The Procurement Value Proposition: The Rise of Supply Management – Chapter 1

Chapter 1: What is Contemporary Procurement?

 

Overview

Procurement began with various dubious roots. In the late 1980s, one of the co-authors regularly attended purchasing conferences at an organization known as the National Association of Purchasing Management.[1] The meetings served largely as a social function for a lot of buyers to get together, sit at the bar and tell war stories. Someone listening in on these conversations was likely to hear people discuss how they had ‘got a great price’ from a supplier, after they ‘threatened to go with someone else’, followed by guffaws and other discussions. Many of the buyers who attended these conferences had been promoted as a result of working in a warehouse, in an administrative assistant role, or even as an assembly-line worker. If one were to attend a supply management conference today, one would meet a very different type of individual, and engage in a very different set of conversations.

This chapter traces the development of purchasing from a principally administrative, tactical service within companies to a managerial, strategic, value-adding function and introduces the implications of supply chain management for purchasing.

[1]Today that organization is known as the Institute for Supply Management.

The emergence of procurement as a profession

Modern societies have for some time articulated the division of expert labour into various ‘professions’. These professions – of which medicine, accountancy and law are obvious examples – are found, on analysis, to meet certain common criteria. It is generally accepted that there are seven criteria that need to be satisfied in order to describe an activity as a profession. The first six of these are:

  • The members of the profession are engaged in the performance of a service, which is vital to society.

  • Their performance is based on a specialized and codified body of knowledge.

  • Those who enter the profession must first undergo a programme of broad general education as well as further education and training for a career in the speciality.

  • Candidates for the profession undergo an examination to test their qualifications to enter the practice.

  • The profession promulgates a code of ethical conduct for members and makes arrangements to enforce compliance to this code.

  • The profession offers a secure career to its members.

The seventh relates to a licence to practise. Whilst the first six criteria can be satisfied by the existence of organizations such as the Chartered Institute of Purchasing and Supply (CIPS) – who provide for all six points through their charter and via their standards, qualifications and certifications – it is the seventh criterion that remains to be achieved. In the United States, the Institute for Supply Management (ISM) has a similar focus on engaging in all of the first six elements, but not the seventh.

That said, at no time in its 80 years has CIPS or its members seen so many opportunities for creativity and leadership via professional procurement. Doubtless this will apply to ISM in the United States and NEVI and others in Europe. Some of these opportunities can be seized and realized by individuals, but more usually they require a team effort under some professional sponsorship.

For a body of specialists to be accepted as professional requires that they meet their obligations to society at large with respect to that specialty. No one wants to become a professional through self-appointment. The deep-down satisfaction comes when others regard one as having earned the status of professional through one’s deeds.

Within the terms of the criteria outlined above, one can decide whether a case can be made for professionalism in procurement. However, while procurement has undoubtedly come a long way – and paraprofessional it may be – it still has far to go if it wishes to be seen in the same light as medicine or the law.

The emergence of procurement as an academic discipline

 

When compared with other business and management professions such as marketing, finance or human resource managementprocurement is relatively new. Whilst the origin of supply management is closely linked with the birth of the company itself, it was viewed by academe as being oflittle interest as it appeared to require little or no skill.

Supply chain management (SCM) as a concept was born at the beginning of the 1980s. At that time research and teaching in the field was almost non-existent. Some of the early academic programmes in supply management were created by Hal Fearon at Michigan State University and Arizona State University, where these early programmes were called ‘Materials Management‘. Both of these universities also created executive programmes in this area.

In the period 1992–99, a group of like-minded academics at Michigan State University created an initiative called the Global Procurement Benchmarking Initiative, and created a series of studies that focused on leading procurement practices.[2] These technical reports were largely focused on documenting what organizations were doing, and classifying these strategies into basicmoderately advanced and most advanced. Out of these early studies were derived many of the maturity models that formed the basis for procurement consultancies at Accenture, AT Kearney, IBM, McKinsey, Booz & Co and others.

Since the mid-1990s, the growth of both teaching and research has been exponential. In 2014 SCM is making the change from being an emerging research field to becoming a consolidated one. The importance of an academic perspective on SCM and, more to the point, the role ofprocurement within it, is that it ensures that any possible gaps between research and practice can be minimized.

