By
Professor Michael Mainelli and Haydn Jones
Published by www.shapingtomorrow.com, 12 pages.
At times, Procurement must be re-active, dealing with problems or opportunities as they arise, yet leading thinkers stress the importance of being pro-active, helping to shape the strategies of the organisation. A pro-active role means identifying, analysing and implementing solutions to problems and opportunities before they arise. How can these two roles be reconciled? What mechanisms can ensure that reactive and proactive roles support the business strategy? Does the current thinking around how Procurement operates provide us with the toolkit that we need to adequately support the business strategy ?
Everyone Loves Procurement
It would be a strange automotive company that said, “our business is automobiles, which are so important to us that we have centralised all decisions about automobiles”. It would be an equally strange company that said, “finance is so crucial to all our decisions that all financial decisions will be made by the finance unit”. So why is it that in an era where “people are our most important asset” and “everyone is in the people business” and “we need to empower our people”, we see Procurement units fighting the impossible battle of imposing centralized Procurement. Whether this relates to the direct Procurement functions found within manufacturing industries, or indirect Procurement functions found within services organizations, the centralization debate creates a potentially destructive tension that yields little.
Shouldn’t we ensure that every manager is equipped to use Procurement effectively in his or her contests, undertaken in such a way that they have the framework to be able to procure in a risk-controlled way on behalf of the organization? Shouldn’t Procurement units be fighting the corporate battle alongside their compatriots in the organization, like medics in the trenches within a medical corps, rather than far behind the battle lines in a quiet, rural hospital? Shouldn’t Procurement Professionals’ contributions be assessed by their fellow soldiers, not some four star general sitting comfortably back at corporate headquarters? Noble sentiments surely – but practical sentiments only if we can measure the value of Procurement in the trenches in a credible fashion that generates answers rather than questions.
David Hussey put forward eight Myths about Human Resources [Hussey, 1996]. As evidenced by ever-more-common, fond interpretations of the HR acronym, e.g. “Human Remains”, it is no surprise that David’s eighth, final Myth was: “Line management knows that HR is a valuable, value adding strategic partner which plays an irreplaceable role in the management of the organization.”
The following fictional, lunchtime conversation between an Operations Manager and a Procurement Professional could have been adapted to many head office functions:
Procurement Professional: “Oh, you might be interested to know we’re conducting a strategic review of the role of Procurement at head office.”
Operations Manager: (More head office S&M - scratching & manoeuvring – it’s always politics at HQ) “Isn’t that a bit like bringing coals to Newcastle?”
Procurement Professional: “Sort of. But there is a serious side to this. We’ve been asked to see if we can radically re-engineer and re-measure our unit. In my opinion, it’s a bit of a wasted exercise because we do so many different things within Procurement. Many of them take such a long time to come to fruition, but you know the routine.”
Operations Manager: (sounds like Hussey’s sixth Myth of HR – “…it is not possible to evaluate the results of many HR actions which should be treated as acts of faith”) “Sure, we’re constantly trying to re-engineer and measure what we do. Who kicked this review off ?”
Procurement Professional: “Oh, nobody in particular, we just think it’s a good idea to do this sort of thing periodically.”
Operations Manager: (What a porker, obviously someone on the board got wind of how large the unit has become) “Isn’t that non-executive director, Sam, always asking for re-engineering reviews?”
Procurement Professional: “Sure, he made a big fuss about how we’re always too busy in Procurement dealing with our problems to help in his reviews and how our procedures impede his ability to get things done. Even now he’s making a few suggestions to my boss, the Head of Procurement, about some of his wacky ideas, but he really doesn’t understand what we do. Anyway, this is mostly our review. In fact, my boss has arranged a brainstorming workshop for tomorrow where we’re going to focus on the question of where we add value to the corporation and report the results upstairs.”
Operations Manager: (What a good question - about time these folks faced our daily treadmill of finding ways to increase value) “By the way, who does your boss report to these days?”
