THE NEW MAGIC WORD IN PROCUREMENT

TRENDS PROCUREMENT

THE NEW MAGIC WORD IN PROCUREMENT What is the biggest difference between good and bad managed procurement departments? Their dealing with sustainability. An international study shows why ecological and social exemplary suppliers bring far more than just a good image.

FROM THORSTEN MAKOWSKI, SUNIL CHOPRA AND FLORIAN WALTER

Many companies tend to underestimate sustainability as an important issue of procurement. Often with fatal conse-quences, as seen in the 2013 collapse of a textile factory in Bangladesh with more than 1,100 dead people. Also enterprises like Apple and Mattel made direct and painful experience – the electronics company by riots and suicides at their supplier Foxcoon, the toy manufacturer with toxic colors in imported articles from China. The catastrophic mistakes of the suppliers dropped back to the purchaser, scratched the reputation and resulted in financial losses. And yet there is any other aspect where the difference between good and bad performing procurement orga-nization is as high as for sustainability: while the best companies highly value ecological, social and raw material gentle products, companies with an below average procurement perform-ance attach less importance to these topics. This is the result of the new edition of our global procurement study, for which we surveyed, for the third time in a row after 2009 and 2011, chief procurement officers, CEOs and other top management executives of 555 companies in 66 countries. In addition to enterprises like Siemens, Coca-Cola, Unilever, IBM and Shell also

6 HARVARD BUSINESS MANAGER AUGUST 2014 Translated from German - Original article in Harvard Business Manager

TRENDS PROCUREMENT

numerous small and medium-sized businesses are represent-ed. The data was collected from July to December 2013. This study was a cooperation with the Kellogg School of Management in Chicago, supported by the American Purchasing Society and the International Chamber of Commerce (ICC) Germany. Because clients request it Our study results show, sustainability has replaced ‘Sourcing from low cost countries’ as the major trend for procure-ment. 57 per cent of the companies in our study already included sustainability in their companies’ values and targets. Additionally 49 per cent state that ecological and social aspects are important to very important for the performance of their company. Thereby this by no means represents a short term trend: 64 per cent of the participants expect an increasing importance of sustainability for the value chain. But why is this the case? As a rule procurement manager are no selfless do-gooders. But they respect the wishes of their customers – and they increasingly insist on companies to take into account the consequences on humans, environment and resources. Thus 61 per cent of the surveyed admit that their sustainable behavior is as reaction on fulfilling customer expectations. Thereby regional differenc-es attract the attention: while in North America and Europe the wishes of customers stand in focus, Asian companies mainly behave sustainable to positively influence the public perception and to fulfill statutory require-ments. Worldwide there are only 20 per cent of the companies that state they are putting effort in sustainability only because this is regulated by law. More than just cost cutter Procurement possess five levers

claimed by tasks that either have no or only little value creation for the company. Higher prices? Yes, but … In fact two-thirds of the participants state that they are able to achieve a competitive advantage by more sustainability in procurement. But this does not mean, that they would accept considerable higher costs at any time. They only do advance payments in case customers are also willing to pay higher prices. In other words only if additional costs of the value chain are mainly borne by the customer.

This is more often the case in B2C- than in in B2B-relations or if the company possesses a strong brand. The willingness of end customers is particularly high if the product is emotionally afflicted. For this purpose food and baby products are good examples as the own health and the one of their children are dear to many people. The willingness to pay is – not surprisingly – highest for customers with a high income. This is one reason why sustainability is rated higher in western countries than in comparably poorer regions in Asia or Africa.

The fact that the purchasing power of customers is out-balancing the emotional habits and preferences is demonstrated by the situation in the textile industry: although clothing is a product of high emotional relevance, this has almost no effect on long term buying decisions of customers with a low income. Therefore textile discounters do not have to fear a substantial threat for their revenue due to negative news about unethical behavior – even if it becomes public that they are buying from supplier who maltreat their employees.

