Ed Cross, Executive Director, Procurement Services, XchangingPrint This Page
As reported by Deloitte in its Q4 CFO Signals survey, improving finance’s ability to be an effective partner to business units continues as a top priority and challenge into 2013. Among
CFOs’ top worries is how to help facilitate growth through funding the development of innovative new products and services – both internal and external facing.
Translation: CFOs will continue to feel pressure to reduce costs and maximize available capital. This isn’t news by any means, but what is notable is that CFOs will continue to overlook procurement of “indirect” goods (those which make production of goods/services possible, but not raw materials) as an opportunity for material savings.
According to the Hackett Group, every dollar invested in the procurement function can yield up to three dollars in spend savings. Our customers who outsource or co-source the procurement function typically see between 10% and 15% savings. So why would a CFO overlook such an obvious, significant source for savings? The general perception is that, while such savings are achievable and traceable in the procurement of “direct” goods (those core to product/service delivery, e.g., raw materials), identifying and tracking those opportunities in indirect procurement is very difficult.
But it needn’t be.
Therein lays the value of the sourcing maturity model, a must-have for any CFO looking to pinpoint avenues for continuous savings. Examining the model and the characteristics of each level will help to analyze a company’s sourcing and procurement practices. Coupling this with an interview process of key players involved and spend analysis will help a CFO determine his or her company’s current maturity ranking.
Once it is determined where a company fits in on the ranking scale, the process of determining potential for savings becomes objective and fact-based, rather than based on gut feel and experience. This exercise matters because it can quickly and sustainably lead to new funds that can be spent on strategic, innovative projects.
In this two part series, I’ll first examine the ranking scale, and then look at the interview process, detailing who to talk to and what to ask to get the answers you need.
So let us begin with the attributes that are considered while making a determination of maturity. They can be broadly classified into:
Enterprise awareness is a measure of visibility that the C-suite has to the actions and successes in sourcing and procurement. In organizations on the lower end of the maturity model, the CFO’s office does not expect, nor examine, any savings from sourcing and procurement. In the best-in-class organizations, not only are targets set at a business unit and P&L level, but they are on the agenda of board meetings and quarterly earnings reports. You must have buy in at the top to achieve your goals.
The attributes that contribute to enterprise awareness are:
Spend under management: Determine whether your sourcing, contracting, buying and spend decision-making are influenced by procurement professionals. Compare that figure with how much of the enterprise spend gets penetrated through partnerships with business units and stakeholders.
Spend under management can range between 15% (on the lower end) to 85% on the highest end.
Linking of savings targets to business outcomes: Any savings achieved at the business unit or;
P&L level must translate into an increase in earnings-per-Share, operating profit and working capital of the organization.
Use of best practices: Of course, there are best practices in the industry on people, processes and technology but determine if your company is aware of these practices and if they are being implemented across the organization. You will be surprised at how often we see a major divide between awareness and actual implementation.
Visibility of Spend
This is about whether an organization is aware of how much they are spending; with whom are they spending; on what they are spending; who within the organization is spending; what opportunities exist to spend smarter; and how spending habits can be transformed. The four attributes that should be considered are:
Spend classification: Create a common taxonomy to use for classification of spend. Also, instill quality assurance processes and implement monthly checks to ensure the taxonomy is accurate and done as planned.
Spend analytics: It's imperative for your organization to study the classified spend and to run reports and analytics on it. In doing so, CFOs can track spend matrixes by source and commodity in order to find synergies and opportunities.
Supplier dynamics: Don’t miss opportunities to align strategic supplier engagements for harmonization and maximizing return on your contracts. Fragmentation between suppliers and buyers can lead to lower ROI.
Opportunity identification: Building from my first tip in this category, double check that your organization uses the intelligence gained from spend classification to identify savings opportunities.
Companies on the highest end of the maturity scale classify up to 95% of spend with 95% accuracy.
Closely related to spend visibility is the actual sourcing process, and companies should measure how sourcing professionals in a company provide services to stakeholders in various business units and their strategy for doing so.
The attributes that need to be considered for an effective evaluation of sourcing maturity are:
Category management: Overall, category management should be viewed holistically and from a long term perspective around annual planning or budgets. From there, your team can then break each project into a short term mode and make decisions with the bigger picture in mind.
Sourcing approach: Consider sourcing activities with respect to their relative merits on specific products or services. For example, if a category lends itself extremely well to a reverse auction, then that avenue should be explored with the stakeholders. Also, identify what percentage of addressable spend is sourced strategically through a competitive process and if that percentage can be increased.
Supplier selection: It is imperative to have a formal process for selecting a supplier i.e. long term view of suppliers, negotiation of rates, terms and conditions, to secure continuous improvement provisions in contracts.
