Opportunities for Action in Industrial Goods. Getting Procurement Right: Positioning the Center to Capture Value

Transcription

1 Opportunities for Action in Industrial Goods Getting Procurement Right: Positioning the Center to Capture Value

2 Getting Procurement Right: Positioning the Center to Capture Value The current economic slowdown has set most companies on a vigorous drive to cut costs. Procurement has been a logical target. The typical cost-reduction program in procurement can initially eliminate 10 to 20 percent of direct sourcing costs, followed in subsequent years by annual savings of 3 to 5 percent. And companies can cut costs even further by using e-procurement to conduct automated searches for low-cost providers. However, The Boston Consulting Group s recent work with clients has shown that few companies are currently capturing as much value as they could from their procurement-cost-reduction programs. Why is this the case, when so many other business areas have become lean and efficient? At the heart of the problem lie two organizational issues: the low status and inadequate skills of many procurement departments, and the inflexible organizational model that governs how they operate. Sourcing in most organizations is either totally centralized or almost completely decentralized, which means that it works well for some forms of procurement but is ill suited to others. The shortcomings of both models have led many divisions to believe that their centers destroy rather than add value in procurement. When sourcing is decentralized, the company misses out on the discounts available through companywide commodity contracts. When sourcing is centralized, the divisions are not consulted and are then expected to use goods and services that do not meet their needs. As a result, division managers often negotiate their own contracts instead of complying with those negotiated by the center.

3 Companies experiencing the adverse effects of this syndrome must take two steps to break out of it. First, they should move the sourcing function from its exile in the backwater of the organization and reposition it as a high-level strategic activity that generates significant value for the entire organization. Then they must free the function from its rigid operating style either at the center or in the divisions and allow it to become a versatile function that can respond flexibly to all the procurement requirements of the organization. From Exile to Center Stage In most companies, sourcing is inextricably linked to success. The typical procurement department influences 50 to 80 percent of a company s cost structure. Moreover, the activity itself providing everything a company needs to make the wheels go around is absolutely critical to an organization s ability to execute its strategies. Ideally, the central procurement department is an empowered, energized place where skilled managers consistently deliver value to the divisions. Unfortunately, in many companies the department is buried deep within the center and is not uniformly staffed with top-quality people. In such companies, line managers tend to view sourcing as clerical at best and as bureaucratic and interfering at worst. An assignment to procurement is often regarded as the final move on the way out of the company. This situation can be remedied. In a major industrial company BCG worked with recently, the sourcing department at the head office was staffed with people who had not made the grade in other parts of the organization. Consequently, division managers refused to use them for anything other than clerical support. With BCG s assistance, the company introduced a new

4 sourcing manager, who had previously run a large operations and logistics business. This new manager reported directly to the CEO and was clearly his heir apparent. At the same time, the CEO introduced ambitious cost-reduction targets into every line manager s performance contract. The combination of the CEO s commitment and a highly skilled area leader transformed the sourcing group into a driving force in identifying opportunities for savings. This example demonstrates three principles that companies should apply in structuring and staffing their sourcing functions: Sourcing should not report more than two levels below the CEO. Executives in sourcing must be well respected within the organization. They must be talented people who are seen as the company s future leaders. They should come either from world-class sourcing organizations or from line positions that involve challenges similar to those in procurement (for example, distribution or customer relations). Line managers and sourcing managers need to have powerful shared incentives. Goals for sourcing improvements should be explicitly targeted in each manager s performance contract. To help companies track performance, BCG has developed metrics that can distinguish between savings achieved through specific sourcing initiatives and cost reductions that occur in the market. From Inflexibility to Versatility Most companies design their sourcing functions according to one of two philosophies: that the com-

5 pany must capture the benefits of scale, so the function must be located at the head office; or that line managers must be held accountable for purchasing, so sourcing must be minimized at the head office. Unfortunately, neither approach can adequately address an organization s overall procurement requirements. Companies operating under either model tend to become frustrated with its limitations and swing the pendulum from extreme centralization to wholesale decentralization, or vice versa. What companies need is a more sophisticated, fine-tuned approach that combines the best of both models. The role of the central sourcing department should be designed according to the two kinds of benefits the center can confer: scale and collaboration. Scale creates value by lowering transaction costs (owing to increased volume) and by lowering the cost of goods (owing to consolidated purchasing). Collaboration creates value through shared learning, either between business divisions or between a buyer and a seller. Collaboration fostered by the center can be particularly valuable when a business unit stands to benefit from the technical expertise or purchasing experience of other business units in negotiating its procurement contracts. For example, in a company that manufactures steel appliances and steel window frames, procurement managers could collaborate on a number of issues: in-depth knowledge of a supplier s grades of steel, for instance, or which people in the supplier s organization to work with in designing new products. Management should classify the full range of the company s procurement requirements along these two dimensions scale and collaboration to determine whether and how the center should be involved. Because of the complexity and diversity of many companies procurement requirements, the central sourcing