Similar is the situation for emotional afflicted technical products with a high innovation

to create value for the company: 1. cost reduction, 2. revenue increase, 3. risk mitigation, 4. tax burden reduction, 5. capital reduction. Our study revealed that procurement organization mainly focus on cost reductions. In addition they should secure material quality and availability not to put revenue at risk. This view on procurement as supporter of production is widespread. However some companies do not only see the potential of cost reduction but also potential for additional growth. Sustainability and innovation are the new magic words of procurement. Amongst all value creation levers of procurement, sustainability is the one where the behavior of good and bad procurement organization differs most. For this we could find several evidences in our study. One example: Only eight per cent of the surveyed companies in our study stated that “sustainability does not play an important role for us”. Yet these eight per cent on average showed a clearly lower procurement performance (only 41 per cent of the best possible performance) than other companies who are actively striving for sustainability. In other words: After the focus on cost – shown in our first global procurement study 2009 – the focus on risk management – discovered in our second study 2011 –, sustainability is the current differentiation attribute with which successful companies are able to achieve additional growth. Companies with a poor procurement performance are putting less effort on sustainability than top-performers do. There are three reasons for that: they underestimated the chance of a social and ecological compliant supply chain, lack necessary resources and are too strongly


TRENDS PROCUREMENT

value. Therefore it is unlikely that customer ostracize brands like Ferrari or Apple if their products cause extensive ecological or social damage. The good ones are convinced Now managers might say: ecological and social commitment are all well and good – but how will sustainable economic activity pay off for procurement and the company as a whole? Indeed our study also reveals some skeptical voices and examples for sustainable initiatives, which did not meet the expectations. Partly they even destroyed enterprise value. However the majority of participants – 72 per cent – is convinced that sustainability pays off for the company on the long run (see graphic above). Only 28 per cent of the chief procurement officers are not able to recognize

not always meaningful. We identified nine different measures, starting from rewarding systems for suppliers to removing them from the supplier portfolio. Thereby we also measured the average procurement performan-ce of companies stating they are applying a dedicated measure. It turned out that the method that was most often applied was not subsequently the most efficient one. Because particularly often – to 58 per cent – companies contractually dictate which sustainability issues a supplier has to take care of. Do these contract clauses significantly change the behavior of suppliers – are they abruptly respecting ecological and social aspects? We do not believe so. In most cases, that’s our assumption, a single fixation in written form does not cause a fundamental change in behavior. This can only be expected if the contracting entity facilitates, motivates, examines and sanctions improved sustain-ability with flanking measures.

The fact that companies anyhow insist on sustainability as a part of supplier contracts, has a different reason: if something goes wrong, they can pass the buck to their supplier – assumed that the end customers do not see through the game.

Fortunately such contract clauses are not the only measure with which companies try to improve sustainability in their procurement departments: 43 per cent of the participants inform the suppliers as well as the public about how sustainable suppliers perform; 35 per cent have implemented a sustainability scorecard, and 31 per cent focus on sustainability criteria as an important part of their supplier audits. In contrast only a minority group uses carrot and stick methods, any threat to sort out none sustainable suppliers, premiums for exemplary suppliers

the advantages that lie in socially and ecologically responsible behavior. As our analysis shows, there is a significant correlation for the overall procurement perform-ance regarding this question: companies with a good perform-ance are almost always – with 97 per cent – convinced that sustainability is a chance for increasing value creation. In comparison, companies with a poor performance in procurement mainly affiliate sustainability with additional costs. But it is stipulated in the contract … If sustainability represents a new chance for value creation, this reveals the question: what do companies do to align their procurement departments with ecological and social criteria? Our study gives a sobering answer: they do a lot, but what they do it


TRENDS PROCUREMENT

or other bonus malus systems. Five steps to success But what is the most efficient way to commit the procurement department to a sustainable business? These five steps will help achieving the objective: 1. Term clarification Sustainability is not always easy to grab. Therefore you need to define what it concretely means for your company. Derive minimum requirements that suppliers need to fulfill and also performance indicators (key performance indicators = KPI), to measure the success. An excellent example is Siemens, which got honored several times as the most sustainable company in the world by the Dow Jones Sustainability Index. The group defined its own six central KPIs for environment (e.g. CO2, energy, waste) and six for the social field (employee fluctuation, training, accidents at work). 2. Management commitment Sustainability needs to be anchored at the top of the company. Ideally it is the CEO who is promoting the topic. By no means may it stay a pure procurement topic. At the Swiss chemicals group Clariant it was CEO Hariolf Kottmann himself who defined the topic as fourth strategic target for procurement – in addition to the existing target figures costs, quality and security of supply. With a Sustainability Council, where he is chairman, Kottmann established a widespread internal support for topics around ecology and social affairs. 3. Control compliance To secure suppliers not only pretend to act sustainable but really act sustainable the contracting entity needs to establish effective mechanisms for controlling and sanctioning.

