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Re-inventing
Direct Procurement
by Pierre Mitchell
Chief Research Officer, Spend Matters
Re-inventing Direct Procurement | © Spend Matters. All rights reserved. 2 of 23
Introduction 3
Looking Forward 21
Appendix—Study Demographics 22
About E2open 23
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Introduction
The quest for innovation and global growth is leading to an increasingly
multi-channel, micro-segmented, localized and customer-focused value chain that
can only be supported by an agile and resilient “virtually integrated” extended
supply chain. So, the ideal management of the multi-tier chain of supply in value
chains must optimally provision and orchestrate internal and external partner
resources alike – which of course is no easy task! So who should be the lead
orchestrator in end-to-end supply management activities?
In 1983, McKinsey & Co. consultant Peter Kraljic published a seminal paper positing
that “purchasing must become supply management,” and that procurement
organizations must elevate their roles to manage the supply base more methodically
and strategically (e.g., using the famous complexity vs. impact matrix to segment
supply markets and associated supply management processes). Back then,
purchasing in the supply chain was primarily a back office role where buyer
planners helped launch, communicate, and expedite purchase orders.
Fast-forward to today, 30 years later, and things have certainly progressed. Most
procurement groups (supported by a bevy of consultants) have both formalized
and centralized their strategies and processes, with particular focus on strategic
sourcing methodologies to help “rightsize” the supply base. But, has procurement
become a truly strategic supply management transformation agent that helps
lead the redesign and orchestration of multi-tier supply beyond its primary role as
negotiator, cost cutter, contract manager, etc.?
In this report, we will highlight how and where direct procurement organizations
are exerting their influence and leadership (or not) on the broader extended supply
chain. We will also examine the impact on performance, and specifically how more
advanced organizations are implementing 11 key supply management activities that
transcend traditional direct procurement (see Fig 4).
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Study Approach: Defining the Capabilities that Matter and Learning from Leaders
For the quantitative aspect of the study, we divided the study population into two groups. The first
was a “top capability” group containing the top quartile firms based on their average capability score
across the 11 evaluated capability areas shown in Fig 4 (see pg. 10). The ‘peer’ group was the rest of
the study population. We wanted to see if the “top capability” firms had higher performance than
the other firms. To ascertain performance, we had respondents self-assess themselves on nine supply
performance KPIs relative to their industry peers. Similar to the ‘top capability’ approach, we created
a “top performer” group for the top quartile performers on an evenly weighted scorecard for the
performance metrics shown in Fig 3.
Fig 3—Higher capability firms enjoy higher supply performance (25% on average)
The bottom line is that these capabilities matter, and they have an impact on performance (to the
tune of a 25% advantage, shown in Fig 3). The next part of the study analysis focuses on how
these capabilities are implemented, and this is where we’ll augment the quantitative results with the
qualitative lessons learned based on primary qualitative interviews and additional secondary research.
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We also conducted over a dozen interviews with supply leaders at some of the
world’s most advanced manufacturers for their candid off-the-record insights.
It’s not surprising to see cost reduction and supply assurance at the top of
procurement’s list, and it is encouraging to see a deeper focus on strategic
partner collaboration.
In the supply chain, strategic partners can include ODMs (original design
manufacturers), CMs (contract manufacturers), 3PL (3rd party logistics) firms, BPO
(business process outsourcing) firms, information/technology providers, and others.
These external partners are not just suppliers to source and monitor. They are also
extensions of the firm that can help satisfy the broader supply chain objectives such
as innovation, M&A, and sustainability. But this can only happen if they are properly
utilized and best practices are aggressively adopted!
This is where procurement has an opportunity to expand its role from the input
cost reduction owner to being an advocate for improving broader supply outcomes.
Procurement must influence internal and external supply chain partners to improve
the collective supply capabilities of all process participants.
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Transformation and leadership requires influence. Dale Carnegie sold a lot of books
on this topic (75 years ago!). But being a high quality influence is just as relevant
as ever, especially in supply-side processes where single accountability is murky.
For procurement, standard benchmarks for direct spend influence hover around
90%, so things look great, right? But this spend influence is typically defined as
“procurement being involved during the sourcing process.”
What about all the other processes in the inbound supply chain? What type of
influence is exerted there?
We asked this question and found that although a slight majority of procurement
organizations owned the sourcing process, a minority of firms could say the same in
over a dozen other key process areas (Fig 2).