The 1970s saw the publication of the first real textbooks on procurementthe most notable being England (1970), Lee and Dobler (1971) and Baily and Farmer (1977). From a pedagogic perspective, these can be seen as the foundation stones of procurement as an academic subject, which in itself affords the subject the gravitas required for a ‘profession’ to be taken seriously.

By the 1980s and early 1990s books and articles were published that really sought to promote procurement as an important business function and therefore as a worthwhile academic field of study. In particular, writers across Europe and North America argued for the position and status ofprocurement as a function, rather than a service, within organizations and that it should be elevated in status accordingly.

 

It is in no small part that this lack of academic credibility of procurement and supply management until relatively recently reaffirms that its practise for some considerable time had been little more than a clerical service, focused predominantly on obtaining the lowest possible prices for goods and carrying out low-level, mundane tasks such as record keeping. Today, more than 50 universities in the United States and more than a dozen in the UK have supply management curriculums.

[2]This group included Robert Monczka, Robert Handfield, Ken Petersen, Gary Ragatz and David Frayer.

Early developments towards modern procurement

Around the same time as procurement began to evolve as a field of academic study in the late 1980s and early 1990s companies had embarked on changes in industrial organization, in particular the advent of ‘outsourcing’. Businesses began moving non-core competencies and other activities that they previously performed in-house to third-party service providers in an effort to reduce cost. This trend had major implications for procurement because it meant that strategically important resources or complementary competencies had to be sourced – and purchased – from specialized suppliers.

As the business landscape began to change so did inter-company relationships, principally due to globalization and rapid developments in new information technologies; and with this change came the need for the proper management of the supply side. Consequently, the position and status of the procurement function within organizations was elevated again. People developed various maturity models, with some portraying procurement as a reactive, passive and tactical service, whilst others portrayed it as an advanced, integrative, strategic function.

Procurement becomes supply (chain) management

Peter Kraljic’s publication in the Harvard Business Review in 1983, ‘Purchasing must become supply management’, was pivotal in the rise of procurement from a tactical service to a strategic business function. His key message was that procurement should focus more on high-value and high-risk supply items and that these called for ‘supply management’ rather than ‘purchasing management’. This is a theme that has since been the subject of much debate and, in some parts of the world, most notably North America, procurement is now frequently referred to as supply management or simply ‘supply’.

The rise of supply chain management is in many ways a natural extension of this development. Adding the word ‘chain’ to ‘supply management’ may seem trivial but is, in fact, significant. The inclusion of the concept of chain hints at the multidisciplinary genesis of supply chain management, most notably the inclusion of concepts such as Porter’s value chain (strategic management) and channel management (marketing and distribution).[3]

As procurement metamorphosed into a professional function, it became more deeply involved with changes in industrial organization. The introduction of ‘outsourcing’ of non-core competencies and other activities formerly performed in-house is possibly the most prominent. This trend towards outsourcing has accelerated; since the mid-2000s or so outsourcing has been an integral part of globalization as companies have looked to low-cost countries for cheaper sourcing. Outsourcing reflects a deep trend; moreover, outsourcing is part of a wider change process of industrial reorganization in which companies focus on what they do best and connect to the rest through a network of business relationships.

Technological innovation is now happening at such a rapid pace that companies can no longer do everything in-house. Today businesses have little choice but to outsource, principally because the most critical resources are intangible and knowledge-based.

Procurement becomes supply (chain) management

Peter Kraljic’s publication in the Harvard Business Review in 1983, ‘Purchasing must become supply management’, was pivotal in the rise of procurement from a tactical service to a strategic business function. His key message was that procurement should focus more on high-value and high-risk supply items and that these called for ‘supply management’ rather than ‘purchasing management’. This is a theme that has since been the subject of much debate and, in some parts of the world, most notably North America, procurement is now frequently referred to as supply management or simply ‘supply’.

The rise of supply chain management is in many ways a natural extension of this development. Adding the word ‘chain’ to ‘supply management’ may seem trivial but is, in fact, significant. The inclusion of the concept of chain hints at the multidisciplinary genesis of supply chain management, most notably the inclusion of concepts such as Porter’s value chain (strategic management) and channel management (marketing and distribution).[3]

As procurement metamorphosed into a professional function, it became more deeply involved with changes in industrial organization. The introduction of ‘outsourcing’ of non-core competencies and other activities formerly performed in-house is possibly the most prominent. This trend towards outsourcing has accelerated; since the mid-2000s or so outsourcing has been an integral part of globalization as companies have looked to low-cost countries for cheaper sourcing. Outsourcing reflects a deep trend; moreover, outsourcing is part of a wider change process of industrial reorganization in which companies focus on what they do best and connect to the rest through a network of business relationships.

