they will have to stick to the plan to collectively succeed. Now, getting the right scorecard might not be easy, but the exercise will get the organizations to a deep alignment that will pay off in the long run if each goes in to the discussions with an open mind and a true desire to work together.

Perfect Procurement Processes Will Not Save the Public Sector

There’s lots of hmming and hawing on both sides of the Atlantic about how the Public Sector has to reduce spend to help get deficits under control and how it needs better procurement processes to achieve this goal. Why, I don’t know, because even perfect procurement processes won’t save the public sector. I could write a treatise, but until the following fundamental problems are solved, there’s no point.

  • Past Performance Does Not Affect Current Awards
    This is so ridiculous its absurd. No private company in their right mind would say “you just screwed up this 500 Million system overhaul, but here, please bid on this other 500 Million system overhaul”. None. Nada. Zip. Zilch. (At least not if they wanted to stay in business.)
  • X% Must Go to Minority/Domestic/Preferred Suppliers
    And while we’re at it, let’s just tag on 10% for the United Way. After all, they claim their overhead is now under 15%. (FYI: The overhead of a best-in-class, private, Supply Management Organization is a fraction of that.) Supply Management is about the best buy. Period. Diversity/Domestic/Preferred should only come into account when all other factors are equal or if they bring value that outweighs additional costs.
  • Salary is based on pay scales out of touch with reality
    Supply Management success requires top talent. And if you’re only going to offer 50% of the going market rate, you’re not going to attract anyone who’s any good. While there should be pay scales to insure fairness, they should be adjusted annually based on regional averages and existing employees making less than the minimum when the pay scale is adjusted should automatically be adjusted to the minimum before the annual raise and/or bonus is calculated.

What Competing Agendas?

The following was recently spoken at a leading sourcing conference:

The dynamics and sometimes competing agendas between finance and procurement are widely known.

Huh? What competing agendas? I am on planet Earth, right?

But more seriously, the fact that this myth is continually perpetuated is a serious problem. The reality is that, in a properly run organization, Finance and Procurement have the same fundamental agenda: Reduce Cost. Increase Efficiency. Drive Innovation. The only difference is that, for the most part, Finance is internally focussed while, for the most part, Supply Management is externally focussed. Just like the real goal of corporate finance is to insure that the company has more than enough money to achieve its goals and generate a return for the shareholders, the real goal of Procurement is to insure that the company has more than enough money to obtain the goods and services it needs and generate value for the customers, which, in turn, generates value for the shareholders.

The ultimate goal of any organization is to derive value for the stakeholders — employees, customers, and shareholders alike. Value is more than profit, it’s also sustainability and brand image. For example, if all a company does is produce cheap products that wear out quickly, either it’s going to go broke in warranty costs, or, if the product is not under warranty, it’s going to have a lot of upset customers who are not going to buy again, putting the long term financial viability of the company on the line.

As a result, Finance is about more than cutting costs and hitting budgets, it’s about analyzing the value of an internal spend and determining if the value is there to help meet the company’s goals. If hiring the best people increases that option, then Finance should determine that a higher payroll is the right decision and cost should be cut from somewhere else or, if there are no less critical areas, debt should be secured to obtain additional value, and profit, down the road.

Similarly, Procurement is about more than cutting costs to hit a savings target. It’s about finding the optimal balance of cost and value-add to maximize the overall return to the company. If buying from a supplier that costs 10% more will have a huge impact in brand perception, because either the component manufacturer is well respected and using their name will increase consumer interest or because the defect rate is significantly lower, then the slightly higher cost supplier is chosen. But if it’s a simple office supplies spend, then cost is cut to the low end of market pricing.

And both organizations are trying to find the right balance between cost cutting and value generation to meet the company’s goals and increase shareholder return. Just because Procurement is always spending while Finance is always trying to cut spend doesn’t mean that the departments are in opposition. Finance knows better than any other department that companies have to spend money to make money, it just wants to insure that the money is being spent wisely. And a good Procurement organization has better spending as its ultimate goal. There is no competing agenda between the Finance and Procurement Group, and any organization that thinks there is has a serious problem as they are not aligned, and alignment is become a key to success in today’s economy now that the Old Normal has returned.

To Maximize Value, Don’t Overlook Tail Spend

A recent article in the Sourcing Interests Group Newsletter on “understanding tail-spend management” noted that while ROI for tail spend categories will generally be lower than for core categories, those companies that keep their eye on the efficiency/effectiveness equation and approach tail-spend intelligently can still find significant savings that make the effort worth while. So how does an organization properly approach tail spend, which:

  • rarely includes direct materials
  • contains a disproportionately high percentage of spend from the furthest-flung subsidiaries
  • contains suppliers that no one in procurement has heard of
  • contains large percentages of non-compliance and maverick spend

Intelligently. And iteratively. Data must constantly be reviewed in the light of changing business requirements to determine the best course of action using the following process:

  1. Spend Analysis
    Focus in on the tail-spend data and figure out what is being bought, from whom, where, and for how much compared to market value.
  2. Filtering
    Focus on commodities that can be reclassified into a category that will have enough spend to be worthwhile.
  3. Sourcing Strategy
    Once the category with the biggest opportunity has been identified, determine the right sourcing approach. If a sourcing project is the right approach, accelerate it with standardized templates, RFX, and/or auctions.
  4. Spot Buy
    If the right strategy is to spot-buy in a weak market, then aggregate demand across the organization and spot-buy through e-RFX or automated auctions.
  5. P2P
    And, regardless of the right sourcing strategy, drive as much spend onto technology platforms, like P-cards, so that it can be tracked and analyzed.

And, most importantly,

  • use procurement technology
  • simplify processes and increase controls
  • establish resources and manage performance