Bill Young |
| The Role of Procurement as Trusted Advisor to Management |
by Bill Young and Charles H. Green
[Original Article]
Summary
Procurement’s journey from transactional processing to strategic business partnering is not
complete. Many argue it has even stalled. Some personal successes are evident, but they
are individual achievements, not an organisational model that can be copied.
We argue that this should surprise no one. There are too many unresolved conflicts
between the role of procurement and its internal clients, and that the savings metrics used
by Procurement belong to a former age and aggravate the problem. Where good
relationships exist, they do so between individuals who trust each other in spite of these
conflicts. We argue that trust is fundamental and essential in the type of relationship that
Procurement is aiming for, but that the metrics and governance used by Procurement are
antithetical to its aims.
Procurement has pushed hard to attract brighter and better staff but research shows that
capability is not enough. A genuine understanding of and concern for clients’ ambitions
and goals is needed: Procurement needs to be benevolent as well as capable in the way it
works with clients
Six distinct areas of conflict demonstrate how Procurement’s targets and metrics serve to
defeat its strategic aims, and to undermine the work it invests in building capabilities.
These include incentives to engage late with vendors, to over-specify requirements, and
even to shrink a business rather than grow it.
We conclude that there is a need for an alternative to Savings as the main reporting metric
for Procurement; the one we recommend is Spend Control Index. This isn’t a completely
new concept, but very few organisations set out to use it rigorously as their primary indicator
of Procurement’s performance. In the authors’ view, doing so would catalyse a change in
behaviour and encourage real trust–leading to the strategic business partnerships all
parties desire.
Tensions in the Realm of Procurement
Procurement today is a complex management service, intended to support the strategic
aims of the organisation. However, some of Procurement’s intended customers are
confused about its role and intentions–and hence don’t trust its motives. This is only
partially due to customers’ misunderstandings; a good bit of it is Procurement’s own fault.
Whilst presenting itself as a strategic business partner, some purchasing practices are in
fact tactical–and worse yet, self-serving.
This creates a trust issue with Procurement’s clientele—both internally and externally. In a
day and age where collaboration is a strategic must, unnecessary tensions created
between an organisation’s own business and functional units are strategically relevant and
financially harmful.
Kinnaird and Movius, arguing for a more sophisticated approach to negotiations observed
that, “On the one hand, business leaders…want to be able to sit down and talk freely with
their counterparts, shaping deals and exploring potential options. On the other hand, we
have procurement attempting to constrain dialogue within a process that it insists on
controlling, seemingly fearful of the very relationships that business leaders want to
cultivate.”[i]
The reasons for lack of trust show up mainly in Procurement’s target metrics and the way in
which Procurement reports them. The metrics are excessively focused on savings, even
when those savings are secondary or cannot be measured. While savings are a proper
target for certain cost-down programs, the aggregated total of savings is a misleading
performance indicator: its acceptance and use create perverse incentives.
Deeper down, these tensions are an outcome of two distinct views of Procurement: one
rooted in transactions, another based on relationships. Both views are necessary; but the
inability to distinguish between the two as the situation demands creates dysfunction.
We suggest that a solution lies in better defining Procurement’s transactional vs.
relationship responsibilities. We offer such a view, as well as a metric for control over
external spend. This is a performance indicator superior to cost savings. Accepting this as
an over-riding objective would align Procurement with its customers, create trust, and make
it a truly strategic partner.
Context: the Changing Role of Procurement
Procurement has three broad functions.
The first is managing internal transactions for ordering and receiving goods and services,
and handling procurement data. The primary goal here is to maximise the efficiency of
transaction-flow and reporting.
The second is support for vendor engagement and contracting processes. Procurement’s
roots are in regular price negotiations for raw materials, packaging, tools, consumables,
components and other regular purchases. It is largely a tactical and transaction-focussed
process.
The third area is “value-based strategic procurement that can translate into bottom line
improvements to the corporation …to ensure that the Procurement strategy is aligned with,
and that it rolls-up to, the overall corporate strategy.”[ii]
The Internet has created massive opportunities for driving efficiency in the first two
functions—from automating order processes to establishing online, blinded bid systems,
for example. These have the lion’s share of attention in the general management press.
However, apart from that, the essence of the first two roles has not substantively changed.
It is in the third role that procurement has attempted a metamorphosis[iii], in several ways:
Procurement is increasingly responsible for buying non-traditional services such as
consultancy, audit, training, and legal.
Procurement now challenges specifications developed by its own internal customers–and
in some cases, even the basic need for a purchase.
It may draft or even own the organisation’s strategy for buying goods and services with high
transaction volumes, such as travel, office supplies and MRO (maintenance, repair and
operation). In some cases
It may support or lead outsourcing projects.
