How to Move Procurement to the Next Level

Procurement departments have been under the corporate Klieg lights recently as companies take stock of the supply continuity risks generated by the downturn and gyrating commodity markets. While those threats and the need for cost containment are paramount concerns, CFOs are increasingly looking for ways to gain competitive advantage from a function that influences anything from 40 percent to 80 percent of operating costs (see "Procurement's Time to Shine").

Few organizations have tapped into the full value of procurement. But investing in the function certainly pays off. Every dollar that a typical company ploughs into procurement yields three dollars in spend savings, according to Chris Sawchuck, procurement practice leader with The Hackett Group. Not bad. But procurement operations that Hackett identifies as world-class do much better, returning up to eight times the investment.

So how do you get to world class? Hackett has released its Procurement Capability Model, which describes the abilities that the function typically develops as it evolves. The model is designed to help finance and procurement pros understand the best practices that unfold along the maturity curve as they relate to people, processes, and technology. Imagine that your CEO asks you what procurement's current mission is, how the function will look five years from now, and what resources it will need to get there. The Procurement Capability Model can help you find the answers.

The model defines four stages of procurement capabilities:

1. Reactive. At its most basic level, procurement is about "getting stuff from the outside world into the business so that it can function -- the right goods, at the right time, at the right place," says Sawchuck. The focus on supply assurance and site-level sourcing, ordering, and expediting is typical of companies at the reactive capability level.

To move beyond this stage, companies need to shift their attention from efficiency to effectiveness. They should consider creating a strategic sourcing group separate from operational purchasing and sponsored by senior management.

2. Planned. As a procurement organization moves up the capability curve, it typically turns its attention to systematic cost reduction. To squeeze supplier margins, it may invest in e-sourcing tools and in efforts to improve employees' negotiation skills. It may progress to initiatives aimed at reducing the total cost of operations (TCO) by tackling, for example, logistical costs. Reducing TCO takes "a lot of analytical horsepower," Sawchuck notes; typical systems at this stage include cost modeling, contract management, and supplier management tools.

Improving alignment with the business's overarching strategies is the key challenge in moving from this level to the next. As procurement strives to become a more effective partner in the business, it should be looking to increase its contribution to M&A, sustainability initiatives, and product innovation.

3. Aligned. At this point, procurement organizations start to add demand management tactics to their repertoire. That may involve curbing or eliminating consumption -- travel restriction policies in tough times are a good example. Or, says Sawchuck, "instead of spending money on travel, you decide to spend it on videoconferencing -- that's shifting demand."

To do this right, procurement needs much deeper involvement with the planning and budgeting process. Indeed, according to Hackett's research, companies in which procurement has a high level of involvement in enterprise planning and budgeting achieve a higher return on assets and higher operating profit margins than organizations in which procurement's involvement is lower. "Companies expect procurement to understand the business and to understand finance if they're going to be much more involved in business processes," Sawchuck points out. "This is a great opportunity for businesses to open up the doors and bring these folks in."

To move beyond this stage, companies need to create a broader view of the external realities of the global supply market without losing sight of internal stakeholders' needs.

4. Strategic. The goal at the ultimate level of procurement capability is to maximize the value of spend and expand procurement's influence at the highest levels of decision-making. Success hinges on innovation and relationships with suppliers. While the relationship with some suppliers may be transactional -- you send me an invoice and I pay you -- in other cases, says Sawchuck, "You bring ideas to me and say, 'What if we did this instead?' And all of a sudden, procurement is leveraging the capabilities of its supply base. More than just getting better prices, you're bringing in ideas for new products, new packaging ... This is additional value that helps you increase market share and revenue."

More details on Hackett's Procurement Capability Model are available here (requires free registration).