CSCMP's Supply Chain Quarterly
December 19, 2018

Procurement at Philips: Total transformation on a global scale

When Royal Philips implemented a new product design and procurement process, it also completely reconfigured its procurement organization. The author, who worked together with Philips executives Fredrick Spalcke and Ad Boon on the project, explains the initiative's origins, challenges, and successes.

In mid-2012, Peter Jeeninga, a product engineer at the Dutch electronics company Philips, sat down for an eight-week stretch with two dozen other engineers, designers, marketing representatives, and procurement managers to figure out how to disassemble and redesign the way the company makes juicers. There was nothing particularly wrong with the existing juicers; customers liked them, and the company's kitchen appliances had a reputation for quality. But Philips, then Europe's largest electronics company, was in the middle of a major restructuring, the latest stage in an ongoing battle to retain its leadership position in an era of global competition fueled by low-cost Asian challengers. As part of that initiative, Philips was taking a fresh look at virtually all of its products and processes.

A new chief executive (CEO), Frans van Houten, had taken over the previous year, and he had already shifted the company's portfolio away from businesses where it could no longer compete, spinning off its loss-making television unit and ultimately its entire audiovisual division. In addition to making strategic decisions about which businesses to drop, Philips needed to squeeze more value out of every product it made. Van Houten had announced a multiyear transformation program, called Accelerate!, that would save 1.8 billion euros by 2016. In addition, he had a new initiative he was counting on to generate an additional 1 billion euros in cumulative savings within three years. That initiative had come out of Philips' procurement department.

Philips had always relied on its procurement staff to drive production costs down by negotiating better prices from suppliers. But what they were embarking on now was something different. Van Houten worked with the advisory firm Russell Reynolds Associates to bring in a new chief procurement officer (CPO), Fredrick Spalcke, previously executive chief procurement officer at the Chinese electronics giant Huawei. Spalcke is a believer in a design procedure called Design for X, or DfX, which initially grew out of work at the equipment manufacturer NRC in the 1980s. DfX entails bringing together different business functions at the beginning of the design process to identify the product's key values for customers as well as what trade-offs are involved in different options.

Traditionally, designers design the product, engineers figure out how to build it, procurement figures out how to source parts and materials, and marketing figures out how to sell it. But with DfX, all of those functions play a role in the design from the beginning: marketing can tell design which features are important to customers and which aren't, while engineering can suggest changes to simplify manufacturing. Most important, procurement is in the process, right from the start, to tell everyone exactly how much the different options will cost. The procurement department can challenge the specifications set by engineers if it thinks they are needlessly demanding and will drive costs too high. It can bring in innovations by suppliers that produce savings. It can also manage the process of deciding whether different elements of the product should be made in-house or purchased from outside suppliers, a key question referred to as "make versus buy."

Setting up the procurement department to execute DfX meant changing processes and lines of command. Philips has three main business sectors: Lighting, Healthcare (medical equipment, such as scanners), and Consumer Lifestyle (everything from kitchen appliances to electric shavers). Previously, procurement staff were scattered across those divisions, reporting to myriad supervisors with entirely different functions—manufacturing, supply chain, operations, country leaders—at each level within their own units. The company's structure resembled a series of vertical silos: procurement staff in Lighting, Healthcare, and Consumer Lifestyles collaborated only haphazardly and on a case-by-case basis. Within each silo, line managers had created a welter of different performance indicators based on their own understandings of procurement's tasks.

The new system created standardized roles and responsibilities that made it easier for procurement professionals to connect with the right people. It also changed reporting lines and shrank the hierarchy, cutting the number of management layers from seven to four. Instead of having to report to an array of local supervisors, most of them outside the procurement function, procurement staff would now report straight to the next layer up in procurement. The only person in procurement with a second reporting line would be the procurement engineer at the "category" level—a bundle of products (irons, baby bottles, defibrillators, and so forth) four levels down from the CEO. That would let procurement approach its task as an integrated mission across the company, rather than treating it as an afterthought in individual businesses.