“This change, with half of [Procurement departments] looking after marketing spend and
more than two-thirds in charge of professional services, suggests an increase not only in
their responsibility, but also in influence at a strategic level. It also suggests a shift towards
an increasing responsibility for people-related buying”[iv]
General Managers and the public still tend to think of Procurement as being essentially
about bargaining. But it now aims to create value and even competitive advantage on
behalf of its internal customers in all activities relating to vendors, according to this received
wisdom. But has its outlook matured sufficiently to match these responsibilities? And how
do its customers see it?
Schiele & McCue[v] describe two main traits that determine the level of meaningful
involvement that a purchasing department can have with client departments. They are:
Ability: the extent to which the purchasing department has the requisite expertise and ability
to benefit the client department
Benevolence: the extent to which the purchasing department is concerned about the needs
and interests of the client department
Chief Procurement Officers (CPOs) have invested heavily in staff and training in order to
build expertise and achieve the first trait. But both traits must be present if client
departments are to have trust in the purchasing department; and there is evidence that
benevolence has not been addressed with the same rigour as ability. [Italics show terms
used in the original paper by Schiele & McCue].
The problems of tactics, conflict and trust arise when Procurement’s traditional, tactical
roles are confused with the strategic position it wants to be in. This typically happens in the
realm of performance measurement.
Six Areas of Conflict
There are six areas in which confusion between the traditional tactical role and the new
strategic role arises, and which in turn lead to conflict.
1. Price vs. Value Assessments
Procurement often helps internal customers (budget owners) to understand a need better,
identify the best goods and services for that need, and undertake cost/benefit analyses for
different solutions. When there are more factors to consider than price alone, Procurement
uses weighted criteria to evaluate the best offer. Customers often appreciate this help.
However Procurement’s target, as well as the annual assessments of its managers, is
based mainly on achieved savings, so they have an incentive to push hardest on price
rather than other factors that contribute to value. The effect is that intentions are unclear,
incentives are mixed, and customers are confused, even resentful.
2. Market-based Solutions
There is an instinct in Procurement to challenge price through competitive tendering. This
is based on a faith in the rational outcomes of markets dealing with common
(commoditized) goods. The aim of procurement then is often to formalise the
requirements, remove subjectivity, and bring the service as close to a commodity as
possible[vi] [vii]. It’s a great theory and hard to argue against – if it did not conflict with the
way people actually make purchase decisions.
In practice, we as humans indeed use rational criteria in the screening part of a down-
selection process, in order to create a short-list of suppliers, all of whom are qualified to
provide the required goods or services. But then we tend to look the supplier candidates in
the eye to decide which one we would like to deal with; this final selection stage is less
cognitively-defined and less tangible. Senior managers are paid to make judgements, and
they do so.
Procurement’s aim is typically to commoditise all goods and services so as to remove
intangibles like trust from the vendor-selection process. This works well in the first phase
of screening, where those are unarguable virtues. In this phase, we want an empirical, fact-
based process in which the vendor is selected by weighted criteria, set against price.
But when it comes to the selection phase, client managers want to explore a relationship
with the final candidates and test their own comfort level before moving forward. This is a
decision model that’s entirely different from the rational, screening process. There’s
nothing wrong with this conflict, but it is one that many Procurement staff fail to deal with
because of their focus on the traditional, tactical transaction processes.
3. Explicit vs. Implicit Contracts[viii]
Explicit contracts are written and formal. Implicit contracts are not: they are usually created
during a working relationship and are based on trust. Often the two go together: the explicit
contract is agreed between the organisations at the start; and implicit deals, based on
trust, develop between individuals working together.
Procurement, reflecting its transactional responsibilities, worries about cosy relationships
that circumvent the formal buying process; but it may fail to recognise that implicit deals are
essential – and try to over-formalise.
It may even go further, towards the deliberate exploitation of a vendor’s trust and the
breaking of implicit deals. For instance, a vendor may invest in production capacity and
stock to provide reliability that justifies a price premium, only to find that the business is
tendered to the lowest bidder. Such a case represents a tragic triumph of the tactical—
taking pride in counting transactional battles won – at the expense of a war lost on
relationships.
4. Strategic Discussions
Chief Procurement Officers say their staff should become involved in projects earlier and
more strategically, in order that they can drive efficiencies and cost avoidance during the
planning and design stages of projects, not just during final vendor negotiations. They
recruit and develop purchasing managers with higher-level skills, who can work
strategically with their clients’ functional leadership teams.
But these strategic discussions raise a tension when it comes to measuring performance,
a tension that is frequently ignored. Procurement performance is typically measured by cost
savings. This is what many clients assume as obvious Truth, and many CPOs don’t offer
an alternative. Unfortunately, pursuing strategic objectives can lower the possible range of
savings targets. Here’s how.
At first, everyone agrees on the value of early, strategic engagement. It creates clarity of the
business issue, sharper specifications, more appropriate technical solutions, and earlier
screening-out of unsuitable suppliers. But this narrows the delta which Procurement is
able to report as a saving. With a smaller number of qualified suppliers, the gap between
the highest and lowest bidder is reduced and it is even possible that the highest bidder
offers the best overall value. How, if they are rewarded mainly on savings, is the
Procurement Manager incentivised to invest time and effort in strategy?
