The New Love Affair Between CEOs and CPOs

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Few managers or departments can write their CEO a cheque for millions and promise more again next year. Procurement however is the exception. Its almost un-paralleled ability to boost the bottom line has earned it a position of influence and power. Little wonder then that procurement is the CEO’s new best friend.

Strategies for Low Growth Markets

Few managers or departments have benefited from the 2007 downturn. Procurement however is the exception – it was perfectly placed to answer the organisation’s crisis call to salvage profits by cutting costs and eliminating waste.

In times of fast growth organisations could overlook waste and inefficiency. However, coping with sluggish, volatile and uncertain markets requires organisations that are more lean, efficient and agile.

As every MBA (and indeed every salesperson) knows; the way to improve the bottom line in a time of low growth is to; cut costs, streamline production and drive efficiency generally. It is to appeal directly to the agenda of the CEO and CFO. That is something that procurement and supply chain managers have done with enthusiasm.

A Spectacular Impact On The Bottom Line

Different studies set out to calculate the impact of best in class procurement, contrasting the results with those of average and laggards performers. These studies make interesting reading, but you don’t need a barrage of statistics to understand the impact of procurement on bottom line results.

With anywhere between 40% and 75% of an organization’s turnover spent on the purchase of goods and services, the ability to generate even small percentage savings on such considerable volumes of spend is a key driver of business performance.

Procurement’s impact on the bottom line can be spectacular. On direct spend categories procurement regularly boasts savings of 3, 5 or 10 percent. But when it comes to the new frontier of indirect spend the savings claimed can be anywhere between 15% and 35%.

Calculating The Impact

Use the table below to see the potential impact of procurement on one of your key customers. Across the top select the % savings achieved by procurement, say 3%. Then along the side of the table, select the percentage of turnover that the organisations spends on the purchase of goods, or services, say 50%. Where the two intersect you will see the savings achieved, for every 10 million of turnover, in this example 150,000 is saved.

Don’t worry if you find the table a bit confusing. The main point is that procurement’s rise is popularity is simply down to numbers. It’s impact on the bottom line is clear-cut.

The New Corporate Super Hero

In many organisations procurement is rightly boastful of its achievements. It is the new corporate hero – a position previously held by sales.

After years of heady growth difficult market conditions put sales and profits under pressure. Suddenly, sales and marketing was no longer the primary driver of corporate growth and survival.

One procurement leader recently boasted at a conference ‘I am worth 10 sales managers!’. He went on to explain; ‘at a net margin of 10%, sales would have to generate 10 million in additional sales to add one million dollars to the bottom line. While, on the other hand we only need to save 1 million to deliver profit of 1 million’.

The point was well made, but of course 10% is a generous margin, in many organisations whose margins are half that, it could be argued that each procurement executive is worth 20 sales executives!

Following on from the earlier table, let’s examine the sales equivalent of procurement savings, based on a 5% net margin. As the table below shows, a modest 3% saving by procurement on purchases that account for 50% of an organization’s turnover – if it was to be generated through sales growth – would require a whopping 30% increase in sales! In low growth times cutting costs is the speediest way to impact on the bottom line.

Again, don’t be put off by the table, its purpose is simply to show that it one way or another it takes a lot of additional sales to achieve the same impact on the bottom line as even a relatively small saving by procurement.

Little wonder that many of the greatest turnaround stories of all time, including those at IBM, Harley Davidson and Daimler Chrysler, owe their success to procurement. Indeed, procurement is the maestro of the turnaround strategy.

Delivering Year On Year Savings

It was traditionally held that the savings achieved by procurement were quick-win in nature and would struggle to be sustained. For example, it was often said ‘you cannot cut your way to growth’. Yet, best in class procurement has demonstrated a surprising ability to deliver savings year on year.

Yes starting from a green field situation, procurement can deliver quick win savings of anywhere between 1% and 10% on raw materials and components for example. But how can it ‘go back to the same well’ to deliver savings year on year?

Delivering year on year savings

The progressive nature of savings owes a lot to the fact that they are not just achieved by cutting supplier margins (something that cannot go on forever). Those strategies include:

1. Procurement’s coverage of organisational spend has in many large organisations only reached the two thirds level. That means there is significant scope for additional savings.

2. In many organisations there is still a significant level of maverick buying, including spot purchases outside of existing agreements or procedures, unapproved vendors and uncatalogued items. Savings achieved will inevitably increase as procurement drives up compliance levels.

3. Procurement is increasingly targeting indirect spend categories, such as marketing, professional services and capital purchases, previously considered out of its reach. Procurement directors often boast savings of 15%, 25% and even 35% in these categories.

4. Procurement is employing a number of strategies to dig deeper in respect of savings and efficiencies. These include;
– Demand management – that includes curtailing demand and better aligning with market demand
– Supplier / SKU consolidation reducing inventory and procurement costs as a result
– Aggregation of purchases so as to maximize economies of scale and leverage bulk buying
– Contract compliance – ensuring that suppliers deliver as promised
– Supplier performance management and partnering with suppliers to identify new ways of driving efficiency and cutting cost
– Value re-engineering, etc.

5. Procurement recognizes that it cannot, or should not seek to directly control all spending. If nothing else it does not have enough manpower to be directly involved in all buying decisions. Additionally, excessive procurement bureaucracy could stifle innovation, slow decision making and increase and costs. Procurement is therefore adopting more sophisticated alternatives to its direct involvement, including use of procurement systems (e.g. online catalogues, and e-auctions), framework agreements and the provision of procurement training.

The Credibility Of Savings Claims

When it comes to the savings achieved, procurement’s figures are often greeted with scepticism by internal colleagues, most notably by the finance department. Indeed our research indicates savings claimed by procurement are often being discounted by anything up to 60%.

There are many reasons why this happens, but the method of calculation and the leakage of savings or other promised benefits during implementation are key among them. It is essential for procurement to collaborate with Finance in forecasting and tracking savings if disputes are to be avoided.

Why is this important? Well salary surveys show that as much as one dollar in 5 earned by procurement is linked to the achievement of results and paid in the form of a bonus. Disputes as regards savings achieved therefore impact directly on earnings.