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November 19, 2017
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Procurement

A look into the future of procurement

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Techniques and strategies for choosing suppliers and building strategic partnerships are due for an overhaul. "Value procurement" may be the next step in the discipline's evolution, say the authors of the new book The Procurement Value Proposition: The Rise of Supply Management.

Much of the writing on procurement since the mid 1980s has focused on the operational mechanisms that are used in what are termed "dyadic relationships." Put simply, a dyadic relationship is between two people, both of whom have the ability to influence the other. This can provide set roles that, in turn, create the glue for the relationship to stick. The stronger the connection, the bigger the impact they have on each other. Essentially it is an understanding that requires both to cooperate with each other for the benefit of both. These relationships—in our procurement world—create, develop, and sustain exchange transactions between buyers and suppliers.

Much of this literature owes its genesis to three philosophies. The first is transaction-cost economics. Then there is the "interactions" approach, and, third, the much broader and growing "relational" approach associated with lean and agile principles of production and supply management thinking.1

Article Figures
[Figure 9.1] Procurement's value proposition
[Figure 9.1] Procurement's value proposition Enlarge this image
[Figure 9.2] The evolution of procurement's value proposition
[Figure 9.2] The evolution of procurement's value proposition Enlarge this image

However, few of these approaches focus explicitly on the interests of or the value that buyers and suppliers receive from transactions. Despite this, most writers assume that some element of mutuality (value as defined by the interests of both parties in the exchange) must occur for transactions to exist.

This implicit view of value does not allow practitioners to fully understand which elements of value must be achieved to sustain relationships for buyers or for suppliers, or [to fully understand] the complex commercial and operational tensions over interests that exist in transactional exchanges, whether in dyadic or the more realistic network relationships. Furthermore, one might argue that much of the current thinking tends to overemphasize the operational and underplay the commercial interests that exist in business relationships.

The mutuality alluded to above needs to be contemplated, as in the majority of buyer-supplier relationships the buyer would benefit from an enhanced understanding of the supplier's needs and wants. An understanding of the sources of supplier value could help buyers to manage a whole range of buyer-supplier interactions and develop them to gain strategic competitive advantage.

In the majority of buyer-supplier relationships the buyers often assume that they are in positions of dominance where they can simply instruct or command suppliers. However, the opposite is far more likely, and buyers need to persuade suppliers to perform in their desired manner.

To be persuasive in the absence of significant levels of power, and without incurring significant on-costs (overhead), it is necessary for the buyer to understand what it is that suppliers want from buyers other than more revenue. Some suppliers, for example, might want stability and be prepared to improve their performance in return for simple, low-cost changes in ordering practices.

Value: Procurement's latest game changer?
Cost reduction will never disappear from procurement's agenda; after all, it is the cornerstone of good procurement practice. The ways in which cost savings are made, however, are high on every chief procurement officer's (CPO's) agenda.

There are indications that procurement is entering a further period of flux that will bring about further change as the function matures, which looks similar in its order of magnitude to the comprehensive introduction of category management. It could be that this change is no less than the demise of category management.

Organizations that embraced category management at the beginning of the 2000s have gone through their spend portfolios for as many as three or possibly even four iterations. Each category and subcategory has been standardized, rationalized, and commoditized. If the big windfalls have not manifested themselves yet, it is possible that they will remain elusive. The savings were eked out via price leverage, but the big gains came from the challenges set by demand management and total cost of ownership. Category management had a big impact, but what, if anything, will be its legacy?

In many organizations there exists a misalignment between procurement and other business functions. In fact, a poor understanding of strategic procurement/category management can lead to disastrous outcomes and a further diminution of procurement's name and the consequential questioning of the value to be derived from it.

For those organizations that have embraced strategic procurement and made category management work for them, there is no denying that it raised the profile of procurement. It got it engaged at a more senior level and secured an ongoing interest by the leadership of the business. Procurement began to call these people internal "clients." It also began to contemplate stakeholder partnerships and corporate alignment. It bashed down the boardroom door. But the hubris created by this activity ignored a unique aspect of procurement practice, creating a fundamental flaw in the notions of partnership and alignment: procurement's business "clients" do not have cost reduction as their primary aim. However, procurement does!

Value procurement versus value-based procurement
Many of today's procurement systems are largely built on purchaser/vendor mistrust, the lack of rigorous purchasing procedures, and a lack of tools that can be used to compare bids and assess value. Going for the cheapest option and pushing the risk onto the supplier looks attractive in the short term but is actually ridiculous in the long term.