Until 2009, Procurement departments accepted (or conspired to ignore?) this paradox.
However, as the financial crisis hit, many CPOs told their staff to focus on tactical savings
and to forget the strategy. The switch in approach confused many clients and reinforced
perceptions that Procurement was, after all, a tactical service.
5. Contrived Calculations
Continued use of transaction-based metrics to evaluate strategic objectives can lead to
serious gaming of the system. For example, procurement savings on raw materials can be
translated into P&L accounts only if there are on-going purchases and like-for-like unit-
price comparisons. Often, however, this is not the case, so Procurement looks for
reportable savings in:
The difference between two quotes
External benchmarks
Internal changes (e.g. job cuts)
Other benefits (e.g. production efficiencies, waste reduction, reduced working capital)
These calculations have a subjective element but they are nevertheless aggregated with
unit-price reductions, to create the headline number reported by the CPO.
Reported savings also address only the areas that Procurement chooses to report. A price
rise (a negative saving?) is likely to go unreported. And there is an incentive for
Procurement managers to harvest savings the way farmers harvest hay, allowing the crop
to grow longer in order to get a better yield. Procurement managers may see larger
reportable savings from areas that previously they have creatively neglected!
One Head of Group Procurement reported hopefully to a seminar[ix], “The single reason for
us being credible, for us gaining strategic and professional status within the business is
nailing the notion of whether something is a genuine cost saving or a made-up number”.
In order to achieve this, Procurement departments may report savings under three
headings: hard savings based on unit price reductions; cost avoidance, e.g. from demand
reduction; and value-add, from additional business benefits without increased spend. In
the opinion of the authors, these acknowledge the weakness of savings reporting without
offering a more useful alternative.
Realistically, most executives know that a CPO’s reported aggregate savings number is not
real. But they accept that cost reductions are generally desirable and should be
encouraged. So they offer praise to the CPO, and pretend that the reported savings are
meaningful. After all, they may think to themselves, there is little to be gained by scepticism.
This back-and-forth game is played with both parties insisting that they believe in rational,
quantitative, measurable results, but with each vaguely knowing that the numbers are
fudged. This lends a hypocritical, even cynical, flavour to the relationship between
Procurement and management–to the detriment of both.
6. Operating Budgets vs. Strategic Spending
Some organisations translate savings into budget cuts, especially those where
Procurement reports through Finance.
Not surprisingly, managers may be disinclined to accept support from Procurement if their
operating budget is reduced as a consequence. Whilst these budget-owning managers
did not previously voice their doubts openly about the unreliability of Procurement’s
reported savings, it may be a different matter when their own budget is threatened in order
to deliver Procurement’s bonuses. To a client, it seems that Procurement’s aim is to
always to shrink the business.
All six of these areas of conflict have one thing in common. They arise because there is a
single metric on which Procurement expects to be measured and which it emphasises
above everything else when presenting its performance and promoting its value to the
organisation: the aggregate total cost reductions across all of its activities, savings.
But savings have no value to other business units (though we duly note the value to
financial stakeholders). Regarding the management of the organisation, the only practical
use to which the reported savings total can be put is the reward of procurement staff. It
does not help or guide decision-making in any other function; it does not inform the ‘what’
or the ‘how’ of management team decisions. It stands alone, detached from everything
else in the organisation; related only to the previously reported savings total.
When the CPO reports the aggregated savings total, she or he compares it only to two
things:
The previously reported total
The volume of extra sales that would be required to deliver the same value to the bottom
line.
Neither is likely to engage the management team positively, still less win their hearts and
minds.
The Procurement Dilemma
The net of these six areas of conflict is that Procurement faces a dilemma. By history and
tradition, it focuses on managing transactions and increasing internal efficiencies of
internal processes. The relevant measure for such a role is a focus on hard savings.
At the same time, Procurement’s increasingly successful self-elevation into strategic
partnerships endangers its reliable sources of hard savings. And since no one—including
CPOs—has effectively argued for a new and discrete metric, unresolved arguments and
confusion abound. The role has changed, but the measurement has stayed the same–
and no one has stated the problem clearly enough to permit resolution.
CPOs may deny this, but evidence is clear. When interviewing Procurement managers
about where they invest their time, they say they have to focus on reporting short-term
savings. Running a tender or auction is a quick and efficient use of their time: it delivers
easily reportable savings and meets their targets.
On the other hand, identifying better business processes and becoming involved in change
management are time-consuming and high risk. In a cost-reduction climate, ‘You don’t
need a weatherman / To know which way the wind blows’[x] so strategy loses out. This is
the message that Procurement teams are getting: ‘Strategy is a nice-to-have, but when the
chips are down, we are measured on savings.’