good for environment but also for the financials of the group. Conclusion Our study shows: companies that see sustainability as annoying or even unnecessary are putting their competitiveness at risk. Instead procurement responsible should see ecological and social aspects of production as chance for development and differentiation. By now the best competitors already use this topic to increase the distance to competitors and make an important contribution to the company’s success. REPRINT Number 201408006, see page 94 or www.havardbusinessmanager.de THORSTEN MAKOWSKI ([email protected]) is managing director at Valueneer, a Berlin based consultancy specialized in procurement optimization. As private respectively guest lecturer he teaches procurement at multiple Business Schools worldwide. SUNIL CHOPRA is professor for operations management at the Kellogg Business School in Chicago. FLORIAN WALTER is management consultant at Valueneer focusing on procurement and supply chain management.

The electronics company Philips has a five digit number of suppliers – according to this number it would be quite difficult to control all of them at the same time. Therefore Philips audits those suppliers first which are related to relatively high sustainability risk, repeating these audits every three years. Suppliers that do not fulfill important criteria have to improve on these issues or will be sorted out. 4. Search for partners A cooperation with other companies or associations increases the legitimation of the sustainability strategy and pools costs. In 2011 the chief procurement officers of BASF, Henkel, Evonik, Lanxess, Solvey and Bayer Material Science established the initiative ‘Together for Sustainability’ in which they standardized the evaluation and auditing of suppliers. As a result suppliers only need to be audited by one of the participating companies. The advantages: higher transparency, industry-wide minimum standards and lower costs. 5. Encourage innovation The innovation strength of suppliers is the least exploited resource for more sustainability. In this context the right selection, communication and motivation of suppliers is essential. In 2008 Pedro Martinez, chief procurement officer of the hotel chain NH Hotels, started, with the mandate of his CEO Gabriele Burgio, the NH Sustainable Club for selected suppliers. The participants discuss innovations, celebrate successes and award top suppliers. As a result the hotel chain was able to reduce its consumption of water and energy, the CO2 emissions and waste by around 20 per cent within four years – a success that is not only 9 HARVARD BUSINESS MANAGER AUGUST 2014 Translated from German - Original article in Harvard Business Manager

May 2012 Translated from German - Original article in Harvard Business Manager Page | 8

PROCUREMENT IN UNSECURE TIMES

The effects of the recent natural disaster caught many procurement departments off guard, as an international study demonstrates. As almost 40 per cent of the companies set aside the management of external risks, they are insufficiently prepared for the case of emergency.

Thereby a comprehensive risk management for procurement can be established in five steps.

FROM THORSTEN MAKOWSKI, FELIX PAPIER AND FLORIAN WALTER

It’s been two years of disagreeable surprise for international companies: first there was the volcanic eruption in Iceland 2010, followed by the tsunami and nuclear disaster in March 2011 in Japan and finally the flooding in Thailand in October. For many procurement departments this meant: delayed supply with material or even cancellation of shipments, supplier got into trouble or even were forced to stop production.

For companies with a working risk management this might have been annoying but not threatening the existence. But, as the new edition of our global procurement study shows, in 40 per cent of all procurement departments there

is no risk management for external risks in place – thereby not only natural disasters are not covered but also problems arising from exploding raw material prices, political unrest, dramatic shift of exchange rates or supplier not sticking to ecological and social standards.

On the following pages we will show you how companies wisely manage these risks in procurement.

For our study – the second after 2009 (see “Saving with procurement” Harvard Business Manager 04/2010 –we surveyed procurement managers, CEOs and other top management executives of 1005 companies in 67 countries. As a result this study is the biggest and most international procurement study

ever conducted. The data was collected from August to December 2011, thus half a year after the disaster in Japan. The consequences of the tsunami and the nuclear disaster therefore were of high importance for the selection of the questions. Besides enterprises like Coca-Cola, IBM, Siemens and Bayer we also surveyed small and medium sized companies. The study was supported by the American Purchasing Society, the Federation of German Wholesale, Foreign Trade and Services, the international chamber of commerce (ICC Germany) and the ESSEC Business School in Paris.