Technological innovation is now happening at such a rapid pace that companies can no longer do everything in-house. Today businesses have little choice but to outsource, principally because the most critical resources are intangible and knowledge-based.

The dawn of the modern era: procurement as an enabler and value adder

What is without question is the fact that today many organizations see their supply function as a key driver of competitive advantage. Procurement is at the heart of supply chain management, but SCM shifts the focus from direct relationships between buyers and suppliers towards entire end-to-end supply chains. In many organizations procurement is now an integral part of the supply (chain) management function, focused on the management of the part of the upstream, supplier-focused supply chain (sourcing).

Whereas the focus of procurement is clearly on supplier relationships, the focus of supply chain management is on the wider business system that includes several layers, or tiers, of suppliers, sub-suppliers, customers, distributors and so on. In some ways supply chain management has absorbed a number of business functions involved in the process of supply, including procurement, operations, logistics and distribution management.

In 2014 the proportion of value across many industrial sectors that stems from the supply chain is almost 80 per cent and in many companies the outsourcing ratio can be greater than 90 per cent. The consequence of the outsourcing trend is that companies become heavily dependent on theperformance of their suppliers and therefore need to make sure that suppliers are effectively managed, as if they were an extended part of their own company.

As a central function to working with suppliers, procurement plays a key role in the management of supplier relationships. This role is not only a matter of cost reduction, although saving money remains a priority for any procurement organization, but it is also about ensuring that the need for a range of criteria – including for example quality, delivery, innovation and service – are being met by suppliers.

Moreover the changes witnessed since the mid-1980s have brought a new complexity. The need to procure complex performance requires not only deep collaborative relationships with suppliers, often spanning multiple decades, but also an understanding of how complex outcomes are articulated over time through a combination of contractual incentives and collaborative relationships, requiring new skills and competencies from procurement people.

It is against this backdrop that the elevation of purchasing – from a passive low-level organizational service to a strategic function with corporate visibility and influence – needs to be understood. The rise of the executive board position of the chief procurement officer (CPO) is symptomatic ofthis trend. Companies are increasingly realizing the importance of improving their knowledge and competence in procurement. They realize that they need to start filling this knowledge gap and to develop fundamentally new ways of thinking about procurement and its potential contribution in order to ensure sustained competitive advantage in an increasingly competitive global business landscape.

Purchasing’s legacy

It is worth reflecting again on where procurement has come from and what the procurement ‘industry’ at large comprises. Many people still think that procurement, rather like buying or purchasing, is nothing more than some form of professional ‘shopping’. This view could not be further from the truth. Procurement has many components: for example, the main types of spend that naturally require different responses. In Table 1.1 the three principal types of spend – direct procurement, indirect procurement (which includes the procurement of goods not for resale) and retail or goods for sale – have been outlined and set against the variables, which help to differentiate the role of procurement in each.

Table 1.1: The three principal spend types in modern procurement
 Open table as spreadsheet

Spend Type

Variables

Indirect Spend

Direct Spend

Retail Spend

Number of suppliers

High

Low

Medium

Value of transactions made

Low

High

High

Number of transactions made

High

Low

Low

Number of stakeholders

High

Low

Low

Does procurement own the spend?

No

Occasionally

Yes

Number of requisitions made

High

Low

Low

Business focus/drivers

Operationalizing the business

TCO

Gross margin

Potential for unauthorized spend

Yes

No

No

Number of spend categories

High

Low

Medium

Procurement‘s focus

Internal: stakeholders External: supply market

Supply market

Supply market

Source of value

Changing internal behaviours

Supply market

Supply market

What is clear from Table 1.1 is that procurement is much more than a simple transaction process between buyer and seller. In fact, procurement does not own the internal stakeholders’ budgets. As can be seen, in many cases procurement will not ‘own’ spend at all. Nor does it run thebusiness unit/function it is procuring for. More often than not, the primary role of procurement is to provide stakeholders with fact-based proposals on how to better manage their spend based on reality, procurement‘s expertise and the good practice methods their professionalism brings.