A Better Way
The solution is two-sided. One part is a better understanding of the emerging role of
Procurement, and the dual function it must perform. The other part is the metrics, a
particularly powerful tool in Procurement.
Because the very nature of performance assessment for Procurement is so quantitative, it
may be useful to put the “cart before the horse” and focus on a revised metric as the most
powerful lever for change.
It would be naive to stop reporting aggregate savings if there were nothing to put in its
place. But there is a move towards a different key performance indicator – one that has
more credibility, can be supported by Internal Audit, and that aligns Procurement with the
interests of its internal clients. It allows procurement organizations to build the trust they
need in order to become a strategic partner.
That indicator is Spend Control Index (SCI). It is not completely new and some
organisations have something close, called Spend under Management, with the nice
acronym, SUM. Instead of focusing on a spend area only when a purchase is imminent –
and restricting reporting to those areas they have actively worked in – the aim is to make
Procurement accountable for all spend. Not just for the spend that can be easily seen and
measured, but for a top-down calculation of external spend, derived from turnover, adjusted
for salaries, earnings, interest, extraordinary activities, depreciation and working capital.
Using this base (100% of spend), Procurement identifies the proportion where spend is
actively and fully managed by Procurement according to a strategy agreed with the
business. This article does not define the calculation of Spend Control Index as it may vary
from one organisation to another; but we can identify factors that could be used as the
basis of an audit. After assessing the monitoring and control systems, an auditor would
examine items of spend from different functional areas and supply channels. By checking
the level of control and compliance in each, they can sign-off on the Spend Control Index
claimed by the Procurement department. Key indicators of control for each item of spend
include:
Is there an identified Procurement manager with accountability for ensuring that the item is
efficiently and effectively sourced and that purchase transactions follow the correct
channels? Is this person recognised by the business as the point of escalation for
purchasing issues?
Is the item covered by a Procurement strategy that is documented, less than twelve months
old, and formally agreed with the budget owner?
Is there an internal communications document to inform users how to acquire the goods or
services? Are users instructed on how to find this document, how to deal with the vendor
and how to escalate issues?
Is there an identified manager who is accountable for ensuring that the item is delivered
and used according to the agreement and in line with business requirements? This
person may be called a contract manager, vendor manager or service manager and they
are usually line-managed by the budget owner, rather than being in the Procurement
department.
Are the correct procurement channels and transactions being used?
Reporting the proportion of total spend that is under control gets real attention from the
executive team and relegates tactical savings to second place. Maximising the Spend
Control Index is more easily aligned with business objectives; and Internal Audit can check
its measurement. It is not even necessary for Procurement to manage everything hands-
on. In the same way that Corporate Counsel is accountable for an organisation’s legal
compliance, but does not have to be present in every business meeting, Procurement’s
role no longer needs to be so interfering.
Increasing Trust in the Procurement Function
If an organisation wants Procurement to manage its cost base strategically it must help it to
escape from the rut of transactional models, and from the exclusive use of tactical savings
as its main performance indicator. Savings are a good metric for individual projects but, as
an aggregate overall measure of performance, they are misleading and lead to perverse
behaviours.
A function trapped by such a metric is unlikely to become a trustworthy partner to the rest of
the organisation. A trustworthy partner should be evaluated in terms of the benefits it can
bring through being trusted more broadly. The alignment of goals and metrics, through
adoption of a Spend Control Index, will itself contribute to greater trust of Procurement staff,
as well as in the system.
Endnotes
[i] T Kinnaird and H Movius “Avoiding the Three Deadly Sins” CPO Agenda Autumn 2008”
[ii] J Mahoney & G Stoller, “Strategic vs. Tactical Procurement – Shifting Focus Towards
Value Creation” July 2009 http://www.slideshare.net/jamie.mahoney/tactical-vs-strategic-
procurement-shifting-focus-towards-value-creation
[iii] A Moorhouse, “Insight into the changing role of the procurement professional” (Bradford
University School of Management) 2006
[iv] S Bagshaw (Editor), “Direct vs. Indirect Procurement – Market Intelligence Survey”.
(Supply Management & buying Team) September 2009
[v] JJ Schiele and CP McCue, ‘Professional service acquisition in public sector
procurement: A conceptual model of meaningful involvement.’ International Journal of
Operation and Production, Vol 26, 3 pp 300-325. 2006
[vi] J Bloom, “Agencies and Media Brands Turning Into Commodities” (Advertising Age) http:
//adage.com/columns/ 22 June 2009,
[vii] M D Kresic (Procurement Tactics, An Interview with Mladen Kresic) – http://negotiators.
com/ (Web only) April 2006
[viii] J Kay, “Foundations of Corporate Success” (Oxford) Chapter 4, Relationships &
Contracts
[ix] S Santarelli “Cost Savings in the Spotlight“ (Procurement Intelligence Unit) 24
September 2009 www.procurement-iu.com/ Internet publication
[x] B Dylan “Subterranean Homesick Blues” Columbia Records [catalogue 43242] 1965
[Original Article]
Summary
Procurement’s journey from transactional processing to strategic business partnering is not
complete. Many argue it has even stalled. Some personal successes are evident, but they
are individual achievements, not an organisational model that can be copied.