Due to the catastrophes and volatilities of recent years most companies realized that they have to change their risk management and include it into the entire supply chain. Thus more than half of the participants state that risk management has a high to very high importance for them today. Solely those companies with a below average procurement performance still do not perceive risk management as being important. Besides some companies realize that risks also contain chances: They increase market shares where competitors are not or

insufficiently prepared for arising risks. THE TSUNAMI AND ITS CONSEQUENCES As our study demonstrates, especially the disaster in Japan had a high effect on the companies: 33 per cent were suffering from supply shortfall, 16 per cent even to a substantially extent. In this context European companies – inherently by their geographical distance – were only struck half as much as the global average. More surprising is that US companies were suffering from the disaster almost to the same

extent as Asian companies did. This is the result from the fact that American companies to a high extent outsourced their production to Asia – an ongoing trend since years which the US government is currently trying to reverse. Also the company size has an effect on the extent, operations was affected by the disaster in Japan: companies with an annual turnover of less than 250 million euro were seldom mentioning that they suffered from supply shortages – probably due to


and Africa. Due to the disaster in 2011 this trend has even accelerated. Worldwide every second company is planning to reduce the procurement volume sourced in Japan. If this is an adequate reaction on the tsunami and nuclear disaster is questionable, because this step is mostly done by those companies having a low procurement performance. In comparison companies with a good procurement performance are questioning their entire supply chain strategy and in general try to decrease the concentration and depen-dency on a single region. 60 per cent of the surveyed companies hold the opinion that, as a reaction to the disaster in Japan, strategic measures are necessary. An improved risk management and more multiple sourcing – thus the sourcing of materials from more than one single supplier – are the most common actions. As risk management is associated with increased effort and multiple sourcing, meaning that smaller amounts are sourced for a higher price, this always results in increased costs.

The same is true for the idea of keeping higher stocks for critical materials, which is the plan for at least 14 per cent of the companies. A minority of 7 per cent is thinking of making highly critical supplies by themselves again.

the fact that only few of them are sourcing globally. Surprisingly especially the risk management of big companies has failed during the crisis: the effects on these companies were even higher than for medium sized companies. The assumption that big enterprises are, due to better methods and resources, less affected by procurement risks than medium sized companies, is wrong.

A close look at the industry sector reveals that the high tech sector has been affected most from production shortfalls in Japan, followed by steel and construction services and the chemical, pharmaceutical and health-care sector. The high sensitivity of technique companies is not surprising as Japan is known to be of high importance for high quality technology products.

Noticeable is that especially those companies suffered the most from the catastrophe which were focusing on cost reduction and innovation in the context of their supply chain strategy. On the other hand a healthy balance of security of supply, quality and costs has been proved as being a successful procurement stra-tegy. The fact that a too strong focus on cost aspects contains high risks – e.g. by just-in-time production with low stocks or maximum bundling of supp-liers – is easy to under-stand. But also companies too strongly focused on innovation are taking high risks. One result of our last study, conducted in 2009, was that several companies are shifting their procurement volume from Japan to other regions with low labor costs like China, India, Eastern Europe

THE MOST FREQUENT RISKS INPROCUREMENTBig concerns about supply reliabilityThe years 2010 and 2011 with its natural disasters and the nuclear disaster of Fukushima have in a remarkable way demonstrated the vulnerability of the supply chain to chief procurement officers. In our study from the second half of 2011 supply reliability has been mentioned as the most important risk in procurement. The financial crisis also continues to have an effect: The credit risk of suppliers with financial problems is still real for 28 per cent of the participants.

12

12

16

22

25

28

48

51

63Security of supply

Material quality

Material price volatility

Suppliers with finanical risks/liquidity problems

Suppliers with low social standards

Suppliers with low ecological standards

Inventory adjustment of the existing stocks

Any form of corruption

Volatile exchange rates

Data shown as percentages


In 2009 Boeing already carried out such a re-insourcing project: due to problems with the integration of the supplier for the Dreamliner project the enterprise bought a part of its main supplier Vought Aircraft Industries. WHAT COMPANIES ARE AFRAID OF? Which risk companies are noticing the most is strongly related to the current economic and political development. In the financial crisis 2009 many of the participants noticed that suppliers with financial problems can represent an enormous risk for the own company. Several companies reacted with a risk management that takes into account the credit risk of suppliers. Therefore they buy economic evaluations from rating agencies, financial service providers or insurance companies. This information is not always tailored to the internal risk assessment and often not available for all suppliers. However this has helped to increase transparency regarding supplier shortfall and enabled the steering of risks.

