A look into the future of procurement Techniques and strategies for choosing suppliers and building strategic partnerships are due for an overhaul, the authors argue. “Value procurement” may be the next step in the discipline’s evolution. MUCH OF THE WRITING ON PROCUREMENT since the mid 1980s has focused on the operational mech- anisms that are used in what are termed “dyadic relationships.” Put simply, a dyadic relationship is between two people, both of whom have the ability to influence the other. This can provide set roles thar, in tum, create the glue for the relationship to stick: ‘The stronger the connection, the bigger the impact they have on each other. Essentially it is an under- standing that requires both to cooperate with each other for the benefit of both. These relationships—in ur procurement workd—create, develop, and sustain exchange transactions between buyers and suppliers Much of this literature owes its genesis to three philosophies. The first is transaction-cost economics. Then there is the “interactions” approach, and, third, the much broader and growing “relational” approach associated with lean and agile principles of production and supply management thinking.! However, few of these approaches focus explicitly ‘on the interests of or the value that buyers and sup- pliers receive from transactions. Despite this, most ‘writers assume that some element of mutuality (value as defined by the interests of both parties in the exchange) must occur for transactions to exist. This implicit view of value does not allow practi- tioners to fully understand which elements of value must be achieved to sustain relationships for buyers or for suppliers, or [to fully understand] the complex IBY GERARD CHICK commercial and operational tensions over interests that exist in transactional exchanges, whether in dyadic or the more realistic network relationships. Furthermore, one might argue that much of the cur- rent thinking tends to overemphasize the operational and underplay the commercial interests that exist in business relationships. The mutuality alluded to above needs to be con- templated, as in the majority of buyer-supplier rela- tionships the buyer would henefit from an enhanced understanding of the supplier's needs and wants. An understanding of the sources of supplier value could help buyers to manage a whole range of buyer-sup- plier interactions and develop them to gain strategic competitive advantage. In the majority of buyer-supplier relationships the buyers often assume that they are in positions of dom- inance where they can simply instruct or command suppliers. However, the opposite is far more likely, and buyers need to persuade suppliers to perform in their desired manner. To be persuasive in the absence of significant levels of power, and without incurring significant on-costs (overhead), it is necessary for the buyer to understand what it is that suppliers want from buyers other than mote revenue. Some suppliers, for example, might ‘want stability and be prepared to improve their per- formance in return for simple, low-cost changes in ordering practices. ND ROBERT HANDFIELD] [GERARD CHICK IS CHEF KNOWLEDGE OFFICER AT OPTIMUM PROCUREMENT GROUP AND ROBERT HANOFIELD, PH.D. 1S THE BANK OF AMERICA LUVERSITY DISTINGUISHED PROFESSOR OF SUPPLY CHAIN MANAGEMENT AT NORTH CAROLINA STATE UNWERSITY 44 cscs supply chain quarterly [QUARTER 1/2016) wun SuopyChalnauarteny comCs ea) ils PROCUREMENT VALUE PROPOSITION magnitude to the introduction of 7 ‘ould be that this an the demise of won SuppyChainQuartery com (QUARTER 12016] CSCMP's Supply Chain Quarter 45,46 csc’ sump chan quarterly Value procurement versus value-based procurement Many of today’s procurement systems are largely built on purchaser/vendor mistrust, the lack of rigorous purchasing procedures, and a lack of tools that can be used to compare bids and assess value. Going for the cheapest option and pushing the risk onto the supplier looks attractive in the short term but is actually ridic- ulous in the long term, Value-based procurement requires you to buy the goods or services that produce the best overall value. For example, if Company A offers to build a soft- ware system that costs £5 million and later yields £10 million in added revenue, then Company A's bid has a net value of £5 million. In contrast, if the system offered by Company B costs £10 million but returns more than £40 million in added revenue, then Company B's bid has 2 net value of more than £30 million. Under a traditional procurement approach, Company A’s bid (the low-cost solution) would win the contract. Under value-based purchasing, Company B wins, paying more up-front but receiving much more in return over the long term. Value-based procurement can take many forms. The benefit may be measured, for example, in an expanded set of services provided by one supplier's solution over another. In other cases, gaining benefit may involve procuring a system with higher initial costs but lower lifecycle expenses and easier