We argue that this should surprise no one. There are too many unresolved conflicts
between the role of procurement and its internal clients, and that the savings metrics used
by Procurement belong to a former age and aggravate the problem. Where good
relationships exist, they do so between individuals who trust each other in spite of these
conflicts. We argue that trust is fundamental and essential in the type of relationship that
Procurement is aiming for, but that the metrics and governance used by Procurement are
antithetical to its aims.
Procurement has pushed hard to attract brighter and better staff but research shows that
capability is not enough. A genuine understanding of and concern for clients’ ambitions
and goals is needed: Procurement needs to be benevolent as well as capable in the way it
works with clients
Six distinct areas of conflict demonstrate how Procurement’s targets and metrics serve to
defeat its strategic aims, and to undermine the work it invests in building capabilities.
These include incentives to engage late with vendors, to over-specify requirements, and
even to shrink a business rather than grow it.
We conclude that there is a need for an alternative to Savings as the main reporting metric
for Procurement; the one we recommend is Spend Control Index. This isn’t a completely
new concept, but very few organisations set out to use it rigorously as their primary indicator
of Procurement’s performance. In the authors’ view, doing so would catalyse a change in
behaviour and encourage real trust–leading to the strategic business partnerships all
parties desire.
Tensions in the Realm of Procurement
Procurement today is a complex management service, intended to support the strategic
aims of the organisation. However, some of Procurement’s intended customers are
confused about its role and intentions–and hence don’t trust its motives. This is only
partially due to customers’ misunderstandings; a good bit of it is Procurement’s own fault.
Whilst presenting itself as a strategic business partner, some purchasing practices are in
fact tactical–and worse yet, self-serving.
This creates a trust issue with Procurement’s clientele—both internally and externally. In a
day and age where collaboration is a strategic must, unnecessary tensions created
between an organisation’s own business and functional units are strategically relevant and
financially harmful.
Kinnaird and Movius, arguing for a more sophisticated approach to negotiations observed
that, “On the one hand, business leaders…want to be able to sit down and talk freely with
their counterparts, shaping deals and exploring potential options. On the other hand, we
have procurement attempting to constrain dialogue within a process that it insists on
controlling, seemingly fearful of the very relationships that business leaders want to
cultivate.”[i]
The reasons for lack of trust show up mainly in Procurement’s target metrics and the way in
which Procurement reports them. The metrics are excessively focused on savings, even
when those savings are secondary or cannot be measured. While savings are a proper
target for certain cost-down programs, the aggregated total of savings is a misleading
performance indicator: its acceptance and use create perverse incentives.
Deeper down, these tensions are an outcome of two distinct views of Procurement: one
rooted in transactions, another based on relationships. Both views are necessary; but the
inability to distinguish between the two as the situation demands creates dysfunction.
We suggest that a solution lies in better defining Procurement’s transactional vs.
relationship responsibilities. We offer such a view, as well as a metric for control over
external spend. This is a performance indicator superior to cost savings. Accepting this as
an over-riding objective would align Procurement with its customers, create trust, and make
it a truly strategic partner.
Context: the Changing Role of Procurement
Procurement has three broad functions.
The first is managing internal transactions for ordering and receiving goods and services,
and handling procurement data. The primary goal here is to maximise the efficiency of
transaction-flow and reporting.
The second is support for vendor engagement and contracting processes. Procurement’s
roots are in regular price negotiations for raw materials, packaging, tools, consumables,
components and other regular purchases. It is largely a tactical and transaction-focussed
process.
The third area is “value-based strategic procurement that can translate into bottom line
improvements to the corporation …to ensure that the Procurement strategy is aligned with,
and that it rolls-up to, the overall corporate strategy.”[ii]
The Internet has created massive opportunities for driving efficiency in the first two
functions—from automating order processes to establishing online, blinded bid systems,
for example. These have the lion’s share of attention in the general management press.
However, apart from that, the essence of the first two roles has not substantively changed.
It is in the third role that procurement has attempted a metamorphosis[iii], in several ways:
Procurement is increasingly responsible for buying non-traditional services such as
consultancy, audit, training, and legal.
Procurement now challenges specifications developed by its own internal customers–and
in some cases, even the basic need for a purchase.
It may draft or even own the organisation’s strategy for buying goods and services with high
transaction volumes, such as travel, office supplies and MRO (maintenance, repair and
operation). In some cases
It may support or lead outsourcing projects.