In fact, procurement is often seen as the poor relation of other business functions and, when it comes to those in indirect procurement, something of an even lesser status. This is partly because procurement is a prisoner of its heritage. As has been outlined above, procurement is in its relative infancy, and as yet has not reached intellectual maturity. Journal articles and books on procurement were rare prior to the 1980s and, as a consequence, there was little to promote procurement as an important business function and therefore as a worthwhile academic field ofstudy.

However, there is an immediate need for businesses to view procurement differently. Those who are already enlightened recognize that it is the essential activity that enables a business to run. Furthermore, the hubris over what is ‘best-in-class’, and who we can benchmark ourselves against to see if we are too, is as pointless as it is misguided. Today it is far more realistic for businesses to understand what is needed for them as a distinct and individual organization.

As has already been noted, until relatively recently the position and status of procurement as a function, rather than a service, within organizations endorses that its practise in the eyes of many was and is little more than a clerical service, focused predominantly on obtaining the lowest possible prices for goods and carrying out low-level, mundane tasks. This has meant that procurement has remained ill-positioned in many businesses; that it has for many years remained unappreciated and its true value has remained unrecognized. This low status has blighted thereputation and attractiveness of procurement and, as a result, as a profession of choice it fails to attract the best talent.

Compounding this lack of clarity of what a procurement organization should look like is the constant change going on in the world we live and work in. As will be seen later in the book, this change is panoptic – none of us is immune – whether it be due to technological advances or the impacts of globalization. As a result, the pressures on procurement are increasing and frequently as we will see that these pressures are conflicting.

Towards procurement‘s value proposition

The ultimate measure of procurement‘s value will be its ability to support the company’s overall business strategy. This will require some procurement organizations to make far more than incremental changes. There will need to be a change in procurement‘s priorities from cost reduction/avoidance only to proactively expanding the scope of its spend influence in order to ensure that a company-wide good-practices-driven procurement process is in operation.

Unquestionably, the goal of raising procurement‘s spend influence indicates that many procurement groups, having reached the upper limit of cost reductions possible within their current remit, are looking to take on new spend categories in an effort to unearth additional savings and further demonstrate their value to the business.

The aspiration of procurement to expand its influence is not a new one. In fact it is the root of the deepest frustration amongst most CPOs and their teams; and whilst leading-edge businesses no longer treat procurement as intermittent in nature but rather as part of the natural business cycle, there are many more that do not. These organizations still see procurement as tactical or low-level work.

To address this misconception let us reflect on an explanation of why procurement is strategic – one that was given in a presentation made in 2008 by Rob Morgan, CEO of Morgan Smith Ltd, who suggested the simple equation below as a way of articulating procurement‘s valueproposition to business:

Image from book

What this represents is that profit equals revenue minus costs divided by assets used. This very simple equation seems to encapsulate precisely how and why good professional procurement is critical to all businesses. However, the perennial debate regarding how procurement tangibly benefits the business continues to rumble on.

If one reflects on the above it makes perfect sense; it is quite simple really – if procurement impacts the profit-and-loss account (P&L) and the business’s cost of goods (COG) then it follows that it has a very real value to business and it demands that businesses realize that they need very good people working in their procurement organizations. In fact, if we reflect for a moment on the reach of people working in procurement today:

  • they operate globally;

  • they communicate and collaborate inside and outside of their business;

  • they have a direct (and often immediate) impact on the P&L;

  • many are fully responsible for the activities of the categories they manage and how they impact operational and/or capital expenditures;

  • they are increasingly expected to be ‘students of their industry’, because it is their understanding of the marketplace that businesses value most – deciding when to go to market to source a product or service is ultimately their responsibility.

The impact of this could be critical. These people are on the front line – a decision they make can swing a budget by £100 million. This is very important work, strategic in nature, which requires working with a wide range of stakeholders and also calls for an adjustment to the skill sets ofprocurement people – as not all of these skills are currently within procurement‘s areas of expertise.