Currently the focus is no longer on the financial fitness of the supplier, but the security of supply is the main risk, which is, after the recent natural disaster, not a surprise: 63 per cent of the surveyed executives are concerned about the reliab-ility of the ordered goods (see graphic on previous page).

Every second company additionally fears variations of quality and price of the used materials. As a fact for a typical total procurement proportion of 50 per cent the increase of procurement costs by 10 per cent results in a decrease of turnover margin by 5 per cent points. This is sufficient to turn a profitable company into an unprofitable one.

While corruption is at least since the bribery scandal at Siemens in 2006 part of the risk awareness of German executives, sustainability does obviously not play an important role – despite the suicides at the Chinese Apple supplier Foxconn or the penalty worth millions, the toy production company Mattel was forced to pay due to plump contaminated toys. Only every eighth company mentions ecologic and social standards as elementary supplier risk. HOW YOU MITIGATE RISKS 1. Scenario planning The first step to an effective risk management is to perform a scenario planning for the main risks. Executives should take the time to go through all possible things that could go wrong in procurement. To evaluate how high the so called expected value is, the probability of occurrence for the risk is multiplied with the size of the damage. Additionally some companies compare this value also with effort and complexity of

possible mitigation meas-ures. The advantage of such an extended analysis is that companies can concentrate on risks which can be influenced and mitigated without high effort. The most important basis for the scenario planning is transparency across all procurement categories. The dependency on the region affected by the tsunami became clear to most procurement managers only as a result of the disaster, as they have told us. 2. Cross-functional teams Scenario planning by itself is not sufficient. Risk management is too complex and therefore cannot be done by employees of one or two functions in the company. The Croatian consumer goods company Atlantic Grupa has understood this fact and established a new and cross functional committee which regularly discusses the most engraving risks of the company. Part of the committee are represent-tatives of operations, marketing, procurement, finance and controlling. Besides existential de-cisions should not be done by employees of a low hierarchical level. There-fore the committee at Atlantic Grupa is solely consisting of managers of the top management; also the CEO is regularly participating.


significantly decreased. ‘Besides there is a precise code of behavior which is controlled for our em-ployees, customers and suppliers.’ CONCLUSION As our study demonstrates, risk management is an important and critical success factor of procurement – especially in times of high uncertainty and volatility. On the one hand risk management terminates the costs or the loss of market shares in case of a negative event. On the other hand smart acting market participants can benefit from the increasing uncertainty on procurement markets – whilst they take competitive advantage and market shares in times of crisis by smart risk management. _______________________ THORSTEN MAKOWSKI is managing director at the Berlin based consultancy Valueneer. As guest lecturer respectively adjunct faculty he teaches procurement at the University of Mannheim, the Vlerick Leuven Gent Management School, the S P Jain Center of Management in Singapore and the University of Cologne. FELIX PAPIER is professor for operations at the ESSEC Business School in Paris. FLORIAN WALTER is Senior Consultant at a leading management and technology consultancy.

3. Hedging Risks – especially those of currency exchange rates and raw material prices – can be mitigated with hedging and forward buying. However such a safeguarding is related to additional costs and effort. A positive example of our study is Evangelos Nestorides, head of procurement at Coca-Cola Nigeria. He decided to counteract on the currently highly volatile raw material prices with forward buying and hedging in order to being able to better calculate costs. This approach is continuously controlled in order to reduce forward buying and hedging in case of decreasing volatility whenever possible. 4. Integration of the customer An intelligent and market- oriented approach for risk management can be seen in the British head quarter of Fisher