updating capabilities. Procurement’s problem is how to judge the value of competing proposals, a task that isn't easy when dealing with large or complex bids. Value-based procurement is about developing solu- tion-oriented bids, where the bid articulates the prob- lem to be solved and requires the supplier to use its expertise to propose a solution. Or perhaps [it is about] evaluating suppliers on factors such as total cost of ‘ownership, the technical merit of the vendor’s propos- al, the vendor's past performance, and the probability of meeting your current and future business objectives rather than just cost. ‘A closer proximity to your supply base and involv- ing the suppliers in a risk/rewand structure incentivizes supplier flexibility and performance. Finally, looking at the delivery promised by your supplier set against projected performance rather than past failures is another way of tightening the relationship and incen- tivizing the organizations you work with. Value procurement is the realization of all of the benefits to be gained by the implementation of good procurement practice (as described in the model in Chapter 2). (That includes} everything from the foundations—the application of procurement’s oUARTER 1/2016) “five rights”—through to the reduction of unneed- ed demand activity, complexity, immediacy, and variability, ultimately stimulating good demand and increasing business value derived from spend (and supply markets) rather than simply reducing spend magnitude. This demands full alignment with the corporate strategy, and integration internally with stakeholders and externally with the supply base, Procurement ‘must be as mindful of delivering customer satisfaction as any other business unit in the organization. Value procurement and customers ‘Are we witnessing the dawn of a big shift in the way strategic procurement is done? Category management thas been the only credible procurement strategy since the late 1990s, and that may be about to change. The techniques devised in category management strategies to choose suppliers and build strategic partnerships are due for an overhaul. Today procurement professionals are under consid erable pressure to deliver value-adding business per- formance, and itis no longer enough to build a supply ‘management capability thar i efficient, demand-driv- en, or even transparent. Procurement must offer the organization something that is value adding: a new supply management where the strategic scope of procurement’s value is delivered via innovation, a networked function, and focus. Procurement must be the function that is contin- ually challenging ways of working. It must look to censure that it helps its internal business stakehold- ers to achieve their goals and targets while, at the same time, taking the opportunity to challenge total cost and facilitate “customer of choice” benefits, such as access to innovation and, of course, the manage- ment of risk. Most critical of all is that procurement must be aligned to the corporate focus, addressing the key question for any business: "What is value to the customer?” The customer never buys a product. By definition the customer buys the satisfaction of a want, which in economics is defined as value. In essence, value is util- ity; that is, the total satisfaction derived from a good or service. As we know, the utility that one derives from a good or service is difficule to measure, but we can determine it indirectly with customer-behavior theories, which assume that consumers will always strive to maximize their utility Taking the view from business to market Its ironic how often the term value is bandied about, especially as it is so difficult to define what value actually is; moreover, its loose and frequent use across ‘wwe Supptycainquartory com2 number of contexts makes it difficult to anchor its For example, in the construction industry the value of meaning in supply management a surface coating may derive from the area covered, We can, however, reasonably attach various conno- while the price is far more likely to be quoted in tations to value volume * Value is relative to an alternative. Value cannot Value management relies on multiple streams of be judged in isolation. information from inside and outside the organic + Value is composite and decomposable. Value can tion—both internal and external perspectives are be analy ary. Today procurement holds information time, cost, quality, and service regarding customers, competitors, demand, offers, * Value can be used in several contexts. In busi- costs, and production constraints. These data are ness-to-business (BZB) relationships it tends to be all used in value management, and this places pro- economic in nature, but other aspects, such as the _curement in a strong position to make this aspect of emotional, environmental, and social, may also be business their own (see Figure 9.1). considered as having a value quotient Procurement leaders are faced with a dichoto- * Value is measureable/quantifiable. Economic