“This change, with half of [Procurement departments] looking after marketing spend and
more than two-thirds in charge of professional services, suggests an increase not only in
their responsibility, but also in influence at a strategic level. It also suggests a shift towards
an increasing responsibility for people-related buying”[iv]
General Managers and the public still tend to think of Procurement as being essentially
about bargaining. But it now aims to create value and even competitive advantage on
behalf of its internal customers in all activities relating to vendors, according to this received
wisdom. But has its outlook matured sufficiently to match these responsibilities? And how
do its customers see it?
Schiele & McCue[v] describe two main traits that determine the level of meaningful
involvement that a purchasing department can have with client departments. They are:
Ability: the extent to which the purchasing department has the requisite expertise and ability
to benefit the client department
Benevolence: the extent to which the purchasing department is concerned about the needs
and interests of the client department
Chief Procurement Officers (CPOs) have invested heavily in staff and training in order to
build expertise and achieve the first trait. But both traits must be present if client
departments are to have trust in the purchasing department; and there is evidence that
benevolence has not been addressed with the same rigour as ability. [Italics show terms
used in the original paper by Schiele & McCue].
The problems of tactics, conflict and trust arise when Procurement’s traditional, tactical
roles are confused with the strategic position it wants to be in. This typically happens in the
realm of performance measurement.
Six Areas of Conflict
There are six areas in which confusion between the traditional tactical role and the new
strategic role arises, and which in turn lead to conflict.
1. Price vs. Value Assessments
Procurement often helps internal customers (budget owners) to understand a need better,
identify the best goods and services for that need, and undertake cost/benefit analyses for
different solutions. When there are more factors to consider than price alone, Procurement
uses weighted criteria to evaluate the best offer. Customers often appreciate this help.
However Procurement’s target, as well as the annual assessments of its managers, is
based mainly on achieved savings, so they have an incentive to push hardest on price
rather than other factors that contribute to value. The effect is that intentions are unclear,
incentives are mixed, and customers are confused, even resentful.
2. Market-based Solutions
There is an instinct in Procurement to challenge price through competitive tendering. This
is based on a faith in the rational outcomes of markets dealing with common
(commoditized) goods. The aim of procurement then is often to formalise the
requirements, remove subjectivity, and bring the service as close to a commodity as
possible[vi] [vii]. It’s a great theory and hard to argue against – if it did not conflict with the
way people actually make purchase decisions.
In practice, we as humans indeed use rational criteria in the screening part of a down-
selection process, in order to create a short-list of suppliers, all of whom are qualified to
provide the required goods or services. But then we tend to look the supplier candidates in
the eye to decide which one we would like to deal with; this final selection stage is less
cognitively-defined and less tangible. Senior managers are paid to make judgements, and
they do so.
Procurement’s aim is typically to commoditise all goods and services so as to remove
intangibles like trust from the vendor-selection process. This works well in the first phase
of screening, where those are unarguable virtues. In this phase, we want an empirical, fact-
based process in which the vendor is selected by weighted criteria, set against price.
But when it comes to the selection phase, client managers want to explore a relationship
with the final candidates and test their own comfort level before moving forward. This is a
decision model that’s entirely different from the rational, screening process. There’s
nothing wrong with this conflict, but it is one that many Procurement staff fail to deal with
because of their focus on the traditional, tactical transaction processes.
3. Explicit vs. Implicit Contracts[viii]
Explicit contracts are written and formal. Implicit contracts are not: they are usually created
during a working relationship and are based on trust. Often the two go together: the explicit
contract is agreed between the organisations at the start; and implicit deals, based on
trust, develop between individuals working together.
Procurement, reflecting its transactional responsibilities, worries about cosy relationships
that circumvent the formal buying process; but it may fail to recognise that implicit deals are
essential – and try to over-formalise.
It may even go further, towards the deliberate exploitation of a vendor’s trust and the
breaking of implicit deals. For instance, a vendor may invest in production capacity and
stock to provide reliability that justifies a price premium, only to find that the business is
tendered to the lowest bidder. Such a case represents a tragic triumph of the tactical—
taking pride in counting transactional battles won – at the expense of a war lost on
relationships.
4. Strategic Discussions
Chief Procurement Officers say their staff should become involved in projects earlier and
more strategically, in order that they can drive efficiencies and cost avoidance during the
planning and design stages of projects, not just during final vendor negotiations. They
recruit and develop purchasing managers with higher-level skills, who can work
strategically with their clients’ functional leadership teams.
But these strategic discussions raise a tension when it comes to measuring performance,
a tension that is frequently ignored. Procurement performance is typically measured by cost
savings. This is what many clients assume as obvious Truth, and many CPOs don’t offer
an alternative. Unfortunately, pursuing strategic objectives can lower the possible range of
savings targets. Here’s how.
At first, everyone agrees on the value of early, strategic engagement. It creates clarity of the
business issue, sharper specifications, more appropriate technical solutions, and earlier
screening-out of unsuitable suppliers. But this narrows the delta which Procurement is
able to report as a saving. With a smaller number of qualified suppliers, the gap between
the highest and lowest bidder is reduced and it is even possible that the highest bidder
offers the best overall value. How, if they are rewarded mainly on savings, is the
Procurement Manager incentivised to invest time and effort in strategy?