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Fig 2—Beyond sourcing, procurement has a relatively low level of influence and responsibility
for broader supply management processes
Even with “managing the matrix” as part of process leadership, few firms allow
procurement to drive key processes such as strategic third-party management/
innovation, inventory/supply planning, and more. Worse still, 30-50% of these firms
have no real procurement participation at all. Whether procurement hasn’t been
invited (or hasn’t delivered), this is clearly a problem.
So, let’s begin to unpack this problem and see how others are solving it. More
specifically, we will evaluate how those with the most advanced capabilities and the
highest supply performance are building the specific capabilities in the processes
above—and in the individual capabilities spelled out in Fig 4 (see pg. 10).
II. Design for Supply. Designing products and services to systematically tap
supply (internal or external) market power for the purposes of innovation, reduced
costs, sustainability, or customer satisfaction.
3. Innovation support (early supplier involvement; make vs. buy; crowdsourcing;
etc.)
4. Multi-tier cost modeling, forecasting, and intelligence
III. Designing the Supply Network. Designing and re-designing the extended
supply network to optimally position supply resources (inventory, tooling, logistics
assets, labor, etc.—whether internal or external) to meet multiple concurrent
objectives from diverse stakeholder segments.
5. Supply base segmentation to drive category management,
supplier management, risk/regulatory, etc.
6. Multi-tier raw material inventory positioning (including at suppliers)
7. ‘Tax-advantaged’ supply strategies
IV. Planning and executing supply against demand within the network.
Optimally matching supply to demand within the current supply network while
providing feedback to strategic supply processes for needed changes.
8. Translation of S&OP to a multi-tier collaborative supply plan
9. Dynamic supply allocations based on supplier rebates, penalties, capacity,
lead times, etc.
10. Performing “buy-sell” to buy on behalf of smaller suppliers
11. VMI support (JIT Warehouses, inventory visibility, etc.)
We asked study participants the extent by which they had adopted these 11
capabilities. They are shown below in Fig 4 for both the “top performer group” (i.e.,
the top quartile performers on the performance criteria shown in Fig 3) and the rest
of the study population.
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Fig 4—Top [quartile] performers have higher capability levels than peers;
capability levels still vary widely
It should be apparent that as the capabilities get more complex (from “basic”
supply base segmentation analysis at the top, down to “buy-sell” support and tax
sheltering, practiced by larger international manufacturers) the level of adoption
drops off and varies quite a bit within each.
also in ensuring that the proper governance structures are in place (e.g., a
cross-functional supply risk council) and that measurement systems are aligned
from supply chain performance to spend/supply category performance to supplier
performance—even down to a purchased SKU level.
Some of these groups may be part of a separate profit center, and even a
separate fiscal entity (e.g., located in a tax advantaged country). But even without
this governance structure, procurement can merely use a well-run supplier
management approach to coordinate the priorities, projects, and capabilities of
different internal groups (risk, EH&S, quality, IT, engineering, logistics, etc.), helping
to drive them into the extended inbound supply chain in a coordinated way.
Case Study— HP’s PPS (Printing conflict minerals, etc.) and a deeper push
into western China.
and Personal Systems) business
unit is a good example of such Although the tier 1 supplier network has been
massively rationalized, it now creates the
cross-functional integration. challenge of orchestrating an equally massive
tier 2 and tier 3 supplier network to support
HP’s corporate head of direct procurement
the different “supply chain pipes” (click here
reports to the head of operations for PPS (who
for a description of these that include the Value
also serves as global CPO).
Added Pipe, the Low Touch Pipe and the No
Touch Pipe), or the proverbial “supply chains
HP is very advanced, but since 2009, PPS has
within a supply chain.” These can change within
used its “Supply Chain Optimization” approach
a product lifecycle and also be driven back to a
to align procurement with logistics and the rest
tier 2 component level.
of the multi-tier network with a combination
of improved processes and tools that not only
Luckily, HP has a strong competency in
reduced supply network complexity by nearly
managing a multi-tier supply network
one-quarter and direct suppliers by almost
with its buy-sell process (that we’ll touch on
50% (down to just over 1,000 for over $40B in
later).
spend!), but also supported other objectives such
as HP’s focus on supplier and environmental
responsibility (carbon emissions, workers rights,
After the recession of the late 2000s, supply One firm that has successfully addressed this
risk management was a very popular corporate problem is a telecommunications equipment
program to identify potential supplier failures, manufacturer (see case study on page 17)
and also natural disaster risk and other threats that set up an agility program for certain tier 2
to supply lines. Risk types were defined, components that are ‘risky’ and in need of agility.
