Adapting for growth in a stable economy

By Marco Marini

By Marco Marini

21 January 2014

It wasn’t too long ago when procurement wasn’t widely recognised, let alone relevant. But, if nothing else, raw material cost increases over the last decade have placed the function firmly in the spotlight.

At present, with a relatively stable global economy, it is fundamental for businesses to understand the role that procurement plays and its ability to have a positive impact on business performance. One of the difficulties, however, in achieving this comes from the misconception that procurement is a rather easy and stable function, focussed solely on sourcing items (quality taken for granted) at the best price.

This still common vision is too narrow for the 21st century procurement function, for the simple reason that the goods and services purchased usually amount to between 70% and 90% of the value that a company produces. It is crucial that the rest of the business understands procurement-specific objectives and above all the fact that they alter according to differing situations and extrernal factors. This shared understanding is what will be explored in this article.

Firstly, some activities related to the task of procurement require definition – or perhaps redefinition, for the purposes of business partners.

Price: This is the ability to obtain goods or services at the best possible price in accordance with user-defined specifications.

Compliance: Adherence to the rules defined in any given contract. For example, production must be done on a dedicated pre-audited production line.

Risk mitigation: Ensure at all times the availability of goods or services. For example, critical components must be subject to double sourcing.

Supply chain efficiency: Ensure a fast, hassle-free flow of products and services within the company, minimising complexity. For example, defining procedures to share goods availability and traceability in order to minimise overall stock.

During my career I have had to manage several business scenarios that forced changes on the company and all its departments, especially procurement. Stable market growth, integration after an acquisition and the global financial crisis are just a few to consider.

Three scenarios

The first scenario hit the majority of companies between 1998 and 2008. During this period global markets improved steadily and China consolidated its growth, which continues, albeit at a slightly reduced rate, up to the present time. However, during this period the commodity markets experienced an imbalance between supply and demand resulting in an increase of input costs of almost all manufacturing processes. The CRB Commodity Index rose from 180 to 460.

In this scenario, procurement had to focus its efforts on mitigating the impacts of price increases with little ability to influence compliance. It had to deal with the lack of availability of raw materials and components on the market. This led to a stock build-up in different points of the supply chain.

One example was steel, which had been relatively stable for many years both in terms of price and availability because of global overcapacity. However, the growth of China destabilised this and resulted in the doubling and then tripling of prices, which had a significant impact on businesses P&L.

Containing price increases with the agreement of new suppliers and new materials was the main focus for many procurement functions. For the first time companies experienced steel sourcing directly from China and India.

However, an attempt to directly import Russian steel into Europe failed. In our case, annual price agreements were constantly disregarded by suppliers and renegotiation was permanently on the agenda. To avoid stopping production the company had to make spot purchases and give in to price demands or specification changes imposed by suppliers, but the problems were not only from the outside. It was difficult to explain to the company what was happening in the raw materials market and that an increase in our selling price was inevitable.

The motivation of the team became problematic too since all the quantitative targets were not achieved. The increased sourcing complexity highlighted a lack of skills within the team and the most talented were attracted by other companies, resulting in a high turnover of staff.

Post-acquisition

The post acquisition scenario is very different from that described above. In one such example,  the due diligence phase had already revealed substantial differences in the purchasing terms and conditions between the two companies. Also the supplier base was different and estimated saving targets were very ambitious.

The focus of the team was to get the highest savings in the shortest time possible. The negotiating power, unlike the scenario described above, was in the company’s hands. When the supplier was common the company looked to apply the best price and when there were two suppliers for the same product the company concentrated quantities on one of them in return for substantial discounts.

The availability of the product was not a problem. Indeed all the vendors wanted to supply the player who was driving (at that time) the consolidation of the industry. The strong bargaining power against almost all suppliers allowed the company to rationalise the supply base and the number of stock keeping units. Indeed, the code-by-code price check stimulated the critical analysis of the need to have a large number of alternatives for the same code.

Although this scenario is very rewarding in terms of image for the procurement department from a professional point of view it is not as challenging as the scenario described before and the one that will follow.

Financial meltdown

The final part of the story, and one that has shaped so many businesses is, of course, the financial crisis. The crisis that started in 2008 changed so many rules of the game that procurement faced challenges it had never experienced before.

Price and production capacity were not significant variables. Meanwhile, it was easy to realise savings and the only concern was to achieve savings in excess of those made by competitors.

However, new challenges arose. A large number of suppliers, especially those we might consider less-structured, found themselves in a cash shortage and a number of them went out of business creating significant product availability issues.

Even those who continued to supply, and for years had been most reliable suppliers, could not fulfill the commitments made in the contract as the entire supply chain was under stress. However, it was the ability to monitor the reliability of the entire supplier base that was the key challenge and continues to be today.

To be successful it has been important to collect and process data together with colleagues in finance. This gave the department confidence in the ability of our suppliers to meet their commitments. In one case, the team had to plan and then implement a phase-out of the first supplier of compressors to the company.

The company agreed 100% with the products in the cooling range with the introduction of alternative compressors. This activity lasted for a year and a half with no economic return and a huge commitment of resources. When the supplier went into liquidation the company was the only one that had completed the phase-out and therefore had ensured business continuity.

However, in the wider context, the challenge was not only towards our suppliers but also internal. The need to minimise the use of capital had forced the company to optimise all supply chain processes in order to reduce stock. In addition, a prudent and justified increase in payment terms was implemented in order to further improve net working capital.

Lessons learned

The three scenarios described above required the adoption of opposite directions for the same activity. The pricing policy that is the most simple to analyse switched from containment and optimisation in the stable growth scenario to a frantic search for savings in the post-acquisition period and then a switch to an almost neutral position in the financial crisis.

What is then the role of procurement? It is to fulfil the needs of the business in every situation. These needs may require the adoption of different pricing, compliance, risk mitigation and supply chain efficiency policies from year to year.

Probably this constant change and renewal is one of the factors contributing to the lack of understanding on the part of internal and external stakeholders of procurement.

To overcome this problem, it is necessary to communicate both internally (including the procurement team) and externally (including suppliers) the particular situation of the company and what action it intends to take.

For this reason, we organised an annual event for our suppliers where the results of the company, its strategic direction, the budget plan and the impact this has on procurement policies for the following year were presented.

In this way, our suppliers knew in advance what they needed to do in order to maximise their business.

However it is much more difficult to explain this multiplicity of roles to colleagues and also to the procurement team itself. In the case of internal communication and recognition, the management skills of the CPO are paramount. The only advice I can give is to have an infinite listening capacity.

As for procurement teams themselves I have two suggestions suggest. From my experience the most effective way to deliver a message is to insert a related target in the Management Business Objectives (MBO).

So if the goal is to achieve a certain price, performance level, contract compliance or certain stock level, insert it in the MBO. Rest assured that it will be checked regularly throughout the year.

However, to allow the team to reach their role awareness within the company and therefore acquire the ability of taking the right decisions at the right time, skills need to be developed; the ability to listen to colleagues and understand their problems; the ability to propose alternative solutions to colleague in a collaborative manner; the ability to relate and empathise with others; the ability to understand the business environment of the company and the attitude colleagues have in response to external challenges .

This, of course requires training, an open-minded approach and leaders who understand that procurement is an ever-changing challenge.

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