Value-based procurement requires you to buy the goods or services that produce the best overall value. For example, if Company A offers to build a software system that costs £5 million and later yields £10 million in added revenue, then Company A's bid has a net value of £5 million. In contrast, if the system offered by Company B costs £10 million but returns more than £40 million in added revenue, then Company B's bid has a net value of more than £30 million.

Under a traditional procurement approach, Company A's bid (the low-cost solution) would win the contract. Under value-based purchasing, Company B wins, paying more up-front but receiving much more in return over the long term.

Value-based procurement can take many forms. The benefit may be measured, for example, in an expanded set of services provided by one supplier's solution over another. In other cases, gaining benefit may involve procuring a system with higher initial costs but lower lifecycle expenses and easier updating capabilities. Procurement's problem is how to judge the value of competing proposals, a task that isn't easy when dealing with large or complex bids.

Value-based procurement is about developing solution-oriented bids, where the bid articulates the problem to be solved and requires the supplier to use its expertise to propose a solution. Or perhaps [it is about] evaluating suppliers on factors such as total cost of ownership, the technical merit of the vendor's proposal, the vendor's past performance, and the probability of meeting your current and future business objectives rather than just cost.

A closer proximity to your supply base and involving the suppliers in a risk/reward structure incentivizes supplier flexibility and performance. Finally, looking at the delivery promised by your supplier set against projected performance rather than past failures is another way of tightening the relationship and incentivizing the organizations you work with.

Value procurement is the realization of all of the benefits to be gained by the implementation of good procurement practice (as described in the model in Chapter 2). [That includes] everything from the foundations—the application of procurement's "five rights"—through to the reduction of unneeded demand activity, complexity, immediacy, and variability, ultimately stimulating good demand and increasing business value derived from spend (and supply markets) rather than simply reducing spend magnitude.

This demands full alignment with the corporate strategy, and integration internally with stakeholders and externally with the supply base. Procurement must be as mindful of delivering customer satisfaction as any other business unit in the organization.

Value procurement and customers
Are we witnessing the dawn of a big shift in the way strategic procurement is done? Category management has been the only credible procurement strategy since the late 1990s, and that may be about to change. The techniques devised in category management strategies to choose suppliers and build strategic partnerships are due for an overhaul.

Today procurement professionals are under considerable pressure to deliver value-adding business performance, and it is no longer enough to build a supply management capability that is efficient, demand-driven, or even transparent. Procurement must offer the organization something that is value adding: a new supply management where the strategic scope of procurement's value is delivered via innovation, a networked function, and focus.

Procurement must be the function that is continually challenging ways of working. It must look to ensure that it helps its internal business stakeholders to achieve their goals and targets while, at the same time, taking the opportunity to challenge total cost and facilitate "customer of choice" benefits, such as access to innovation and, of course, the management of risk. Most critical of all is that procurement must be aligned to the corporate focus, addressing the key question for any business: "What is value to the customer?"

The customer never buys a product. By definition the customer buys the satisfaction of a want, which in economics is defined as value. In essence, value is utility; that is, the total satisfaction derived from a good or service. As we know, the utility that one derives from a good or service is difficult to measure, but we can determine it indirectly with customer-behavior theories, which assume that consumers will always strive to maximize their utility.

Taking the view from business to market
It is ironic how often the term value is bandied about, especially as it is so difficult to define what value actually is; moreover, its loose and frequent use across a number of contexts makes it difficult to anchor its meaning in supply management.

We can, however, reasonably attach various connotations to value:

  • Value is relative to an alternative. Value cannot be judged in isolation.
  • Value is composite and decomposable. Value can be analyzed into a set of value drivers; for example, time, cost, quality, and service.
  • Value can be used in several contexts. In business-to-business (B2B) relationships it tends to be economic in nature, but other aspects, such as the emotional, environmental, and social, may also be considered as having a value quotient.
  • Value is measureable/quantifiable. Economic value might be seen as revenue or cost savings, but other aspects have their own forms of measures; for example, the ability to exploit intellectual property right (IPR).

CPOs can map the way in which the customer gets value to the way in which the seller charges for value. For example, in the construction industry the value of a surface coating may derive from the area covered, while the price is far more likely to be quoted in volume.

Value management relies on multiple streams of information from inside and outside the organization—both internal and external perspectives are necessary. Today procurement holds information regarding customers, competitors, demand, offers, costs, and production constraints. These data are all used in value management, and this places procurement in a strong position to make this aspect of business their own (see Figure 9.1).

Procurement leaders are faced with a dichotomy: cost (savings) versus value (creation), and this requires CPOs to think hard about how well they understand the market. If CPOs are to be truly market facing—and for too long their focus has been internal clients and stakeholders—then there is a real need to bring the balance of their focus to some sort of equilibrium. It will be because of this equilibrium between the business and the market that the long-heralded co-creation of value can take place. This is where the next big windfalls, the next big gains, and the next competitive advantages will come from. Value procurement will be category management's legacy.