Procurement Professional: “Well, the Chief Executive of course, but that too is part of the review. We do so much that is unappreciated by anyone but the Chief Executive, who has so little time. All of us in Procurement do a bit of work with most of the directors - finance, the various operations directors, international, marketing - because the Chief Executive often forces them to clear things with us before they can proceed. Most of the time we help directors to improve things. In fact, I even did a small study for the Chairman last year after the Chief Executive told the Chairman he needed to use us.”
Operations Manager: (Bet the Chairman was pleased - looks like they depend totally on the Chief Executive’s clout) “Does your boss get on well with the other directors?”
Procurement Professional: “Definitely. Well, except for Joan who heads up International. She complained that we stuck our noses in everything and were just lackeys for the CEO. I mean the rest of them understand that we need to give guidance on the big, holistic, long-term, overall picture, the total Weltanschauung, as we say in Procurement. It can take some time. The directors may not be our friends, but they know how useful we are and don’t mind waiting for our assessments. Just the other day, Suzanne, that special project director for Australasia, mentioned to the board that we should get involved in the feasibility study for Azerbaijan. It’s dragging and they need our input. Suzanne’s too tied up to help.”
Operations Manager: (Interfering busybodies with no friends whatsoever - not surprising without a power base or proof of value-added) “How do you even start to work out how many people you need to work with all these directors?”
Procurement Professional: “An excellent question. With so much going on we never have enough quality people. It’s been that way for years. Always too much to do - annual budgets, directors’ strategy weekends, corporate plans, annual appraisals, etc. Procurement touches every aspect of the business.”
Operations Manager: (Definitely over-staffed and over-nosy) “Getting back to this review, don’t you think it would be helpful if you could measure the value of what you contribute?”
Procurement Professional: “That’s not a bad thought. Although we’re not on the front line, we are absolutely essential. If we could measure our contribution credibly then some of these politically-inspired reviews (oops) might not get started. The last time we tried to measure the savings generated there was a big row about how we define the term ‘Cost Avoidance’. Only when Audit got involved did it become clear that our $430m annual saving was in actual fact something closer to $93m – this caused several senior red faces, not to mention a move to pastures green for my predecessor. It was also a bit embarrassing when our supposed cut from 45,000 suppliers to 300 turned out to be based on a faulty count in the first place. I have always maintained that you folks in Operations obsess about measures in order to give you the peace of mind that we are adding value. We’re very busy, so we don’t have the resources to trawl through our antiquated general ledger to get the data we need. This is hardly the right time to open up that can of political worms. Anyway, with the sheer variety of our projects I’m convinced it’s impossible to measure the value of what we provide.”
Operations Manager: (He doesn’t want to change - he hasn’t got a clue) “For what it’s worth, my tuppence of advice is ‘if you can’t measure it, you can’t manage it’. But enough business; what’s for lunch?”
Surely, ‘Tis Better To Proact Reactively than To React Proactively?
Of course both are better than splitting infinitives with To Reactively Proact or To Proactively React – but what do we mean? “Reactive” has become the ugly sister word to “Proactive”. At times, though, “reactive” is fine. Sometimes things just need to get done. Sometimes things are so uncertain that it can be better to do nothing, just react. Clearly, “proactive” implies that, in some way, we have control over our environment. While proactive seems desirable, it can be a dangerous illusion in a world where uncertainty reigns. Proactive projects have a tendency towards the grandiose – the Sorcerer’s Apprentice projects that we can’t remember why we began, but now can’t stop. On the other hand, just sitting back and “taking it as it comes” is to ignore the power of vision, commitment and organisation. When we look at linking Procurement to the business strategy, we must ensure that we include the reactive and the proactive – both roles have an important place.
Too frequently, Procurement units scurry about doing their master’s bidding, like a bunch of presidential aides who, being close to power, get carried away by the illusion of having power. If the Chief Executive asks them to do something, it must certainly be assumed worthwhile and in the best interests of the organisation. They rarely see themselves as others do. When times are good and the Chief Executive hobnobs with his or her fellow wizards in the boardrooms and dining salons of the corporate world, he or she adores the social cachet of phrases such as “I’ll have my Procurement bods look into that idea” or “With all the new e-sourcing ideas around, I keep my Procurement team busy just checking out all of the fringe opportunities”. When times are bad, Procurement units are just an expensive overhead. Procurement units are particularly expendable when their sponsor needs to show the ability to take cuts him- or her-self.