Procurement‘s starting point is its ability to capture and understand the total volume of spending that falls under its purview. This sounds like an obvious statement, but in fact it is a mystery to many organizations. That’s right – many companies do not fully understand the full measure oftheir external spending, and cannot identify who they are spending their funds with. In the case study below, we look at one of the first companies to realize this, and how this led to the roots of what is now known as strategic category managementThe story also emphasizes how small the role of technology is in this effort. The individuals in this case study were using ‘green screen’ technology. Today’s technology certainly would have made their life easier – but it was the understanding and leadership in this case that made the difference for Ford Motor Company.

This story told by Steve Zimmer holds several key points that merit discussion:

  • Prior to launching any type of major procurement transformation initiative, there is a need to really understand the discipline of what you are buying. The discipline involves beginning to understand and build better data on what suppliers are doing, so that you can establish the right type of business driver you are asking them to deliver to!

  • Once you understand your buy, you can begin to organize it around similar categories of products and services, which then allows you to study the behaviours and markets for those categories. Conducting category analysis studies helps procurement executives to discover the cost drivers, and begin to establish ways to take out costs that cross multiple part numbers and purchases. For stampings, Ford used to get quotes on one part at a time, with no concept of ‘press loading’. They would bid and source only one part at a time! In such cases, the material cost doesn’t change, so the only advantage one can derive is to load the presses at a given supplier efficiently to drive the best productivity and reduce set-up costs.

  • Once you understand the variance in cost and productivity drivers, you can begin to understand risk. Supplier risk is a function not only of single sourcing situations, but also of the extent to which you are exposed in the tier 2 level of supply to material price variance. By looking at supplier volumes across categories, Steve could also see if they were giving too much business to one supplier given their capacity load. These types of thoughts on cost drivers and risk didn’t come from just the buying activity, but came from understanding thedata, differentiating the strategy and establishing the optimal approach to source each category.

A final thought: an important moment came when we asked Steve Zimmer about the importance of trust in supplier relationships. He thought a moment, and then responded: ‘I don’t like to use the word trust – I prefer the word expectation. Trust comes and goes, and there is a lot of variation in the way trust evolves across cultures. In the United States people will trust you early but be easily disappointed and not come back. In Europe they may not trust you at all, and only much later begin to approach something like trust. In other cultures in Asia, trust may never really occur.’ By really understanding what it is you are buying, you are able to set the expectation of the supplier that drives the relationship. Trust is a function of people meeting expectations, which in turn builds the relationship, not the other way around. You can look back at supplier relationships and you trust those that met the expectation and the commitment.

Conclusions

In this chapter we outlined the reasons why procurement is no longer simply an administrative or clerical responsibility, but a critical and strategic priority for companies. In particular, we emphasized the importance of the trend towards outsourcing: as companies have outsourced a high proportion of production and service activities, procurement plays a key role not only in cost reduction but also in value creation. In many companies the outsourcing ratio is around 70–80 per cent, in some cases even higher, so reducing purchase costs has a direct and significant impact on the bottom line.

Furthermore, by helping to ensure that product materials, ingredients or components, as well as services, are purchased at the right quality and the right time, procurement contributes significantly to the competitive advantage of the company. Ensuring that procurement makes such a contribution to the company requires an understanding of procurement as a strategic value-creating function and not simply a service whose sole aim is to save money.

Having touched on outsourcing and globalization as two of the issues that have brought procurement to the fore, there is a third issue: sustainability. This is a rapidly emerging concept with strong implications for procurement. In fact, the trend towards sustainability looks set to transform theways in which we think about, design and manage both procurement processes and supply chains.

It must be pointed out that sustainability refers to three dimensions: the social (people), environmental (planet) and economic (profit) – where profit is not made at the expense of people and/or the planet. The sustainability challenge is real: regardless of one’s personal feelings towards climate change, the planet’s resources are in decline, placing increasing pressures on companies to reduce carbon emissions, recycle or reuse, and to develop green technologies. Moreover, the current model of extensive reliance on global low-cost country sourcing is not sustainable, as demonstrated by frequent media reports.

In conclusion, it is interesting to note that when tackling three of the biggest issues confronting contemporary business, which have indeed brought procurement to the fore – outsourcing, the increased use of technology and globalization – many organizations have in their myopia simply succeeded in managing cost out of the company only to manage risk in. It is in light of this that we decided to embark on the undertaking to produce this book, which looks at procurement‘s journey and its current impact on business.