Companies at the higher end of the ranking scale typically source between 70-80% of their spend through a competitive environment and even have advanced methodology for spot buys, low dollar spend and capital expenditure.
Post-Contract and Compliance
While sourcing process lays the foundation for negotiating favorable contracts that have the potential to deliver savings, it is what happens after contracting that is important in realizing the savings. There are various aspects to consider in this category:
Contract implementation and organization: Firstly, identify the average time needed to ramp up savings off of the contract, retaining and saving price lists, and store the contract in a searchable, indexed repository for easy retrieval.
Internal compliance: Educate your internal team on new contracts to combat against procurement outside of contract. To further facilitate compliance, implement requisition and purchase order processes.
Supplier Management: Create a formal process to manage suppliers and their compliance to pricing, services, delivery and warranties. Include the ability for your stakeholders and the consumer of services to rate and rank suppliers, qualitatively and quantitatively.
Companies that rank high in the maturity ranking scale have contract compliance rates upwards of 50%.
Procurement technology plays an important role in enabling all the factors described above. A good spend analysis tool can bring spend classification and accuracy to the 95% level. A robust sourcing tool can cut down the cycle time in sourcing by as much as 65% and reduce the cost of acquiring goods by up to 25% (Gartner). Such numbers prove that a procure-to-pay platform can bring about significant increases through contract compliance and invoice accuracy. By implementing the appropriate technology, it makes it easier for buyers and stakeholders to see the deals and make their purchase decision.
Innovation comes from great ideas but instituting these great ideas across an organization can cost money. And there are pockets of cost saving potential – the proceeds from which can ultimately fund these great ideas – hidden across every organization. Well-equipped Sourcing and Procurement functions can locate and pull these savings through to the bottom line – and feed the corporate innovation engine. In fact, according to the Hackett Group, every dollar invested in the procurement function can yield up to three dollars in spend savings.
In Part I of this discussion on maximizing procurement savings through “the sourcing maturity model”, I examined the attributes that are considered while making a determination of maturity on a business unit by business unit basis. In this post, I’ll discuss the process of interviewing individuals within the organization and what to ask to get the answers you need to determine the sourcing maturity level of each unit. From there, the process of determining potential for savings becomes objective and fact-based.
But how do you put the interview process, category managers, stakeholders, their stakeholders, spend data, contract data, vendor data, business unit initiatives and category initiatives all together?
Now, that we know a little more about the attributes that make up the maturity ranking, it is time to understand how one goes through the exercise of determining the maturity.
Who to interview
While the best group of people to interview would be the sourcing team in a company, because they are the ones responsible for strategic sourcing and category management, they are not the only group that can provide the answers. The stakeholder community that holds the spend budget and the purchasing department who are responsible for actual procurement are just as important.
There should be adequate representation from all the categories of indirect spend, as well as the business units that are the biggest contributors to the spend.
What to ask
This is a bottom up exercise, i.e. the maturity of an organization is determined through an aggregation of maturity rankings in different categories. So each category manager or stakeholder is asked questions pertaining to their category that will determine the ranking of that particular category.
Each of the attributes described earlier in my first post will be ranked based on answers to a number of questions pertaining to that category. For example, in order to determine sourcing maturity, interviewees will be asked a series of questions on how often competitive sourcing has been used for this category, whether savings targets have been defined in an annual planning process, etc. Each answer will be ranked on a scale of 1 to 5, 1 being the lowest.
In addition to questions on maturity attributes, there will be questions on addressability, recent contracts, openness of stakeholders to allow spend to be managed by a Co-Sourcing partner, supplier dynamics and preferential relationships with the supplier community.
Responses from various interviewees are analyzed and put through a weighting system that determines overall maturity of a category. Once category maturity is determined, the spend in each category is run through a model that takes the spend and maturity as input and determines the appropriate savings as an output. The model is based on the experience of the Co-Sourcing partner as well as industry benchmarks. The output is further adjusted for a number of factors, such as addressability, timing of contracts, supplier dynamics, etc.
The outcome of this entire exercise is a procurement map (see image below). The top half of the procurement map displays the spend of the company in a matrix of categories and sub categories on the top, with business units on the side. The middle section of the map displays the maturity index of the category, color coded
for visibility and easy understanding. The bottom section of the map provides high-level savings estimates for each category, adding up to a total opportunity analysis.
Ultimately, the value of an exercise like this is that it takes the guess work out of opportunity analysis and provides companies with tangible savings estimates. It adds a process of due diligence and the findings can be presented to senior executives as part of a business case for procurement. In addition to funding, the other required part of implementing corporate innovation is getting senior management sign off. The sourcing maturity model exercise – though a significant commitment – is handy for both.