Clinical Service, an international service provider for the healthcare and biotech industry. ‘In core of clinical business costs and risks are partly very high’ Helen Underwood, global director for customer management, explains. ’We develop tools for the client, in order to give the client the ability to understand which risks can occur and jointly develop scenarios how to counteract. 5. Corporate culture The company Clean Energy Fuels, biggest US supplier for liquid petroleum gas, has identified that unethical behavior as well as corruption are hazardous risks. The solution can be found in the own company, as Louis Cheung, global head of procurement, states. By establishing a fair and transparent corporate culture the misbehavior of suppliers has

THE WRONG EXECUTIVES

What our study also revealedIn our broad study a great number of aspects of procurement management have been analyzed – also including personal questions. That is: Which attribute of the chief procurement officer stands for the best performance in procurement? As our study indicates the total procurement performance is correlated to the leadership abilities of the head of procurement. More surprising is the fact that, of all facts, the one type is typically chosen which does not achieve the best performance.

Who are the best procurement officers?The best chief procurement officers are quiet young, highly motivated, energetic and creative. However companies prefer to fill a vacancy with older, more experienced, popular and team oriented executives. These on average have a worse procurement performance than their younger colleagues.

Most successful are those chief procurement officers who have worked one’s way up in the same procurement department into their current position. Although only 28 per cent of the questioned persons have worked inside procurement of the same company before they got into their current position, these are the ones achieving the best performance. Less advisable is to headhunt externals from other companies or employees from other departments of the same company. 30 per cent of the chief procurement officers have not worked in procurement before. Not surprisingly among the participants these are the ones with the lowest procurement performance. There are no significant differences in performance between men and women. Anyway only elven per cent of the top procurement executives are women.

April 2010 Translated from German - Original article in Harvard Business Manager Page | 8

Is your procurement department working perfectly? And did you use the financial crisis to reduce procurement costs? If you can not answer initially with ‘yes’ you are as good as or let’s say it directly in bad company with numerous companies worldwide. As our global procurement study has shown, most companies missed levering additional potentials to reduce costs within the financial crisis. But even today the supply management can still be set up to be fit for future. How this works out, which trends shapeprocurement and what the best companies are doing right will be shown on the following pages. For this study we analysed 790 companies from 62 countries. More than 800 chief procurement officers, CEOs and other top management executives answered our questionnaire and make this study the biggest study ever conducted for procurement worldwide. We collected the data from September 2009 till January 2010. Companies like Coca-Cola, Siemens and Unilever are as well represented as small and medium sized companies. This study was supported by the international chamber of commerce (ICC Germany), the most important German Chambers of Commerce Abroad around the world, the Federation of German Wholesale and Foreign Trade, the Austrian Association of Material Supply, Procurement and Logistics and the Lorange Institute of Business.

Missed chancesIn many companies procurement is responsible for by far the largest amount of total costs. Therefore it can not be explained why top management executives and scientists are hardly interested in this part of business. Less than ever if you take into consideration the additional cost reduction

SAVING WITH PROCUREMENTPROCUREMENT: Within the financial crisis many companies did not exploit additional saving potentials. A large-scale study shows how you still even today can reduce costs without effects on security of supply.

From Dr. Thorsten Makowski and Florian Walter

potentials that came up due to thefinancial crisis. But only few companies are able to take the unique chance. Thereby costs saving potentials within the crisis are – besides the common potentials – on average about 4 per cent. The estimation is based on the indications of procurement managers and CEOs that we questioned for our study. Companies can realise cost reductions not only as a result of declined raw material prices. They also have a higher bargaining power as a result of the financial crisis. But it seems that they are not willing to invest in the additional workload for tendering which would be necessary. In fact companies were only able to realise 1% point of the additional saving potential within the crisis – only a quarter of the total potential. Energy supply companies are giving away the most money. They have an additional potential for cost reduction of considerable 6 per cent but they do realise 1% only. Companies of the FMCG industry do know better how to realise the upcoming potential: based on a good performance – especially through renegotiation of prices and a professional tendering management – they have recently spend almost 2% points less for procurement (total potential of 4 per cent). The biggest strategic mistake is done by those companies which try to reduce costs in procurement by saving

personnel costs. Almost half of the analysed companies did a temporary reduction of working hours; 17 per cent even downsize procurement personnel. These are the absolutely wrong actions. The financial crisis would have given the chance to bring down prices based on tendering and renegotiation of contracts. But therefore qualified and strategi-cally thinking procurement personnel are necessary. Of course it does make sense to arrange an extension of the time for payment with your suppliers in difficult times. This was the case for 50 per cent of the questioned companies. As this most common measure can be done with a simple phone call it can however only be an additional action. It is a major omission that companies only did additional tendering for 5 per cent of the total procurement volume.

