The reinvention of procurement

18 Supply Chain Management Review • May/June 2016 scmr.com
Procurement is at an inflection point. For many leading companies,
procurement has been transformed into a linchpin of enterprise strategy. Yet
many remain trapped by outdated paradigms and struggle for influence within
their companies. Here’s how organizations can reinvent the procurement
function and put the past behind them.
OF PROCUREMENT
REINVENTION
THE
Jonathan Hughes is a
partner at Vantage Partners,
and the firm’s sourcing and
supply chain management
practice leader. He can
be reached at jhughes@
vantagepartners.com.
Danny Ertel is a partner
at Vantage Partners. He
can be reached at dertel@
vantagepartners.com.
By Jonathan Hughes and Danny Ertel
AT MANY LEADING COMPANIES, procurement has been transformed in pro-
found ways to become a linchpin of enterprise strategy. Meanwhile, many procure-
ment groups continue to struggle for influence within th ir companies—in large part
because they remain trapped by decades-old paradigms that are far too prevalent.
In this article, we will share what we have
learned during our work with leading procure-
ment organizations around the world as they
seek to adapt to a future that is already upon
them. In these organiza-
tions, the need to drive
innovation is paramount,
and an increasing propor-
tion of the opportunity
and risk with suppliers
involves not only physical
materials or equipment,
but also complex services
and intangible assets like
intellectual property, data
and brand equity. In that
new environment, the strategies and skills that
constituted a recipe for procurement success
in the past need to be reevaluated, and to some
extent upended, based on a 21st century world
with new risks, threats and opportunities.
A changing world and a changing context
In order to understand the future of procure-
ment, it is useful to briefly review its history
and evolution. For a very long time, procure-
ment was a back office function focused on
processing transactions. The selection of sup-
pliers, and the negotiation of supplier agree-
ments, was highly fragmented, unsystematic
and non-rigorous. That began to change in the
1990s with the advent of strategic sourcing.
Over the past several decades, this simple but
powerful discipline has delivered enormous
savings at countless companies, and earned
procurement groups a substantial degree of
respect and influence.
What is unacknowledged is the fact that stra-
tegic sourcing rests largely upon a set of concepts
and principles laid out by Peter Kraljic in his clas-
sic Harvard Business Review article “Purchasing
must become supply management”—which was
published in September 1983.
SUPPLY PROCUREMENT CONTRACTS MRO MANAGEMENT

scmr.com Supply Chain Management Review • May/June 2016 19
The article is full of many useful examples and case
studies that remain relevant, as do many of the principles
and methodologies of strategic sourcing that developed
later. At the outset of his article, for instance, Kraljic asks
how a company can “…guard against disastrous supply
interruptions and cope with the changing economics and
new opportunities brought on by new technologies? What
capabilities will a profitable international business need to
sustain itself in the face of strong protectionist pressures?
Almost every kind of manufacturer will have to answer
these questions.” Those questions remain top of mind to
business leaders who are grappling with disruptions from
natural disasters, rapidly changing technologies, the digiti-
zation of business and shifting geo-political alliances.
While the article remains an often quoted classic, there
is also much that is obsolete, and some that has become
counter-productive. For example, the word “innovation”
never appears in this article. What’s more, it viewed pro-
curement through the lens of a manufacturing economy;
indeed, all of Kraljic’s article focused on the procure-ment
of physical goods. Yet in 1984, services were already
approximately 55% of U.S. GDP; today the number is
approximately 70% (Figure 1). Here’s another important
statistic that procurement needs to understand and grapple
with. According to Leonard Nakamura, an economist at the
Federal Reserve Bank of Philadelphia, U.S. companies may
have intangible assets worth more than $8 trillion. That
figure is almost half of the $18 trillion market capi-
talization of the all the companies comprising the SP 500
index. Moreover, according to research conducted by
economist Carol Corrado and reported in the Wall Street
Journal, in 2014, companies invested the equivalent of 14%
of the private sector’s share of GDP in intangibles (such as
their brand and data assets) versus approximately 10% in
physical assets (such as factories).