It is no longer enough to build a supply management capability that is efficient, demand-driven, and transparent. Procurement must offer the organization something that is value adding—a new supply management, where the strategic scope of procurement's value is delivered via innovation, a networking function that is focused.

So how does this change the game?
We have been wondering for some time: has the big business idea of the last 30 years gone rancid? The idea being that you drive cost out of the organization in order to make it more profitable and to maximize shareholder value, only to drive risk in. Why do organizations continue to get this so wrong, pursuing the will-o'-the-wisp of cost reduction with measures that end up increasing them? This preoccupation seems to have tainted the cream on the top of most business models.

It is quite clear to us that the procurement function is going through something of an evolution, as the strategic impact of it comes to the fore. Organizations are increasingly moving away from the discrete function of the past; the doers (buyers) are being replaced by enablers (value adders). Enablers are deemed more useful to the organization and stay embedded in strategic business units.

Another interesting aspect is that more and more we are seeing profits replace cost savings. Consequently, the cost-savings focus is giving way to a strategically aligned emphasis on profitability. Moreover, as the discrete procurement function moves into a new modus, the battles to ensure that cost savings are reflected in their budgets will fade, and the emphasis on cost savings only will have less weight than [the emphasis on] timeliness and quality.

If we reflect on the above, it points to the "doers"—those who excel at cutting deals in the back office—finding themselves and their role outsourced to third-party services organizations. Procurement then will be freed up to operate on a strictly strategic remit, perhaps embedded in other strategic business units (SBUs) or operating as a loose network. Certainly they will be market/supplier facing. They will be there when required, constantly moving and reinventing their roles as needs shift.

The commentary in much of the business press these days relates to the desire for the emergence of a new supply management to meet modern business needs. Procurement's horizon has clearly widened since the 1980s and has seen procurement transform from tactical to strategic. But the notion of "strategic" remains hemmed inside the function, almost a prisoner of its own history. It requires a change in mindset and the development of a cultured understanding of the (strategic) value-adding capability of procurement—and, with it, the realization of what strategic can mean gets much broader.

Procurement needs to become more commercially focused, as its new, highly strategic role requires that: 1) it understands the workings of the financial supply chains; and 2) that it stimulates good demand and increasing business value derived from spend (and supply markets) rather than simply reducing spend magnitude.

These changes bring with them new issues:

  • As outsourcing takes off, many current procurement and supply-side activities (the ones that do not get pushed elsewhere in the business) will be outsourced as organizations adjust and "slim down."
  • Increasingly, third-party service providers call the shots as the quantity and quality of third-party procurement services increase. Their performance, across many spend categories, will surpass what can be achieved in-house; as these operational activities move outside the business, often in extended supply chains with little transparency, this will have very real consequences.

Naturally, there will be several areas of business management that will be materially impacted. At the top of the list will be corporate governance and risk. A cursory glance at today's business landscape reveals why business leaders must ensure that activities in their extended and more complex supply chains are acceptable. This applies to both core and non-core suppliers in equal measure.

There is also need to re-evaluate where business risks lie. Risk since 2008 has changed in nature. Today there is much more emphasis on fragility and, as such, the financial and reputational standing of organizations is subject to global market volatility. As businesses have replaced internal operations with external suppliers, risks associated with them are also externalized.

Added to these issues, an increase in collaboration brings with it potential problems regarding the ownership of intellectual property (IP). Since the 1990s the move from closed to open innovation models has facilitated innovation-oriented cost-saving strategies. Today, suppliers invest heavily in research and development, so it follows that relationships are established to facilitate this innovation to flow into the business—and equally for the suppliers to understand the needs of the businesses they service in order to guide and tailor innovation.

With the dawn of the "extended enterprise" there are tangible changes regarding intellectual property ownership and exploitation. Manufacturing has been led by the "make versus buy" paradigm for many years, and in so doing created what is known as "shallow depth of manufacture." While the manufacturers intend to stay there, services organizations are increasingly engaged in outsourcing. Clearly, as IP development moves into the supplier base any future exploitation of IP will depend on where it sits, and who owns it.

Suppliers are one of the main engines of income, and, as suppliers, take on bigger chunks of things they already do for their customers, for example by developing end-to-end solutions if they do not already exist. Where solutions do already exist, then customer enterprises must become much more receptive to sourcing them, with suppliers moving out of their comfort zones to drive customer performance.