“heat maps” generated, gaps identified, and This is defined by the parts needing shorter
remediation steps executed—down to the lead times and/or higher upside capacity to help
location and even part level. mitigate the risk of demand side volatility relative
to customer services levels and corresponding
But, risk is not a one-time phenomenon, and it’s impact on product revenue/profitability.
not limited to tier 1 suppliers. Many research
studies have shown that tier 2 supply is one of We will dive into some of these details shortly,
the biggest problems, and many manufacturers but the basic lesson here is that procurement
are trying to focus on supply chain ‘agility’ and is applying a more sophisticated segmentation
‘resiliency’ as a more systematic approach to (similar to the Krajlic 2x2 matrix discussed
dealing with supply volatility and risk. This is not earlier) to not just tier 2 supply, but also
a one-time supply risk project. into ongoing supply planning and supplier
contracting (e.g., upside flexibility) and
Rather, it needs to be systematically “baked” into collaboration (e.g., lead time reduction, VMI
other supply-side processes such as extended planning).
supply network design, buy-sell, supply planning,
and contract management.
Study Respondent: “Make sure that your risk mitigation plans are current!”
Study Respondent: “Start early. Inject yourself into the process at the earliest
possible time with sales and engineering. The more you know sooner, the sooner you
can engage the supply base.”
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For procurement, this is not just about being involved from the phase-gate
development process and then sourcing components from a single tier BOM (Bill
of Material) to existing suppliers on the approved vendor list. Developing strategic
supplier relationships AND supply market intelligence is critical to wring the most
innovation and value from supply markets. It’s the difference between being an
innovation-centric “gate opener” rather than just a compliance-centric “gatekeeper.”
• Senior executive support to set up the resources and processes for externalizing
such innovation. P&G’s Connect & Develop program is an obvious example,
but there are dozens of others: open innovation events, supplier innovation
centers, supplier study groups, co-location/rotation of staff, joint technology
roadmapping, etc.
• Strategic SRM programs that segment the truly strategic suppliers as customers
of choice, allowing deep collaboration on revenue uplift programs, cost
reduction projects, value analysis/engineering, and any types of joint capability
development.
• Pre-M&A work to identify innovative and game-changing suppliers. We
interviewed a Life Sciences manufacturer who called this “Invent to Order.” They
supported a key business strategy of embedding new technology into a ‘system’
that would essentially ‘give away’ the customized device to make money on the
consumables over the product lifecycle.
Cost management is decidedly unsexy, but critical as a core competency for any
manufacturer. If you believe that all supply is in scope for supply management
(i.e., an internal manufacturing plant is evaluated like a supplier—just as a key
supplier’s factory might need to be managed with similar rigor as an internal one),
then product cost management will primarily be about supply cost management.
Therefore, procurement will have a key role to play.
This doesn’t mean procurement does the activities alone. Rather, it helps build
an organizational capability to perform cost management—such as during the
design process. A “design for cost” process is a critical capability that is often
associated with a “Design for Manufacturability & Assembly” (DFMA) methodology
that helps ensure that a product design can be executed, either internally or
at a supplier’s factory.
The same is true for the design of the supply chain itself. It must be advanced, but
it must be executable with the right resources: people, tools, management support,
etc. This is the subject of our next capability area.
HP is a great example to revert to. The company was very successful with
its “Design for Supply Chain” efforts in the mid 2000’s, but also with
its “Buy-Sell” capability. Buy-Sell has allowed HP to design a supply chain that
is heavily outsourced to ODMs and CMs, but they still retain supplier control
and collaboration with the tier 2 and tier 3 suppliers.
HP has been deliberate and adamant about retaining key engineering and
manufacturing staff (augmented by third parties) in core processes/technologies,
having them work alongside procurement and other supply chain staff to
continually and cross-functionally optimize the extended inbound supply chain.
Most people know the Buy-Sell program for how HP uses buying power to
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negotiate with tier 2 suppliers, and then uses ‘price masking’ to keep favorable
pricing proprietary (so CMs/ODMs/competitors can’t lean on suppliers to demand
comparable pricing—and reduce HP’s advantage3).
3
This multi-tier procurement model is
also popular with major automotive
and A&D OEMs who buy metal on But there’s more to this story. Although most companies don’t have HP’s buying
behalf of their suppliers. Honda
Trading of America sources 60-70% power, some of this model can still be emulated. But it requires appropriate
of its steel, aluminum, and plastics technology to orchestrate. It’s not just a simple drop-ship process, but rather
purchases on behalf of its supplier.