6 function is likely to play three roles at various times: the doer, to maximize scale in commodity contracts; the coordinator, to ensure that expertise is shared in the sourcing of complex products; and the leader, to enforce product standardization when it is required. (See the exhibit Three Value-Adding Roles for the Center. ) The Doer Role: Managing Commodity Contracts In many large organizations, the center is solely responsible for purchasing commodity products and services, such as stationery supplies, maintenance contracts for office machinery, telecommunications equipment, and computer hardware. Because scale is extremely valuable for these products and services, the company s primary objective is to pool all its contracts. Such purchases have little impact on the individual businesses Three Value-Adding Roles for the Center High Value of Collaboration Low Coordinator Ensures the sharing of expertise in sourcing complex products No involvement from the center Leader Gathers input from all divisions but manages sourcing to ensure product standardization Doer Negotiates the lowestprice commodity contracts with minimal input from the divisions Low SOURCE: BCG analysis. Value of Scale High

7 beyond direct cost, so they require minimal businesslevel knowledge or input. Here the center should be given full responsibility for negotiating contracts. As the doer, the center should focus on the contracts that have the greatest potential for scale benefits. In general, it should target the highest-value categories of products and services, and negotiate with the suppliers that provide some 80 percent of the company s goods and services within those categories. The Coordinator Role: Sharing Expertise For products that are vital to a company s strategic success, sourcing should be left to the business units because they have deep expertise in their product specifications and performance requirements. However, the center should play a coordination role, ensuring that the business units share their knowledge of materials technology, techniques for managing suppliers, and collaborative approaches to R&D. For example, when the business units of a leading engineering company assess target prices for complex goods, such as pump machinery, they use cost models developed by the central sourcing department. These models are reliable because they are built on the cumulative experience of dozens of different kinds of projects. Line managers make the final purchasing decisions, but they benefit from access to the companywide experience that the center provides. Although this coordination role is sponsored by the center, it does not have to reside there. Instead, a manager within a business unit can be responsible for coordinating the overall sourcing for a particular category of purchases.

8 The Leader Role: Enforcing Standardization In cases where sourcing requires particular business expertise from the divisions but the company would benefit from pooling its purchases, the center must play a different role. The best approach in such cases is to make the center accountable for ensuring product or service standardization and to employ the business units in an active advisory role. For example, a high-tech company set up a sourcing unit in Singapore to be closer to leading manufacturers of electronic components. The unit collects information and specifications from division managers, who outline the functionality they need from the components in question and suggest ways in which different manufacturers can provide it. However, the center itself negotiates with suppliers to ensure that all divisions buy and use a standard set of components. It is often worthwhile for a single division to sacrifice the incremental value of a customized product in favor of a standard solution that can achieve significant savings across the organization. For instance, various types of capital equipment might be slightly more effective if each type had a customized motor. But using one kind of motor in several different kinds of equipment often means lower procurement costs, a reduced spare-parts inventory, and minimal training requirements all of which lower the overall cost of motors. It is critical that the center provide mechanisms to manage such tradeoffs. * * * We have described a versatile approach that meets the varied and complex sourcing needs of most companies today. In our experience, some companies have

9 adopted some of these principles, but few are applying them all. To fine-tune your company s procurement capability, first move the sourcing organization onto the fast track by developing the skills and leadership required to transform it into a strategic operation. Then segment your purchasing of products and services on the basis of how and where the center can deliver the benefits of scale and collaboration, and align its role accordingly for each procurement category. Applying these relatively simple measures will transform your organization from a clerical backwater into a vital engine of value creation. Kathleen Conlon Pascal Cotte Klaus Neuhaus Kathleen Conlon is a vice president in the Sydney office of The Boston Consulting Group. Pascal Cotte is a vice president in the firm s Paris office. Klaus Neuhaus is a vice president in BCG s Düsseldorf office. You may contact the authors by at: conlon.kathleen@bcg.com cotte.pascal@bcg.com neuhaus.klaus@bcg.com The Boston Consulting Group, Inc All rights reserved.

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