Procurement had always reported the savings it generated each year. Spalcke had convinced van Houten that within three years, his new system would beat the old system's high-water mark for savings by 1 billion euros. But not everyone was convinced.

"I was not at all supportive," says Murali Sivaraman, at that time CEO of Philips' Domestic Appliances group, which includes the juicers Jeeninga and his colleagues worked on. Sivaraman was based at Philips' Shanghai research center, where the domestic appliance category's headquarters moved in 2012 as part of the company's drive to decentralize from its European base and move closer to its suppliers and to growth markets. He saw making procurement officers report back to the CPO as a step backwards.

"My first reaction was, why are you trying to create another central body? We had already come out of that and brought things closer to the business." Besides, Sivaraman argued, Philips' lifestyle products are customized to different markets based on consumer feedback; the juicer it sells in Singapore is not the same as the one it sells in Paris. DfX, he worried, would strip that away.

Royal Philips' Chief Procurement Officer Fredrick Spalcke (left) and Ad Boon, the company's human resources officer for procurement, led efforts to radically redesign the multinational's procurement practices and organizational structure.

The Design for X process
Earlier in the year, DfX had gotten its first test at Philips, in the Lighting division's crucial light-emitting diode (LED) section. Philips is one of the world's two largest lighting companies, but its LED division had been under severe pressure. It was "a very, very competitive market, with quarter-over-quarter price reductions, very fast erosion," says Colin Kavanagh, the senior vice president, procurement engineering at Philips Lighting brought in by Spalcke. Overall margins in the lighting division had fallen from 11.5 percent in 2010 to 5.8 percent in 2011.

Sivaraman had expected to hear that the LED division's DfX project was generating incremental savings, with percentages somewhere in the mid single digits. Instead, he was told, the resulting cost cuts had generated "significant double-digit savings"—a massive breakthrough that none of the staff had thought possible. The DfX process was more holistic than Philips' earlier cost-saving efforts in Lighting, which had focused on whether individual aspects of the product delivered value to the market. DfX took into account whether the supply chain for a product was optimal, whether the design was optimized for manufacturing, and a host of other factors. Ultimately, the aim of a DfX exercise is to arrive at a "total cost of ownership" over the lifecycle of the product, for each element in the product. With that information, Philips can plan at what premium price the product will hit the market, how quickly it will drop to a lower one (very quickly, in the competitive LED environment), and how to maximize return on investment.

Based on the positive results of the DfX system implemented in the Lighting division, Spalcke gave Jeeninga the go-ahead to do the same thing with juicers.

The starting point of the DfX process is to quantify both the value and the cost of every element in the product. For instance, when marketing claims that a particular feature is important to customers, they should be able to substantiate the claim with consumer data. The point is to get to the optimal balance of cost versus value for a given product.

"We started out by benchmarking the products," Jeeninga says. It was his first experience working as a procurement engineer under the DfX system; today that is his full-time job. "You take certain juicers, strip them technically, [and then] compare every part in the Philips juicer to a competitor. You check the cost base—are we cheaper at the component level?"

More important, the team determined which aspects of Philips' juicers were delivering real value for customers compared to the competition. Many of the more efficient competitors were focusing on only one or two key points per product, such as juice output or the quality of the finish, while Philips focused on five or six. Such selectivity is "not the strongest point of Philips," Jeeninga says. "We usually focus on everything. That's nice, but it brings a certain price."

When the team identified an element in the juicers where efficiencies could be wrung out, a few members would break off in a working group for several days and come back with a proposed fix. Some of the changes identified in the process were simple. For example, it turned out that the different juicer models used over 30 different kinds of power cords. Engineering, procurement, and design agreed that this could be reduced to just two. In a more complex case, engineers found a cheaper way to make the "cat's-eye" reflective button surface that marketers said played a strong role in customers' sense of quality.

After six weeks, the team presented more than 40 ideas to the senior management team of the category, in what is known as a "convention." At the end of these conventions, binding decisions are made about how the product will be designed, manufactured, and sourced. In the case of the juicers, the ultimate savings would fall within the range of the company's target for the DfX process, though they would prove less impressive than they had been in the LED unit. Most important was that separate functions that previously had different interests were now working collaboratively.