my: cost (savings) versus value (creation), and this value might be seen as revenue or cost savings, but requires CPOs to think hard about how well they other aspects have their own forms of measures; for understand the market. If CPOs are to be truly market example, the ability to exploit intellectual property facing—and for too long their focus has been internal right (IPR), clients and stakeholders—then there is a real need to CPOs can map the way in which the customer gets ring the balance of theit focus to some sort of equi value to the way in which the seller charges for value, librium. Iewill be because of this equilibrium between ed into a set of value drivers; for example, nece [FIGURE 9.1] PROCUREMENT’S VALUE PROPOSITION Procurement’s value proposition a The S'rights’ and Reduction of Stimulating good total supply cost | unneeded demand, increasing reduction demand activity. business value Strategic derived from Procurement’s category spend and supply game changer management market focus Business CS Geeticarg Cost reducer Supporting business strategy Influencing business strategy Negotiation, cost ‘modelling; Procurement fully Procurement exploits supplier/market ‘engaged in CRM; the power of supply analysis; SRM; money manage- market gaining real Project management; | ment; demand/ competitive risk management specification advantage influence Increasing value and development of supply-side capabilities and business impact wor SuppyChainQuetry com QUARTER 1/2016] cSCMP's Supply Chan quanery 4748 cscl's supply chain Quarterly the business and the market that the long-heralded co-creation of value can take place. This is where the next big windfall, the next big gains, and the next competitive advantages will come from. Value procurement will be category management's legacy It is no longer enough to build a supply manage- ‘ment capability that is efficient, demand-triven, ancl transparent. Procurement must offer the organi something that is value adding—a new supply man- ‘agement, where the strategic scope of procurement’s value is delivered via innovation, a networking func- tion that is focused. sation So how does this change the game? ‘We have been wondering for some time: has the big business idea of the last 30 years gone rancid? The idea being that you drive cost out of the organization in onder 10 make it more profitable and to maximize shareholder value, only to drive risk in. Why do orga: nizations continue to get this so wrong, pursuing the will-o’-the-wisp of cost reduction with measures that cend up increasing them! This preoccupation seems to have tainted the cream on the top of most business models. Ie is quite clear to us that the procurement function is going through something of an evolution, as the strategic impact of it comes to the fore. Organizations are increasingly moving away from the discrete func- tion of the past; the doers (buyers) ate being replaced by enablers (value adders). Enablers are deemed more useful to the organization and stay embedded in stra- tegic business units. ‘Another interesting aspect is that more and more we are seeing profits replace cost savings. Consequently, the cost-savings focus is giving way to a strategically aligned emphasis on profitability. Moreover, as the discrete procurement function moves into a new modus, the battles to ensure that cost savings are reflected in their budgets will fade, and the emphasis oon cost savings only will have less weight than [the emphasis on] timeliness and quality If we reflect on the above, it points to the “doe those who excel at cutting deals in the back office— finding themselves and their role outsourced to third-party services organizations. Procurement then will be freed up to operate on a strictly strategic remit, perhaps embedded in other strategic business units (SBUs) or operating as a loose network. Certainly they will be marketupplier facing. They will be there when required, constantly moving and reinventing their roles as needs shift. The commentary in much of the business press these days relates to the desite for the emergence of a new supply management to meet modem business QUARTER 172016] needs. Procurement’s horizon has clearly widened since the 1980s andl has seen procurement transform from tactical to strategic. But the notion of strategic” remains hemmed inside the function, almost a prison cr of its own history. It requires a change in mindset and the development of a cultured understanding of the (strategic) value-adding capability of procure ment—and, with it, the realization of what strategic can mean gets much broade Procurement needs to become more commercially focused, as its new, highly strategic role requires that: 1) i understands the workings of the financial supply chains; and 2) that it stimulates good demand and increasing business value derived from spend (and supply markets) rather than simply reducing spend magnitude. These changes bring with them new issues: + As outsourcing takes off, many current