We must also not confuse being at the proactive phase with being proactive. To paraphrase Hussey’s second Myth: “if Procurement is allowed to be proactive when new corporate strategies are considered, this automatically means that all Procurement activities will become business driven.” Too often a proactive project or sub-project gets underway, but the bulk of Procurement continues plodding along in an unmeasured state. While operations managers who participate in the proactive, planning phase take responsibility for the outcomes, Procurement often settles for “facilitating and supporting the strategy”, “developing a sourcing sub-strategy” or other non-committal, non-measurable input.
What’s required is a structured programme that focuses on making sure that the right kind of controls are in place for each ‘cost-risk interface’ that exists for the suppliers that make your organisation tick. Such a programme should represent a portfolio of proactive well sponsored initiatives that embrace a broad range of areas that will add value, whilst leaving enough bandwidth for the reactive fire–fighting that will inevitably be required. But be careful; proactively contacting the Procurement guys the day before the contract needs to be signed and asking them to check it out is just plain dumb.
Strategic Hierarchies
Strategy and strategic planning are involved, and involving, subjects. This paper focuses on linking Procurement to the business strategy. It may be helpful to apply a simple, generic model of strategy to the remainder of the paper, five questions and a three phase planning cycle. The five basic strategic questions are:
The three cyclical phases of strategy are planning, implementing and evaluating. The frequency of this cycle is increasing in companies for a variety of reasons – a belief in an increasing rate of change, increasing uncertainty, changes in strategic fashion.
In the past, strategic planning retained an air or aloofness, even a touch of academia within the corporate world. Today strategic planning is seen as a key, but routine, function of the Board. The link between planning and Procurement is well-developed, particularly as boards have increased Procurement representation. This established link leads us to paraphrase Hussey’s first Myth, “if the top Procurement Manager is on the Board, this is enough to ensure that Procurement is business driven.” Below we examine alternative ways of implementing the next two phases of strategy – implementing and evaluating – although much could be written about Procurement and strategic planning.
A good place to start looking for alternative ways to implement and evaluate strategy is to consider four key reasons organisations do anything – it’s a money-maker; it’s politically expedient; it’s legally required; it’s essential - e.g., respectively, sales commissions, much public relations, most health&safety, toilet cleaning. Looking at Procurement, the last two reasons probably don’t feature in this discussion. Procurement is unlikely to be legally required soon. Without Procurement, firms hardly grind to a halt; managers go out and buy what they need. In fact, there are large numbers of successful, fast-growing organisations which shun all formal Procurement functions. So Procurement units need to bind themselves tightly to money-making or political expediency. Too often Procurement units choose political expediency. Yet can we find ways to link Procurement with money-making?
Perhaps a few detailed examples of how Procurement can help line managers make or save money may bring the measurement of effective Procurement to life:
No Guarantees – No Procurement Value
In the four examples above, Procurement has measured what it can do, measured what it did and shared the rewards with the operation it has helped. The list of possible measurables can continue, e.g. Procurement and an innovative recruitment method, Procurement finding and pre-qualifying suppliers in advance of direct business requests, Procurement indemnifying the organisation centrally that following proper procedures will lessen litigation, Procurement indemnifying a manager financially against late delivery or poor quality, Procurement taking responsibility for an annual survey of supplier opinion improvements. What makes measurement difficult in the above examples for some people is that the measures involve recognising risk. Further, risk in the above examples will be difficult to quantify in advance. On the other hand, while recognising that risk complicates measurement, the presence of risk does not invalidate measurement.