"Previously [research and development], marketing, procurement, we were in a negotiation. 'You want to have this spray paint? It'll cost this much'... It was more 'them versus us,' " says Jeeninga. "But in the DfX convention you're literally standing up to sell the ideas. Procurement, R&D, the marketing teams, you all present as one team to the senior manager: 'This is what we propose.' " The information exchange, worked into consistent DfX conventions where each team must demonstrate its case and then come to binding agreements on how to design and build the next generation of products, "breaks down silos," Kavanagh says.

Three years later, Philips has completed more than 400 such DfX conventions, working through 130 percent of the company's annual spending. (That number exceeds 100 percent due to high repeat rates and increased depth of analysis based on the speed of the products' lifecycles and changing value propositions.) "There is not a single company known to us that has tackled its spend so fast," Spalcke says.

Spalcke is an intense fireplug of a man whose analyses tend to end in forceful declarations, often delivered with a slight smile. A true "citizen of the world," he grew up in Singapore, Hong Kong, Iraq, Bulgaria, and the United States, and has spent his career in the U.S., China, Southeast Asia, and Germany. Most of his business roles have been related to large-scale corporate transformations, mergers, and performance-improvement initiatives. He took the job at Philips, he says, because he was intrigued by the challenge of helping to turn around one of Europe's great old companies.

"When I got there, I understood Philips had a burning platform," Spalcke says. "The first mission was to make sure that everyone else in the company's procurement structure felt the same sense of urgency."

Spalcke's conviction that Philips needs to reform its procurement practices is driven by a recognition of how intense the cost-containment drive is at Asian companies like Huawei, and how great the competitive threat is. In each of its three sectors, he says, the company needs to combine innovation with cost leadership, and it must embrace that philosophy quickly. "You cannot bank on having innovation fix deficiencies in cost competitiveness. Even the most technically 'aloof' industries are now under cost pressure," Spalcke points out. A failure to lead on cost can be fatal, and businesses must try to lead on innovation and lead on cost at the same time, he believes. "If you happen to hit both sweet [spots]," he adds, "you make a ton of money."

The human side of transformation
The DfX process was only one part of the shift Spalcke wanted to bring to Philips. The other major task entailed reorganizing the procurement department along standardized processes, with crystal-clear roles and responsibilities. The department would need to become the neutral arbiter of how design, procurement, and manufacturing decisions were made, and in running the DfX process, it would also need to take on a strategic role in planning the company's products. That meant doing two things. First, it meant reorganizing procurement and redefining the roles of procurement engineers. Second, it meant putting the right people into those roles, and making sure they had the skills to carry them out. Ad Boon, the company's human resources officer for procurement, decided to do both at the same time. Boon had been at Philips in the early 2000s before moving to NXP, formerly the company's semiconductor division, when it was spun off, and then working as a private consultant. He came back to Philips in November of 2012 to join Spalcke's campaign.

When Boon examined Philips' procurement function, he found no less than 261 different descriptions of roles and responsibilities. His first move was to lay out the 25 standardized job profiles procurement engineers, commodity managers, governance roles, and others would need to fill in order to implement the new organizational structure, instead of the 261 then in place. These were matched with a set of core leadership, functional, and technical capacities the procurement engineers would need to possess, in different combinations, for a given role. "We did an enormous exercise to translate what is needed in terms of the right competency profile, [and] what's the leadership capability these people need to have," Boon says.

Not all of the engineers possessed all of the capabilities the new structure would require, however. Rationalizing the confusing tangle of job descriptions allowed Boon to make sure the people in those positions had the necessary capabilities, and to begin putting the right people in the right jobs.