Dr. Thorsten Makowski([email protected]) is Director at the Berlin-based consultancy VALUENEER. Besides that he is senior lecturer for supply chain management at the university cologne and for logistics, international production and global sourcing at the International Business School (IBS) Lippstadt.

Florian Walter([email protected]) is management consultant at VALUENEER.


Where is the strategy?

For day-to-day operations the procurement department of most companies is well positioned. But in strategic functions of procurement there is a totally different situation. A percentage of 20-25 per cent of working time for strategic tasks is seen as optimal. As we found out regularly only 12 per cent of the working time accounts for strategic tasks. The reason is a too high focus on security of supply while financial aspects often miss out. Typical procurement personnel get feedback from production every day. Are parts missing? Is the delivered quantity sufficient? Mostly they received feedback for their savings only once a year. Thus it is no wonder that requests of production often overlay financial aspects. Procurement departments do rarely and little tendering. In 50 per cent of the tenders only two to four suppliers take part in the tendering. And in even 20 per cent there is not any new supplier – what makes

the tendering no longer a tendering as such. Main reasons for this failure are too few and poorly qualified procurement personnel. About one third of the companies have job vacancies in procurement as they do not find adequate applicants with negotiation skills and international experience. Only 23 per cent of the procurement managers are satisfiedwith the qualification of their personnel; 52 per cent complain about too few procurement personnel.

Where to source from?

Global Sourcing, the worldwide supply of raw material and goods, also offers unexploited potentials. According to the procurement managers about 2 per cent of the costs could be saved if they would focus more on foreign suppliers.Surprisingly German and European managers do not see China or India as the sourcing market with the highest increase. For them it is Eastern Europe: 60 per cent of the companies are thinking of sourcing

their material from Poland,Russia or Hungary (currently 34 per cent). Although costs are a bit higher than in Asia in most cases east European suppliers are of better quality, there are less cultural differences and also the lower transportation costs make Eastern Europe an attractive sourcing market for German-based companies. In contrast sourcing markets in Western Europe (today: 76 per cent; 48 per cent in future) and North America become less important. While weighing all the relevant criteria an increased sourcing from Eastern Europe seems to be the most efficient solution.If you plan your sourcing strategy you also have to take into account possible changes in price. The financial crisis accounted for lower prices –procurement managers estimated the decrease with an average of 4 per cent – but they expect a slight increase of prices within the next two to three years. 71 per cent of the companies want


to counteract by negotiating longterm contracts with their suppliers. Only one third of the participants states that they are in the position to pass increased material prices on to their customers.

Who is performing best?In our study we also examined the question what separates companies with the best procurement performance worldwide from those which are only average. We identified four decisive criteria: branch, size of company, location and organisational responsibility. The procurement performance was measured based on 141 questions regarding strategy, saving potentials and incentives. (For a quick audit of your procurement performance we have summarized the five most important questions at the top of this page)Branch. Obviously companies with a very good procurement performance can be found in those sectors where procurement accounts for a high percentage of total costs. Best performing is the trade sector (procurement costs of about 60 to 70 per cent) followed by consumer goods and the automotive sector.

The tail-light for procurement performance is the finance sector where procurement is not part of the core business (procurement costs of 10 to 15 per cent). Transport and traffic sector and chemical, pharmaceutical and health care industry are only slightly better.Revenue class. Large-sized enterprises have a more professional procurement department and therefore a better procurement performance. The procurement performance of enterprises with a turnover of more than 100 million euro is above average whereby affiliated groups are only a bit better than medium-sized companies. Enterprises with a turnover of less than 100 million euro are in our study averaged with a “poor” to “very poor” procurement performance.Location. In our study India can be seen as role model of procurement. Based on the high qualification level of the procurement personnel only Indian companies achieve the predicate “good”. India is followed by companies from German-speaking countries that only achieve the predicate “average”, closely followed by companies from North America, remaining Western