Until 2009, Procurement departments accepted (or conspired to ignore?) this paradox.
However, as the financial crisis hit, many CPOs told their staff to focus on tactical savings
and to forget the strategy. The switch in approach confused many clients and reinforced
perceptions that Procurement was, after all, a tactical service.
5. Contrived Calculations
Continued use of transaction-based metrics to evaluate strategic objectives can lead to
serious gaming of the system. For example, procurement savings on raw materials can be
translated into P&L accounts only if there are on-going purchases and like-for-like unit-
price comparisons. Often, however, this is not the case, so Procurement looks for
reportable savings in:
The difference between two quotes
External benchmarks
Internal changes (e.g. job cuts)
Other benefits (e.g. production efficiencies, waste reduction, reduced working capital)
These calculations have a subjective element but they are nevertheless aggregated with
unit-price reductions, to create the headline number reported by the CPO.
Reported savings also address only the areas that Procurement chooses to report. A price
rise (a negative saving?) is likely to go unreported. And there is an incentive for
Procurement managers to harvest savings the way farmers harvest hay, allowing the crop
to grow longer in order to get a better yield. Procurement managers may see larger
reportable savings from areas that previously they have creatively neglected!
One Head of Group Procurement reported hopefully to a seminar[ix], “The single reason for
us being credible, for us gaining strategic and professional status within the business is
nailing the notion of whether something is a genuine cost saving or a made-up number”.
In order to achieve this, Procurement departments may report savings under three
headings: hard savings based on unit price reductions; cost avoidance, e.g. from demand
reduction; and value-add, from additional business benefits without increased spend. In
the opinion of the authors, these acknowledge the weakness of savings reporting without
offering a more useful alternative.
Realistically, most executives know that a CPO’s reported aggregate savings number is not
real. But they accept that cost reductions are generally desirable and should be
encouraged. So they offer praise to the CPO, and pretend that the reported savings are
meaningful. After all, they may think to themselves, there is little to be gained by scepticism.
This back-and-forth game is played with both parties insisting that they believe in rational,
quantitative, measurable results, but with each vaguely knowing that the numbers are
fudged. This lends a hypocritical, even cynical, flavour to the relationship between
Procurement and management–to the detriment of both.
6. Operating Budgets vs. Strategic Spending
Some organisations translate savings into budget cuts, especially those where
Procurement reports through Finance.
Not surprisingly, managers may be disinclined to accept support from Procurement if their
operating budget is reduced as a consequence. Whilst these budget-owning managers
did not previously voice their doubts openly about the unreliability of Procurement’s
reported savings, it may be a different matter when their own budget is threatened in order
to deliver Procurement’s bonuses. To a client, it seems that Procurement’s aim is to
always to shrink the business.
All six of these areas of conflict have one thing in common. They arise because there is a
single metric on which Procurement expects to be measured and which it emphasises
above everything else when presenting its performance and promoting its value to the
organisation: the aggregate total cost reductions across all of its activities, savings.
But savings have no value to other business units (though we duly note the value to
financial stakeholders). Regarding the management of the organisation, the only practical
use to which the reported savings total can be put is the reward of procurement staff. It
does not help or guide decision-making in any other function; it does not inform the ‘what’
or the ‘how’ of management team decisions. It stands alone, detached from everything
else in the organisation; related only to the previously reported savings total.
When the CPO reports the aggregated savings total, she or he compares it only to two
things:
The previously reported total
The volume of extra sales that would be required to deliver the same value to the bottom
line.
Neither is likely to engage the management team positively, still less win their hearts and
minds.
The Procurement Dilemma
The net of these six areas of conflict is that Procurement faces a dilemma. By history and
tradition, it focuses on managing transactions and increasing internal efficiencies of
internal processes. The relevant measure for such a role is a focus on hard savings.
At the same time, Procurement’s increasingly successful self-elevation into strategic
partnerships endangers its reliable sources of hard savings. And since no one—including
CPOs—has effectively argued for a new and discrete metric, unresolved arguments and
confusion abound. The role has changed, but the measurement has stayed the same–
and no one has stated the problem clearly enough to permit resolution.
CPOs may deny this, but evidence is clear. When interviewing Procurement managers
about where they invest their time, they say they have to focus on reporting short-term
savings. Running a tender or auction is a quick and efficient use of their time: it delivers
easily reportable savings and meets their targets.
On the other hand, identifying better business processes and becoming involved in change
management are time-consuming and high risk. In a cost-reduction climate, ‘You don’t
need a weatherman / To know which way the wind blows’[x] so strategy loses out. This is
the message that Procurement teams are getting: ‘Strategy is a nice-to-have, but when the
chips are down, we are measured on savings.’
A Better Way
The solution is two-sided. One part is a better understanding of the emerging role of
Procurement, and the dual function it must perform. The other part is the metrics, a
particularly powerful tool in Procurement.