Clearly, the world economy has changed, and procure-
ment needs to catch up—quickly.
The next wave of value
Procurement is, in many ways, a victim of its own success.
As recently as 10 years ago, there was significant value to
be gained by using competition to motivate better supplier
performance and to re-balance supplier profit margins and
customer costs. But rigorous and coordinated sourcing
has enabled companies to maximize purchasing leverage
based on their total spend. While there will always be some
suppliers with a high degree of pricing power because of a
unique technology or market position, today we find a co -
solidated supply base, operating with profit margins kept in
check by competitive pressure.
In other words, the low-hanging fruit has been picked.
So what will drive the next wave of value?
Fundamentally, we believe it is innovation—not just
in product design or manufacturing technology, but also
in business processes and models, and in the capture and
utilization of data and information. A critical function for
procurement in the future will be the capability to strike
the right strategic balance with different suppliers between
competitive pressure and associated uncertainty (which
helps guard against supplier complacency, but also acts as
FIGURE 1
Increase of services-producing
companies as a share of U.S. GDP
Source: U.S. Dept. of Commerce Bureau of Economic Analysis–
Gross-Domestic-Product-(GDP)-by-Industry Data; Gross Output
(http://www.bea.gov/industry/gdpbyind_data.htm)
80%
60%
40%
20%
0%
1965 1975 1985 1995 2005 2014
PercentageshareofGDP
Goods-producing
Services-producing

Reinventing procurement
power dynamics between a company and suppliers—and
thus encourages an unhelpful over-emphasis on “bar-
gaining power” and an under-emphasis on the power of
engaging suppliers in the joint exploration of ways to work
together that deliver mutual benefits. Or, as Kraljic put it:
“The purchasing portfolio matrix plots company buying
strength against the strengths of the supply market and can
be used to develop counterstrategies vis-à-vis key suppliers.”
Traditional ways of thinking about supply markets
and suppliers, rooted in an industrial past, also fail to
guide effective thinking about the fairly different risks
and opportunities that arise in working with suppliers of
services, and suppliers whose primary value derives from
their intangible assets.
Services, solutions and innovations
Procurement groups need a new framework for driving
additional value in different sourcing contexts, including
complex services such as legal services, marketing and
advertising, research, design and engineering and yes, even
management consulting. Such categories of spend used to
be off limits, but are now increasingly managed by leading
procurement organizations. Even in manufacturing con-
texts, companies increasingly rely on top suppliers to col-
laborate in early stages of new product design and develop-
ment. Such suppliers may make most of their money from
manufacturing parts, tools or equipment, but they also sup-
ply critical services on which their customers rely.
Sourcing services is different from sourcing physical
goods in a number of ways. For one, economies of scale do
not reduce unit costs in the same way as they do in a man-
ufacturing environment. For another, the profit drivers of
service supplier are different from those of manufacturers.
The primary asset of service suppliers is talent—people.
And “A-Team” talent is highly mobile—in a way that physi-
cal assets are not. Procurement needs to think differently
about leverage, risks, opportunities and value with suppli-
ers whose business depends in whole or in part on selling
services. Moreover, companies should often be sourcing
more than discrete products and services. They should be
sourcing solutions to important business needs. What do
we mean by this?
Consider an industrial company we worked with for
many years. For this company, the regular maintenance of
chemical manufacturing and storage tanks constituted a
major spend category. Historically, procurement sourced
a powerful disincentive to supplier investment), and deeper
collaboration and longer-term commitments to suppliers
(which act as a positive incentive to supplier investments).
In our experience, most companies need to re-balance
their strategic focus with more emphasis on supplier com-
mitment and joint investment. Companies are not simply
in competition for customers and revenue. They are also
in competition with one another for preferred access to
supplier innovation, ideas, “A-team” talent, and invest-
ment of various kinds. As firms in industries from semi-
conductors to bio-pharmaceuticals to financial services
recognize this fact, procurement is increasingly charged
with developing and implementing strategies to become a
“customer of choice.”