Before advancing with the discussion further, it is probably worthwhile to make some clear statements around the priorities facing the procurement function on a daily basis, which can broadly be summarised as follows:
1. To improve the quality of information in and around the procurement process in order to:
2. To reduce the cost of goods and services delivered to the organisation via the negotiation of new contracts or re-negotiation of existing contracts whilst ensuring that the respective quality of goods and services delivered is either maintained or improved;
3. To ensure that the organisation only makes use of preferred suppliers through:
4. To ensure that the two-way relationships that exist between supplier and client are governed by an effective contract and that the relationships are managed in accordance with the terms of that contract over its full term and supported by relevant objective data;
5. To reduce the cost and improve the efficiency of the entire purchasing process;
6. To ensure that the actual price charged by the supplier is equal to the contractual price as stipulated within the contract and that relevant volume discounts have been applied;
7. To ensure that relevant static data relating to vendors, approval processes, contract pricing etc., is correctly maintained.
Each of these are measurable and each of these help to reduce the level of risk in and around the procurement process. What is important to recognise is that it doesn’t necessarily have to be the Procurement function that undertakes these activities; the Procurement function just needs to make sure that they get done in the most efficient manner possible, and if that means that Procurement is actually undertaking them, then so be it. What’s at stake is making sure that points 1 to 7 happen day–to–day within the organisation, and that the organisation understands why they are required. People like to buy things, so let them buy things, but make sure that they have the toolkit to be able to do so is such a way that they can neither damage themselves or damage the organisation, and that the data exists to track what is happening. The more complex the category or contract, the more support that is required. Having a Procurement function that focuses the bulk of its time on the low value, non–critical categories will typically fail to generate the return for the investment that is made.
Recognising risk is the first step in being able to manage it effectively and this is where procurement functions really need to focus. Conventional approaches to managing the procurement function can broadly be divided into two; reactive, steady-state sourcing cycles coupled with ‘ad–hoc’ supplier relationship management versus consultancy driven ‘shake the place up a bit’ projects usually involving strategic sourcing, with potentially a technology or re–engineering twist to address the multitude of processes and systems that are intertwined with the procurement activities. The truth is that there is a symbiotic relationship between the former and the latter – procurement grows stale, the CEO bumps into an alumnus/alumna from his old consulting firm, they get talking and hey presto you have $5m sourcing programme. Within 3 years, the story repeats itself. Procurement functions seem to oscillate between these two extremes, never quite managing to break free. What is needed is a different approach that takes account of risk and peoples inherent desire to buy. To understand where the damage can be done by maverick buying, a clear analysis of the supplier risk that the organisation is exposed to on a daily basis needs to be developed. This can then be used to filter, channel and manage the buying activity in a controlled way.
Each contract is essentially a framework for managing a group of risks that suppliers and customers are exposed to. For the various risks that the supplier incurs, a premium is charged - this is overlaid onto the various range of fixed and variable costs that flow from supplier to customer. Suppliers exploit customers by charging for risks that the customers don’t understand. A deeper understanding of the risks that the supplier faces strengthens the negotiating position, and allows the risks to be priced correctly. The ideal contract is where the risks are fully understood and priced correctly - ‘the marginless contract’. As such, it may be possible to structure a price/risk profile for the supplier and overlay current pricing thus showing how far away the contract is from the optimal position. It may be possible to compare different risk profiles for different suppliers, and it may also be possible to combine the risk profiles of the suppliers so that your exposure to market place conditions remains flat. Adopting this approach would ultimately allow you to assess the services provided by each supplier relative to the risk profile of your own business - this raises the level of understanding of the issues/risks associated with particular suppliers, thus benefiting the Operations functions on the customer side. It stops the whole debate around cost being the only measure for procurement, and positions the subject in a more rational and objective context.
Risk management is a constant factor in managers’ lives, arguably the main reason why managers are employed and given responsibility for other people’s capital is to manage risk. Subjective measures of risk by managers can be used – much traditional insurance relies on subjective measures, “experience”, when statistically valid information is only partially available. A Procurement professional, as any professional, should be able to provide non-professionals with risk assessments and measurements, not just opinions.