Because the very nature of performance assessment for Procurement is so quantitative, it
may be useful to put the “cart before the horse” and focus on a revised metric as the most
powerful lever for change.
It would be naive to stop reporting aggregate savings if there were nothing to put in its
place. But there is a move towards a different key performance indicator – one that has
more credibility, can be supported by Internal Audit, and that aligns Procurement with the
interests of its internal clients. It allows procurement organizations to build the trust they
need in order to become a strategic partner.
That indicator is Spend Control Index (SCI). It is not completely new and some
organisations have something close, called Spend under Management, with the nice
acronym, SUM. Instead of focusing on a spend area only when a purchase is imminent –
and restricting reporting to those areas they have actively worked in – the aim is to make
Procurement accountable for all spend. Not just for the spend that can be easily seen and
measured, but for a top-down calculation of external spend, derived from turnover, adjusted
for salaries, earnings, interest, extraordinary activities, depreciation and working capital.
Using this base (100% of spend), Procurement identifies the proportion where spend is
actively and fully managed by Procurement according to a strategy agreed with the
business. This article does not define the calculation of Spend Control Index as it may vary
from one organisation to another; but we can identify factors that could be used as the
basis of an audit. After assessing the monitoring and control systems, an auditor would
examine items of spend from different functional areas and supply channels. By checking
the level of control and compliance in each, they can sign-off on the Spend Control Index
claimed by the Procurement department. Key indicators of control for each item of spend
include:
Is there an identified Procurement manager with accountability for ensuring that the item is
efficiently and effectively sourced and that purchase transactions follow the correct
channels? Is this person recognised by the business as the point of escalation for
purchasing issues?
Is the item covered by a Procurement strategy that is documented, less than twelve months
old, and formally agreed with the budget owner?
Is there an internal communications document to inform users how to acquire the goods or
services? Are users instructed on how to find this document, how to deal with the vendor
and how to escalate issues?
Is there an identified manager who is accountable for ensuring that the item is delivered
and used according to the agreement and in line with business requirements? This
person may be called a contract manager, vendor manager or service manager and they
are usually line-managed by the budget owner, rather than being in the Procurement
department.
Are the correct procurement channels and transactions being used?
Reporting the proportion of total spend that is under control gets real attention from the
executive team and relegates tactical savings to second place. Maximising the Spend
Control Index is more easily aligned with business objectives; and Internal Audit can check
its measurement. It is not even necessary for Procurement to manage everything hands-
on. In the same way that Corporate Counsel is accountable for an organisation’s legal
compliance, but does not have to be present in every business meeting, Procurement’s
role no longer needs to be so interfering.
Increasing Trust in the Procurement Function
If an organisation wants Procurement to manage its cost base strategically it must help it to
escape from the rut of transactional models, and from the exclusive use of tactical savings
as its main performance indicator. Savings are a good metric for individual projects but, as
an aggregate overall measure of performance, they are misleading and lead to perverse
behaviours.
A function trapped by such a metric is unlikely to become a trustworthy partner to the rest of
the organisation. A trustworthy partner should be evaluated in terms of the benefits it can
bring through being trusted more broadly. The alignment of goals and metrics, through
adoption of a Spend Control Index, will itself contribute to greater trust of Procurement staff,
as well as in the system.
Endnotes
[i] T Kinnaird and H Movius “Avoiding the Three Deadly Sins” CPO Agenda Autumn 2008”
[ii] J Mahoney & G Stoller, “Strategic vs. Tactical Procurement – Shifting Focus Towards
Value Creation” July 2009 http://www.slideshare.net/jamie.mahoney/tactical-vs-strategic-
procurement-shifting-focus-towards-value-creation
[iii] A Moorhouse, “Insight into the changing role of the procurement professional” (Bradford
University School of Management) 2006
[iv] S Bagshaw (Editor), “Direct vs. Indirect Procurement – Market Intelligence Survey”.
(Supply Management & buying Team) September 2009
[v] JJ Schiele and CP McCue, ‘Professional service acquisition in public sector
procurement: A conceptual model of meaningful involvement.’ International Journal of
Operation and Production, Vol 26, 3 pp 300-325. 2006
[vi] J Bloom, “Agencies and Media Brands Turning Into Commodities” (Advertising Age) http:
//adage.com/columns/ 22 June 2009,
[vii] M D Kresic (Procurement Tactics, An Interview with Mladen Kresic) – http://negotiators.
com/ (Web only) April 2006
[viii] J Kay, “Foundations of Corporate Success” (Oxford) Chapter 4, Relationships &
Contracts
[ix] S Santarelli “Cost Savings in the Spotlight“ (Procurement Intelligence Unit) 24
September 2009 www.procurement-iu.com/ Internet publication
[x] B Dylan “Subterranean Homesick Blues” Columbia Records [catalogue 43242] 1965
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