Clearly, the foregoing demonstrates that there are new sources of value for businesses to explore. Collaboration creates value. Developing structures to support shared purpose, ideas, and insights is inherently value creating. In turn, this demands a shift in how the supply base is viewed. Suppliers, too, can be enablers who will deliver value. For example, networks for innovation—a transition from the dyadic "buyer and supplier" relationship to "integrated supplier networks"—will enable greater coordination of innovation road maps across connected businesses and industries.

With developments such as these, organizations share risks and rewards. As supply management professionals get better at segmenting, defining, and measuring value, they will begin to incorporate both gain- and risk-sharing into commercial relationships with suppliers. Ultimately, this kind of relationship also facilitates "motivational contracting." As well as sharing risks and rewards in contracts, supply management professionals will accept greater risk in commercial relationships with critical suppliers by leaving out all the demotivational stuff that inhibits supplier innovation.

The evolution of procurement's value proposition
The focus of much of this book has been to establish the notion that new practice is needed within business with regard to its use of supply management and its position in the business. Today's uncertain and volatile markets make agility and change inevitable as well as essential.

Supply management mind and skill sets must change. Many business leaders have ambitions to improve profitability by reducing costs. But to do so, they must also reshape their supplier relationships, aligning their supply chain with a more progressive strategy and securing a competitive advantage. So what are the new realities?

Procurement professionals need to get savvy. Their professional credentials will be measured by their ability to influence, persuade, and provide vision. Their mindset must be strategic, global, collaborative, and, above all, commercial (see Figure 9.2).

No strategy—whether it is business-as-usual or a radical shift—can now be implemented without listening to and working with stakeholders and suppliers. We have seen how they fulfill the majority of a corporation's needs. How well they are mobilized will determine how well the organization can execute on its strategy. Procurement professionals have to be able to connect, network, and trade.

In Chapter 5 we looked at the impact of technological applications on business. Today everything starts with an "e"! Procure-to-pay, sourcing, contract management, and other automated solutions are integrated up and down supply chains, fully adopted, providing greater transparency and real-time insight.

More and more we see people working "on the go." A new Internet-savvy and technically confident generation is entering the workplace, using smartphones, tablets, embedded chips, and other devices to create a mobile work environment for procurement professionals and suppliers alike. This, coupled with the Internet of Things, will change the shape and dynamics of supply chains and our working lives.

To [keep up with those changes] we must connect and collaborate. For some considerable time we have been talking about dynamic supply chains and how networks are the way forward, but actually manifesting that in our day-to-day work life has been difficult. Now we have an opportunity where in 10 minutes you can find second- and third-tier connections in global networks, with people who know people you know. Buyers and sellers are increasingly relying on digital trading networks and communities that allow them to quickly and easily discover each other, connect, and collaborate.

Business intelligence has become critical to the sustainability of corporations wishing to compete in global markets. Open pricing for goods and services is becoming increasingly transparent due to the Internet, e-sourcing, global trading networks, online communities, and procurement's intrepid scrutiny into still-cloaked categories. Might negotiation become a lost art? We are beginning to see too some consensus develop around risk and complexity and how to model risk. This is helping to develop more standardized, readily available third-party information and networked communities where people pool data for operational risk assessment.

The emergence of intelligent data is reversing procurement's reliance on looking backward at money spent or supplier past performance. The increased use of "big data," the cloud, and analytics enables procurement to work with information, data, and models that predict. With analytics comes more visibility regarding spend, risk, and performance, which will be available when you need it. Ready access to accurate, timely, structured internal and external business intelligence will create unprecedented capability regarding information manipulation in support of decision making.

Notes:
1. For transaction-cost economics, see Williamson, O. E. (2005) Handbook of New Institutional Economics, Transaction Cost Economics, Springer U.S., pp. 41-65. For interactions method, see Ford, D., et al. (2002) Understanding Business Marketing and Purchasing, Thomson Learning, London. For relational method, see Lamming, R. C. (1993) Beyond Partnership: Strategies for innovation and lean supply, Prentice Hall Harlow; Hines, P., et al. (2000) Value Stream Management: Strategy and excellence in the supply chain, Financial Times/Prentice Hall Harlow; and Christopher, M. and Towill, D. R. (2002) "Developing market specific supply chain strategies," International Journal of Logistics Management, 13 (1), pp. 1-14.

Editor's note: Excerpted from The Procurement Value Proposition: The Rise Of Supply Management, published by Kogan Page Ltd. (2015). Reprinted by permission of the publisher.

Gerard Chick is Chief Knowledge Officer at Optimum Procurement Group. Robert Handfield, Ph.D., is the Bank of America University Distinguished Professor of Supply Chain Management at North Carolina State University.

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