There are a number of possible models for Procurement unit measurement. Few existing models put a strong emphasis on money, possibly because direct contribution to performance is a tough measure, as anyone who has set sales commissions knows. In practice, the first two of the following five models are common and they both typically result in a central, politically-driven Procurement function:
| Model | Measurement | Pros | Cons |
|---|---|---|---|
| 1. Cost-centre: Procurement is just a corporate overhead | largely political, possibly supplemented with customer satisfaction surveys or structured feedback | easy to do – the organisation subsidises all Procurement |
subject to all politics size set arbitrarily no power – decisions made politically |
| 2. Consultancy (profit centre): Procurement projects are costed as if done by an outside consultancy firm and possibly partially subsidized |
organisational units’ expenditure project appraisals customer satisfaction benchmarked against external consultants |
people may buy to get reinforced corporate knowledge simple measures – utilisation for instance size partially set by demand |
consultancy is not a core organisational competence people may be compelled by corporate policy to buy consultancy, or to buy at non-market rates difficult to remain an Procurement unit rather than a consultancy business why shouldn’t people buy from outside |
| 3. Value-added advisor: a sometimes used Procurement unit, typically for complex projects | measured on a portfolio sampling of projects and their relative success rates with and without group Procurement’s involvement |
unit size kept low identifiable specialist expertise |
self-selection of flattering projects or selective interpretation of “savings” too easy to avoid involvement in core organisational problems, e.g. improving customer service easy to become an internal Machiavelli |
| 4. Risk management unit: charges insurance premia (e.g. to business units, sites and projects) |
performance in managing group risk - ideally quantified benchmarks against other firms and insurers |
strong risk control with teeth helps key projects and units avoid major pitfalls spreads best practice will work throughout the organisation – not just for mega-decisions |
focused more on the negative rather than the positive a natural extension for finance and internal audit |
| 5. Risk/reward unit: combines capital charge and risk management |
as a venture capital fund merged with an insurer shareholder value enhancement |
strategic advice matters Procurement Professionals have controlled power looks at the totality of the opportunity or risk |
an emerging model complex measurement not a quick fix - need for management continuity |
The biggest transition in the above models is from the third to the fourth. The risk management unit model already exists in some large corporates and is naturally progressing to the risk/reward model. The risk management unit model does couple the Procurement unit with the business strategy and a key reason for existence - making money; the risk/reward model even more so. Risk/reward models are used in some of the larger multi-nationals, particularly those which have evolved structured finance operations yet realise the importance of implementing sound strategic thinking. Results have been largely positive, sometimes very positive. However, some hard-won lessons show that risk/reward models require sophisticated management, need a management team with a keen eye on increasing shareholder value and must be led by a politically-astute head who knows how to say “no” to other directors through ‘price’ mechanisms.
Ensuring the Strategy is Met
The risk/reward model began over 150 years ago as a mutual insurance model in a number of areas such as shipping, health and trade or as factory mutual insurers. Today most multi-nationals and many large corporates have established risk management units, often very insurance focused, running their own internal mutuals. Recently, some of the leading corporates have moved markedly from having the risk management unit handle commercially insurable risk, e.g. fire, theft, employer’s liability, to managing less quantifiable direct business risks as well, e.g. brand damage or contract delay. A very few have merged the risk management unit with the central capital allocation function to form risk/reward units which function as structured internal investors, fitting the management internal systems to the corporate strategy.
It is not all finance. One British corporate hands management of ISO9000 compliance to the risk management unit. As managers in the corporate need to ‘cut corners’ in ISO9000 to achieve their business targets, their ‘premia’ will rise and their ability to meet targets impacted appropriately – markedly for some, hardly at all for others. As managers fully comply with ISO9000, their premia will fall. The board sets an overall risk profile (e.g. loss of ISO9000 will cost us 3% to 6% loss in productivity, £3M in bad PR and 2% loss of turnover). The risk management unit distributes that risk around the organisation and reports back to the board, over time, on the accuracy of its distribution and assessments. Managers can make decisions about the balance of effort they put into all corporate initiatives, but have the consequences brought back to them in terms they understand – the bottom line on which they are measured. Mandatory corporate schemes attract suitably high premia, yet the corporate centre cannot over-apply ‘mandatory initiatives’ because the centre too can see the risk and cost effects.