Over 2,000 procurement staff members had to be individually assessed for the skills they would need in moving to a management level. One example was dealing with ambiguity. "We don't want people to shy away from uncertainty; we want them to welcome the uncertainty and turn an uncertain environment into a certain one," Boon explains. "But we also don't want them to overuse their capacity to cope with ambiguity so much that they stop using data and just go on gut feeling, or become reckless." Many procurement professionals required extensive training as they moved into their new roles. "In many cases, they needed to take a step up in terms of their executive presence, in terms of their decision-making timing, in terms of their savviness," he says.

One major group affected by the change in responsibilities was the procurement engineers, on-site procurement staff in various roles who often were attached to small functional organizations and had little responsibility beyond chasing parts, managing suppliers, and trying to negotiate lower prices. In their redefined positions, they would play a strategic role on the leadership team of their business units and would sit at a level equal to that of research and development or of manufacturing.

Another group, the commodity managers, who were responsible for sourcing, also experienced significant organizational change. They would now become a separate function from the procurement engineers. Moreover, in the old system, commodity managers were located at the business group they worked for. Under the new system, commodity managers would be sited at the point of origin for the commodity they sourced. They also would perform sourcing for that commodity across all of the company's different organizational units, rather than for separate business groups. This meant that some commodity managers had to relocate and that some groups were merged. Commodities groups would now also report directly to Spalcke, the CPO, who has a direct line to CEO van Houten. Spalcke calls this "verticalizing and virtualizing" the company's commodities management.

This was no easy task, but the company moved quickly to put everything and everyone in place. "Basically, we took 2,000 people, we put them in a new structure, and we moved them from the tactical to the strategic level," Boon says. "The thing is, we did it in 18 months. That's really fast."

At the same time, Boon was hiring a 12-person executive leadership team in procurement, to become Spalcke's allies in pushing his transformation. Boon partnered with Russell Reynolds Associates (RRA) to find the right candidates for these roles. He chose RRA because its global supply chain practice has experience assisting clients across all industries to find leaders who understand the challenges and complexities of operating end-to-end supply chains. The candidates RRA and Boon found for the new procurement executive team came partly from inside Philips and partly from outside the company.

An ongoing transformation journey
While Spalcke has largely won over erstwhile skeptics at Philips, some elements of his procurement revolution remain controversial. For example, one of his mantras is that every organization inside and outside the company should be treated as a supplier. In other words, he believes it is beneficial to dissect every piece of the value chain and have everyone, internally and externally, bid for each piece of business. Each element of the design and production process should be examined and many questions asked: Is it a core Philips element? Or is an external supplier likely to deliver more value over the lifecycle of the product? How does the company minimize the total cost of ownership through the lifecycle?

Some in the company worry that submitting every design and production element to such rigorous strategic evaluation may lead to outsourcing that compromises aesthetics. "The consumer expects a certain touch and feel of the product," says Murali Sivaraman. "That's what I'm sacrosanct about."

Spalcke says he understands these concerns. Focusing ruthlessly on total cost of ownership through the lifecycle and on maximizing customer value may lead to products that are cheap and efficient but dilute the brand. Moreover, allowing purely competitive concerns to decide which elements should be outsourced can lead the company to give away too much control over technology and design, and to hollow out its capabilities. Spalcke thinks the procurement department can play the role of a neutral arbiter in the DfX deliberations, because, unlike design or marketing, it has no vested interest of its own in the shape of the product, and, he points out, it is the CEO of each product category who always makes the final call. But more importantly, the DfX process gets every role and department collaborating with each other, hashing out the best trade-offs to maximize value.

The procurement transformation program continues, and van Houten, Royal Philips' president and CEO, sees it—and the procurement organization—as critical factors in ensuring the company's future. "At Philips, we are building a world-class procurement organization. One that engages early in the design process of our products, that involves suppliers early on, and ensures we take the right decisions to optimize outcomes for customers and improve procurement savings. A procurement organization that utilizes state-of-the art tools and processes to create more value and manage the supply chain better," van Houten says. "I am proud of our procurement team; they embody what our transformation program Accelerate! stands for."

Pieter Ligthart is Managing Director with Russell Reynolds Associates and leads the firm's EMEA Supply Chain Practice.

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