Drivers of past success will not drive future success
A service-oriented and innovation-powered economy
requires procurement to develop new strategies and com-
petencies. While still relevant, Kraljic’s original sourcing
matrix is no longer sufficient. It is implicitly based on
markets for physical goods and the traditional relation-
ship between supply, demand, power and pricing in such
markets. Of course, the physical economy and associated
supply chains still exist. Capacity constraints will continue
to arise in many markets and lead to cost increases and/or
supply shortages that lead to lost revenue.
Nonetheless, the traditional way of classifying catego-
ries of supply and suppliers focuses primarily on zero-sum
FIGURE 2
Effective sourcing of services,
solutions and innovation
Source: Jonathan Hughes and Danny Ertel
Sourcing
innovation
Value drivers of what
is being sourced
Key strategies
and skills required
• Creative ideas
• Risk taking
• New investment
• Joint problem solving
and co-creation
• Learning from failure
Sourcing
solutions
• Communicate context
• Apples to oranges
comparison
Sourcing
services
• People
• Talent management
systems
• Creative payment
and incentive
structures
Sourcing
goods
• Process
• Scale
• Prior capital investment
• Tight specifications
• Competitive pressure
• Knowledge and expertise
• Ability to integrate
assets and capabilities

specific services including the set up of scaffolding fo
maintenance workers, a number of specific cleaning an
maintenance services and, when the job was complete, the
breakdown of and removal of the scaffolding. What hap-
pened when the company looked at what they needed to
source in a different way? They ran a sourcing initiative
without traditional requirements. Instead, they shared infor-
mation they had never shared before with potential suppliers
under a non-disclosure agreement (NDA) about their busi-
ness model, manufacturing processes, production schedules
and bottlenecks. They then asked their suppliers for new
and better ways to maximize production up-time and reduce
operating costs. What happened when they did this?
Most suppliers offered proposals and bids similar to
those they had provided in the past. But one supplier noted
that they were prototyping a new portable elevator system
that might eliminate the need for scaffolding set-up and
break down. The supplier’s bid was more expensive than
its conventional competitors—but it reduced maintenance
and lost production time from weeks to days. The increase
in revenue from more up time made up for the increased
cost many times over.
Of course, as companies seek revenue and profit
growth in a hyper-competitive global economy, a further
mental shift toward sourcing innovation is required. In this
realm, customers may not even be aware of the needs or
opportunities relative to which suppliers may have new
technology under development, new ideas or untapped
expertise. Procurement thus needs to engage with suppliers
in completely different ways. They need to encourage and
reward supplier investment and innovation—and ensure a
disproportionate share of that comes to them versus their
competitors. Traditional RFX and bidding processes will
not go away, but they need to be augmented with greatly
enhanced “upstream” engagement with key suppliers.
Such engagement may take many forms, including not
only joint ideation sessions with suppliers, but also regu-
lar joint strategic business planning—during which a cus-
tomer and its key suppliers exchange information about
their respective strategies, business plans and technology
road maps, looking many years into the future. Customers
who do this well will gain disproportionate influence ove
supplier investments, and the innovations that results.
Suppliers will benefit from more information to guid
their investments such that risks are reduced and time to
revenue is accelerated.
Figure 2 is by no means exhaustive, nor are the value
drivers, nor are the strategies and skills for each context
mutually exclusive. Nonetheless, this framework high-
lights some of the critical ways in which the effective
sourcing of services, solutions and innovation differs from
the sourcing of physical goods.
The questions we ask determine our answers
In our work with procurement organizations across a range
of industries, we have observed that most are guided by a
set of fundamental questions, often to a degree they are
not consciously aware of.
• How do we extract more savings from our suppliers?
• How do we motivate suppliers to improve their
performance?
• How do we get internal stakeholders to involve us ear-
lier, and comply with sourcing strategies, policies and
decisions?