Some generic thoughts on risk/reward management can be explored in Mainelli (1999). The key features of the Procurement risk/reward model are a central unit which:
Connecting Procurement to Corporate Strategy
Risk/reward models strongly connect Procurement with the corporate strategy. They also connect Procurement strategies, policies and procedures with line managers – uniting managers Procurement adherence and decisions with bottom-line results. Risk/reward models put Procurement managers in the front-line being measured with their fellow managers. The era of large corporate centres has gone. Organisations have moved to business models where the ‘system’ encourages appropriate behaviour in a unit, or the unit is eliminated. Procurement professionals need to encourage the formation of appropriate Procurement systems within the organisation that demonstrably link Procurement to business strategy – uniting Procurement with shareholder value. In summary, we believe that:
Procurement units will never have an easy ride. Few operational directors want anyone second-guessing their decisions. At the same time, few Procurement units want to spend their time devising unused procedures or exhausting strategies to justify other people’s gut feelings. Unless the Procurement unit wishes to remain the Chief Executive’s lapdog, it must stand up and state how it proposes to measure its own success in comparison with the rest of the organisation. Publicising a clear measure of success, and meeting it, attracts political power in its own right. If there is a corporate political strategy lesson for Procurement units, it must be to agree with the organisation a rigorous way of measuring their own contribution to corporate success. If there is a lesson for head office contemplating the future of Procurement, it must be to dispel a paraphrasing of Hussey’s fifth Myth, “Evaluation and performance measures are too difficult and expensive for Procurement activities, and Procurement does not need to be subject to such disciplines.”
[An edited version of this article first appeared as "Insuring Risks, Rewarding Procurement: Proactive and Reactive Link of Procurement to Business Strategy" on www.shapingtomorrow.com, (June 2005)]
References
David Hussey, Business Driven Human Resource Management. John Wiley & Sons, 1996 [enjoy Myths 3, 4 and 7].
Michael Mainelli, “Organisational Enhancement: Viable Risk Management Systems” (2 parts), Kluwer Handbook of Risk Management, Issues 27&28, pages 6-8/2-4, 16 April 1999, 12 May 1999, Kluwer Publishing
Professor Michael Mainelli, PhD FCCA FCMC MBCS CITP MSI, originally did aerospace and computing research followed by seven years as a partner in a large international accountancy practice before a spell as Corporate Development Director of Europe’s largest R&D organisation, the UK’s Defence Evaluation and Research Agency, and becoming a director of Z/Yen (Michael_Mainelli@zyen.com). Z/Yen was awarded a DTI Smart Award 2003 for its risk/reward prediction engine, PropheZy, while Michael was awarded IT Director of the Year 2004/2005 by the British Computer Society for Z/Yen’s work on PropheZy. Michael is Mercers’ School Memorial Professor of Commerce at Gresham College.
Michael’s humorous risk/reward management novel, “Clean Business Cuisine: Now and Z/Yen”, written with Ian Harris, was published in 2000; it was a Sunday Times Book of the Week; Accountancy Age described it as “surprisingly funny considering it is written by a couple of accountants”.
Z/Yen Limited is a risk/reward management firm helping organisations make better choices. Z/Yen undertakes strategy, finance, systems, marketing and intelligence projects in a wide variety of fields (www.zyen.com), such as developing an award-winning risk/reward prediction engine, helping a global charity win a good governance award or benchmarking transaction costs across global investment banks.
Haydn Jones is a consultant with A. T. Kearney, and a former regional Head of Procurement for a global investment bank.
A. T. Kearney is a strategic consulting firm that specialises in strategic sourcing. A. T. Kearney is one of the world's largest management consulting firms. With a global presence that includes more than 60 offices in 37 countries, spanning major and emerging markets, A.T. Kearney provides strategic, operational, organizational and technology consulting and executive search services to the world's leading companies. A.T. Kearney is the high-value management consulting subsidiary of global services leader EDS.