Similarly, ‘supply chain finance’ a multi-tier execution run in conjunction with a VMI hub (a ‘J IT warehouse’ that
programs use a large buyer’s low replenishes the CM/ODM sites). The P2P process for direct materials is not a
cost of capital to lower the trade
credit rates for suppliers (and get simplistic Req-to-Pay process like that found in many indirect spend categories. It’s
some gain sharing too). P&G’s a complex inbound supply chain execution process. Without the ability to execute,
recent program around this is
featured here. the best sourcing and planning activities are for naught.
Beyond Buy-Sell, there are many other examples of capturing more of value by
designing a multi-tier supply network. Before sharing some, it is important to clarify
what we mean by “supply network design 2.0” and how it differs from the traditional
notion of supply network design. The latter has historically focused on using
high-level ‘steady-state’ optimization modeling tools to re-jigger plants and
warehouses within a firm’s internal supply chain. In contrast, advanced firms mix
and match the following elements of the network design, driving them upstream
into the multi-tier network:
business to regulators.
• Designing flexibility into the network through alternate parts, dual sourcing,
multi-tier/region buffer stocks, alternate tooling, contingency plans/playbooks,
product/platform redesign, lead time reduction, financial hedging, and
other methods.
• Segmenting the supply base on multiple dimensions (spend category, supplier
type, risk type, customer/demand type, geography, compliance requirements,
etc.) to “rightsize the processes” appropriately for each segment rather than
using a one-size-fits-all approach.
Once the supply network is generally implemented, you can move toward some of
the progressive techniques to match supply to demand and then execute on the
promised commitments.
• What if the firm uses contract manufacturers? How can this information be
passed on to tier 2 suppliers? How do we share requirements through multi-tier
BOMs and routings?
• If demand is coming from several different upstream channels, is it wise to lump
all the requirements together as a dampened consensus demand signal to feed
further upstream (and to merely size the inventory buffers to hopefully absorb
fluctuations that inevitably show up)?
• What if some form of supply allocation rules that transcend simplistic fixed
percentages for allocating supply to different suppliers are necessary?
• How do we reflect reality with the supply plan in factoring in contractual
requirements with suppliers, such as penalties or rebates?
• How can we get early commitments from suppliers to ensure they can execute,
especially if there’s a demand spike (rather than only finding out when the PO
drops, or worse yet, when materials don’t show up)?
• What if forecasted supplier price increases are on the horizon when a contract
renews or price escalators take effect? How will that feed back into the plan,
especially if eroded product margins will change demand itself?
• Similarly, how do we deal with end-of-life issues when it’s necessary to run out
raw material existing stock (which might be sitting on the suppliers’ books)?
Most traditional supply planning processes don’t deal well with these issues, and
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readers will likely have additional industry- and company-specific ones to add. Even
if a firm has a strong S&OP (Sales & Operations Planning) process, procurement
and other inbound supply chain staff be integrated into this process, plus they
must also have the tools to deal with the above scenarios and bring the suppliers
in as well. If this doesn’t happen, the plan will not reflect reality on the ground, and
downstream problems will inevitably flair up.
Study Respondent: “Share your forecast, but also update regularly so a trend could
be noticed or problems on the supply side may be foreseen.”
More broadly, the overall process cited above creates a collaborative link between
planning and execution that helps to failsafe the execution by doing more robust
fine-grained planning—with better tools.
And process execution costs should not be ignored. Based on 2013 process
benchmarks from The Hackett Group, typical procurement organizations allocate
nearly 70% more of their activity-based costs for transactional processes in direct
procurement than their ‘world class’ procurement counterparts. If you are spending
35–40% of your procurement labor and outsourcing on transactions rather than
10–20%, the opportunity cost of precious budget squandered on wasteful expense
vs. productive investment is a tragedy, especially given all the opportunities we’ve
laid out so far.
But this is a complex area, and the “Other” bucket in Fig 5 is indicative of the
breadth of domain-specific enablers needed for success.
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It was also clear that the pacesetters shared some common attributes. They were
motivated by the quest for ongoing value creation that made them aggressively go
after new cross-functional and cross-enterprise methods to unlock new value when
they hit a wall. This quest was not always pleasant, especially when old business
strategies no longer met new global business realities (see “LapCo” case study on
the next page).
There were also multi-year journeys that used external benchmarking to learn
the “art of the possible” before choosing which capabilities made the most sense
for them specifically. Finally, they rigorously executed and used the best people
and partners that they could find. They practiced what they preached in terms
of tapping supply market power, and used a broad ecosystem of providers from
the physical supply network players (e.g., CMs, ODMs, 3PLs) to supply chain
information network providers to support their IT requirements.