• How do we define supplier requirements in a way tha
enables us to conduct “apples-to-apples” comparisons
across suppliers and maximize competitive leverage?
• How do we get more innovation from suppliers?
There is nothing wrong with these questions. But as
with any questions, they focus attention in certain ways,
and reflect and reinforce assumptions that can be limiting.
In any event, new solutions to business challenges and the
identification and realization of new value will not come
from asking the same questions. Below are a fundamentally
FIGURE 3
Procurement paradigms
Traditional
procurement paradigm
• Primary value is cost reduction
and securing external supply of
goods and services
• Primary value is solving
business problems and
delivering competitive advantage
• Competitive pressure and leverage
over suppliers is key to value
• Collaboration with suppliers
and balanced dependence is
key to value
• Internal focus is on stake-
holder compliance
• Internal focus is on being a
trusted advisor to the business
• Manage transactions • Manage relationships
• Analytical skills • Business acumen and soft skills
• Own and execute • Facilitate and enable
New
procurement paradigm

Reinventing procurement
different set of questions. They are not meant to replace
the questions above, but rather to augment them and
expand the scope of solutions and opportunities that pro-
curement can uncover and address.
• How do our suppliers make money?
• What do we do that creates cost, risk or frustration for
our suppliers? How do we inhibit their ability to deliver
maximum value to us?
• How can we better support the goals and strategies of our
internal business partners? How can we more effectively
challenge their assumptions and thinking, while also
remaining open to learning from them?
• How can we help our suppliers better understand the
challenges and opportunities our business faces, so that
they can propose solutions based on their unique exper-
tise and capabilities?
• How do we create more innovation with our suppliers?
A new procurement paradigm
Sitting at the intersection of a company and its external
suppliers, procurement can play a unique role in leveraging
supplier assets and capabilities to drive innovation, actively
support revenue growth and deliver competitive advan-
tage—all while minimizing risk to a company’s operations
and reputation.
In other words, procurement can—and must—focus
on maximizing total value from suppliers. This requires
a new procurement paradigm (Figure 3), or a revolu-
tion in the way procurement leaders and their teams see
themselves and their role, the value they can add to their
enterprise, and the ways in which they deliver value to
the enterprise.
New metrics and KPIs for procurement
Currently, most procurement organizations focus primar-
ily on a limited set of metrics and performance indica-
tors—with cost-related metrics foremost amongst these.
They also typically rely heavily on supplier spend levels to
segment suppliers, and to make decisions about where and
how to focus limited resources on supplier management.
To be successful in the future, procurement organizations
will need to learn from current leaders and expand what
they measure to better align with an expanded focus and
delivery of broader value.
For example, levels of spend (within a commodity or
category, or with an individual supplier) are often a poor
proxy for the strategic importance of that category or sup-
plier. Often a more useful metric is “revenue-at-risk”—a
more complex but also more meaningful calculation
that links external expenditures to the customer revenue
streams that depend on supplier inputs, whether those are
materials, equipment or services.
Similarly, the current emphasis on cost-savings should
be expanded with broader measures of value delivered—by
suppliers and by procurement. For example, a few years
ago we worked with a consumer products company that
was in the process of designing a new product. Based on
extensive research, the marketing organization believed
that a more expensive packaging would be highly valued by
consumers, which would lead to greater sales and higher
profit margins. Rather than fight a battle to select the l -
est cost supplier, procurement partnered with marketing
and product designers to select a supplier that had the
expertise to help design and manufacture a unique packag-
ing solution. (Incidentally, this was not the supplier that
the marketing group had initially wanted to work with.)
The result was a substantial cost increase—but one that
paid off in expanded market share, increased revenue and
higher margins.