Europe, China and Africa.Organisational responsibility.Which member of the executive board should be responsible for the procurement department? The COO (Chief Operating Officer), the CFO (Chief Financial Officer) or possibly the CEO (Chief Executive Officer)? Our research came to a clear result. The best performance can be found in companies where procurement reports directly to the CFO. Interestingly this is the most unpopular organisational line up for procurement managers. Anyway it achieves the highest savings as the CFO is in general focusing on cost discipline. The performance for a CEO lined procurement department is only slightly lower. Nevertheless both variants are chosen only in about a quarter of the companies. Most common – in every second company – procurement is reporting to the COO. Anabsolutely wrong decision as the performance for COO lined procurement is far worse (rated ‘poor’ to ‘very poor’).


This can be explained by the origin of the procurement manager who himself in many cases was part of the operations department before. The result: COO and CPO are to strongly focusing on operative purchasing – security of supply and product quality – and therefore not able to use all strategic resources for possible cost reductions.

How you improve your procurement performanceBased on our questionnaire we tested 187 hypotheses on their relevance for an excellent procurement performance. Hence we identified the five most important criteria that make companies succeed in procurement. Some examples will show what these best practices are about.

1. Set up a procurement strategy that is clearly defined, communicated and effectively appliedAlready on the homepage of the Swiss automotive technology producer Georg Fischer the procurement philosophy is clearly communicated. Suppliers are able to inform about what is expected from them, which products and services are needed and they get the responsible contact person. Already in 2004 the company based in Schaffhausen defined a clear procurement strategy as 70 per cent of the turnover account for procurement. To reduce material costs and to ensure the security of supply the company established a category management, strengthened strategic procurement, qualified their procurement personnel and invested in supplier development. Not only the management is familiar with the importance of procurement, also the procurement personnel are reminded of its importance continuously.

2. Ability to exploit saving potentials very quickly At the beginning of 2009 the mechanical engineering company MTU Friedrichshafen, a subsidiary

of the Tognum-group got to work on its suppliers: a short term screening of the suppliers was done to analyse which suppliers had a significant contribution to cost reductions in the past. Those who obviously had room for improvement were contacted in order to make a lump-sum contribution for the improvement of earnings. Also cash discount and payment targets were analysed. Although the method was very labour-intensive the Tognum-group achieved significant improvements.

3. Incentivise procurement manager and procurement personnelFor David Valentine, Vice President Global Procurement at the major online job board Monster Worldwide it was always clear: Achieving procurement cost reductions is only possible if the team members are getting a variable bonus based on their monetary success – just like seller’s commission. Therefore he determined that 20% of his own bonus structure will be based on the ability to meet or exceed an annual financial target of cost reductions. Also the bonuses of the regional procurement managers are based on defined cost reduction targets. To focus procurement personnel on the best price-performance ratio and not only on material prices the cost reduction targets are only a part of the financial targets.

4. Make procurement have a high standing within the companyAt the Berlin site of the Canadian rail manufacturer Bombardier procurement is playing a central role within the company. André Navarri, President of Bombardier, is leading the monthly procurement committee where also other departments like engineering and operations participate. Within this committee the departments decide cross-functional and cross-divisional strategic initiatives to force cost reductions programs of procurement.

5. Apply at least 20% of procurement resources for strategic tasksAbout one third of the procurement personnel at Knorr-Bremse in Munich, leading manufacturer of braking systems for rail and commercial vehicles, account for strategic tasks and is mainly responsible for tendering and searching of new suppliers. ‘We do not really have more procurement personnel than other companies’, Stephen Bradley, Vice President Purchasing, indicates. Instead the department is continuously focusing on optimisation and automation of operational procurement processes. This safes time that can be used for strategic issues. Thereby the company is making sure that there is a clear separation of operational and strategic procurement personnel. Otherwise, so Bradley’s apprehension, operational tasks would overlay the strategic tasks as they are of a higher urgency.

Conclusion

The procurement cost reduction potential has not yet been exploited by most companies. But as our study proves and best-practices show, a change is not connected to high efforts. Especially the organisational lining of procurement at the CFO and the stronger focus on strategic tasks are necessary to make procurement become more professional and efficient –without any reduction of staff or other painful cutbacks.

THE NEW MAGIC WORD IN PROCUREMENT

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