From an IT perspective, the scope of the inbound supply chain is so large that there
isn’t any single provider, nor even class of application that is supporting all
of the 11 capabilities that we’ve outlined. However, there is a clear trend toward:
So, in essence, we’re talking about a trend towards near real-time extended supply
network design (and re-design) and execution. But, if we may be so bold, we
believe that the future will not just be about a broader cloud-based supply chain
application footprint, but rather a supply chain information network that also serves
as a supply chain PaaS where the platform provides a ‘loosely coupled’ set of
applications and value-added services integrated into the platform and network(s).
Think of this as a supply chain equivalent to what Salesforce has done with its
Force.com PaaS, but deeper in terms of process specificity. It might seem like a
stretch, but it’s closer than you might think.
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Case Study: How Multi-Tier Of course, there were challenges. The make vs.
buy decisions were frequent—and critical. Every
Supply Management Helped platform entailed specific negotiations with CMs
Save “LapCo” from extinction on the BOM about who had the volume and
who would own the contract. As the executive
A well-known PC manufacturer (that we said: “We were careful with the categories and
will call “LapCo”) was facing a crisis. It was where you need a category strategy. We had a
wildly successful with its consumer-facing whole procurement department that had a pretty
configure-to-order supply chain. However, by cool continuity of supply strategy… this is easy
the mid-2000’s, PCs, in the words of a senior to screw up.”
supply chain executive we interviewed, were
“starting to look like toasters with price points The firm also worked with a third party
at $500-750.” The firm found itself selling into technology provider to build a multi-tier
a cutthroat retail channel with demanding platform (including multi-tier BoM) that
customers (“NEVER miss an order” was a key supported the virtual orchestration of demand/
mantra), in addition to supporting the firm’s supply signals, inventory visibility (none of
enterprise business. So, cost became mission it held by LapCo), and total cost tracking
critical to survival, and air-freighting laptops throughout the system from tier 2 suppliers to
from Asia to US-based final assembly locations various VMI hubs near the manufacturing sites.
obviously was not a sustainable supply. From a logistics standpoint, the firm picked
the 3PLs, and then “set the network protocol”
So, the firm outsourced fixed configuration that all partners used for execution. The firm
models to large contract manufacturers, but the was very process-centric and procurement was
inability to strongly control upstream supply part of the core cross-functional design team,
not only had cost disadvantages, but also risk helping the team not just with category strategy,
issues as became evident in 2006-2007 with market intelligence, and sourcing execution,
battery shortages that cropped up. The firm but also helping to build standard component
took a multi-pronged approach. First, it set libraries, performing supply-demand matching
up a separate trading organization that would (e.g., translating forward looking supply
perform a “Buy-Sell” model with items like pictures back to demand estimates and making
LCD displays and batteries, and also use tax adjustments), and various other processes.
efficient supply chain methods (e.g., buy raw
glass and mark it up in low-tax/no-tax areas). By overhauling the multi-tier supply network,
Although the tax benefit was felt to be ‘icing this firm was able to get cost competitive with
on the cake’, the visibility and supply assurance its peers and to survive the 2008-2009 recession.
in this virtual model was the key. To wit: “we While the industry remains hyper-competitive
didn’t have to stand up anything but supply/ and the firm’s future success is not guaranteed,
demand signals.” it has at least stayed in the game so it can play its
cards down the road.
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Looking Forward
Hopefully, this report has illustrated the vast opportunity available to direct
procurement organizations and broader supply chain organizations seeking to
capture this larger prize associated with optimizing the multi-tier supply network.
From a bottom-up standpoint, map the prioritized opportunities to your “in flight”
projects and priorities to see where there is alignment (or not). You may end up
shifting things around or completely mothballing others. But, re-inventing direct
procurement is obviously not about business-as-usual. It’s about bringing best
practices and transformation to the broader supply management opportunity—with
benefits ascribed to all the process participants. If direct procurement organizations
can be advocates for improving strategic supply outcomes rather than just owners
of purchased cost reductions, and if they can learn from the leaders to apply
the best strategies, methods, and tools, the world will be very bright for them and
their organizations.
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Appendix—Study Demographics
The study was conducted during June–August 2013 through a combination of
an online survey for quantitative analysis (n=122) and augmented by a set of
qualitative interviews with supply executives at large progressive manufacturing
firms who have chosen to remain anonymous due to the confidential nature of
many of the insights. The industry, functional, and size breakouts are shown below.
Study participants ranged from manager level up to the VP-CPO level.
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