Companies put significant emphasis on measurin
their return on assets and invested capital—naturally,
because the shareholders that provide them with invest-
ment capital care about these metrics. But we now live
in the world of the extended enterprise, where a major-
ity of what goes into the products of most companies is
manufactured, and often designed, by or with external
suppliers; where an increasing percentage of a company’s
operations are outsourced and/or enabled by third-party
solutions and services; and where a company’s RD
Commitmentto
stakeholdersuccess
FIGURE 4
Ways procurement can engage
with internal stakeholders
Expertise, initiative and assertiveness
HighLow
High
Dead-weight Rival
Order-taker Trusted advisor

investments and patent portfolio are usually dwarfed by
the combination of innovation investments and assets of
its top suppliers. Consider that Unilever reported a few
years ago that 70% of its innovations came from suppli-
ers. World-class procurement organizations will therefore
increasingly measure and report the returns they realize
from supplier assets (RoSA), and the extent to which
they are commanding and benefiting from a dispropo -
tionate share of supplier investment and innovation
vis-à-vis their competitors.
New competencies for procurement
The transactional and routine activities (from PO pro-
cessing to market analysis) that used to be procurement’s
focus are increasingly being automated or outsourced.
What remains, as we have argued above, is for procure-
ment to take on an increasingly strategic role within the
enterprise. This entails developing the competencies that
are most difficult to replace with software, and taking o
a role that is so closely integrated with a company’s core
competencies and sources of strategic advantage that it
cannot be outsourced.
Based on our benchmarking and work with clients,
there are three broad competencies that procurement
organizations generally need to strengthen. The first is
business acumen. Analytical skills to calculate total cost
of ownership or develop should-cost targets are valuable,
but they are far less valuable than the ability to think like
a business owner or executive, to understand the very dif-
ferent business models of different suppliers and how they
make money (even when those suppliers operate in the
same industry) and based on that, to determine how best
to design an engagement model with a given supplier and
construct contract terms as well as informal incentives to
motivate that supplier to deliver maximum value.
The second competency is strategy development and
strategic thinking. What passes for a category or com-
modity “strategy” within many procurement organizations
would often be better termed a category “profile”—a
often impressively researched and formatted report of
past and projected spend, information about the supply
market and the classification of spend or suppliers int
segments like “strategic” or “bottleneck.” Such analysis
is useful, but it is not a strategy—a long-term plan that
articulates important choices and explains why difficul
choices and trade-offs must be made, and how.
For example, if our company is highly dependent on a
particular supplier, and our business is not particularly
important to them, what should we do? Invest in devel-
oping one or more alternate suppliers? Or invest in try-
ing to make our business more attractive to our current
supplier—and if so, how? Framing such choices and
rigorously articulating the costs, risk and benefits of di -
ferent choices (under conditions of uncertainty) is the
hallmark of true strategic thinking.
The third area of competence that is increasingly
important, and often deficient, is that of soft skills
including: relationship building, influence, confli
management, negotiation, change management and
leadership. For example, not too many years ago, procure-
ment groups looking for negotiation training were often
interested in the latest bargaining tactics and techniques.
More recently, we have seen an increasing interest in
building skills for a more strategic approach to negotia-
tion focused on principled persuasion and joint problem
solving, while also accounting for the psychological and
emotional dimensions of negotiation.
Another example: We have seen a huge upsurge in
requests for training focused on stakeholder engage-
ment, alignment, influence and how to become a truste
advisor to internal business partners (Figure 4). This is
a welcome change from a not too distant past in which
many procurement organizations were focused on obtain-
ing C-level mandates that they could use as a cudgel to
enforce compliance from recalcitrant stakeholders.
A procurement road map to the future
Different industry sectors confront different procurement
and supply management issues, and the pressures to bring
procurement practices up to date with the realities of an
innovation-driven and increasingly service-oriented econo-
my will likewise vary. Nonetheless, we believe that almost
any procurement organization that seeks to maximize the
financial and strategic value it delivers to the enterprise
must evolve and mature.
As we noted at the outset: Procurement is at an
inflection point. Those organizations that evolve along
maturity model will drive innovation, deliver value and
enable their enterprises’ strategies. Those that remain
trapped by old paradigms will continue to struggle in a
21st century world with new risks and threats, and miss
out on new opportunities. jjj

The reinvention of procurement

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