procure- ment and supply-side activities (the ones that do not get pushed elsewhere in the business) will be out- sourced as organizations adjust and “slim down.” + Increasingly, thixt-party service providers call the shots as the quantity and quality of thind-party procurement services increase. Their performance, ‘across many spend categories, will surpass what can be achieved in-house; as these operational activities move outside the business, often in extended supply chains with litle transparency, this will have very real ‘consequences, Naturally, there will be several areas of business management that will he materially impacted. At the top of the list will be corporate governance and tisk. A.cursory glance at today's business landscape reveals why business leaders must ensure that activities in their extended and more complex supply chains are acceptable. This applies to both core and non-core suppliers in equal measure. There is also need to re-evaluate where business risks lie. Risk since 2008 has changed in nature. Today there is much more emphasis on fragility and, as such, the financial and reputational standing of organizations is subject to global market volatility. As businesses have replaced internal operations with external suppliers, risks associated with them are also externalized ‘Added to these issues, an increase in collaboration brings with it potential problems regarding the own- ership of intellectual property (IP). Since the 1990s the move from closed to open innovation models has facilitated innovation-oriented cost-saving strategies. Today, suppliers invest heavily in research and devel- ‘opment, s0 it follows that relationships are established to facilitate this innovation to flow into the busi- ness—and equally for the suppliers to understand the vn Supotychainguarterty.comnceds of the businesses they service in order to guide and tailor innovation. ‘With the dawn ofthe “extended enterprise” there are tangible changes regarding intellectual property own ership and exploitation, Manufacturing has been led by the “make versus buy” paradigm for many years, ancl in so doing created what is known as “shallow depth of manufacture.” While the manufacturers intend to stay there, services organizations are increasingly engaged in outsourcing. Clearly, as IP development moves into the supplier base any future exploitation of IP will depend on where it sits, and who owns it. ‘Suppliers are one of the main engines of income, and, as suppliers, take on bigger chunks of things they already do for their customers, for example by developing end-to-end solutions if they do not already exist. Where solutions do already exist, then custom: cr enterprises must become much more receptive to sourcing them, with suppliers moving out of their comfort zones to drive customer performance. Clearly, the foregoing demonstrates that there are new sources of value for businesses to explore. Collaboration creates value. Developing structures to support shared purpose, ideas, and insights is inher- ently value creating. In turn, this demands a shift in how the supply base is viewed. Suppliers, to0, can be enablers who will deliver value. For example, net- works for innovation—a transition from the dyadic “buyer and supplier” relationship to “integrated sup- plier networks’—will enable greater coordination of innovation road maps across connected businesses and industries With developments such as these, organizations share risks and rewards. As supply management professionals get better at segmenting, defining, and measuring value, they will begin to incorporate both gain and risk-sharing into commercial relationships with suppliers. Ultimately, this kind of relationship also facilitates “motivational contracting.” As well as sharing risks and rewards in contracts, supply management professionals will accept greater risk in commercial relationships with critical suppliers by leaving out all the demotivational stuff chat inhibits supplier innovation. {FIGURE 9.2] THE EVOLUTION OF PROCUREMENT’S VALUE PROPOSITION ‘The evolution of procurement’s value os ‘Traditional view | Strategic category Direct business ‘of procurement. | management. value derived from Cost driven and | Corporately spend and supply tactical aligned provides market focus. Game changer, strategic support. Influences corporate ‘moves beyond strategy cost-out eae Procure- ‘ment Business Value Market Procurement tegory Manage- Purchasing ment > Will become less | Procurement engaged Procurement moves important to the _|with supply base beyond internal business and many of | working collaboratively. perspectives. Exploits these activites will be |Foci are demand supply markets with outsourced to third finance and extemal perspectives Party suppliers. specification influence and customer focus wn Supplycainquartorty com Bei ee ee Increasing strategic impact and market focus raise procurement’s business impact [QUARTER 12016) CSCN's Supply Chain Quarterly 49The evolution of procurement's value proposition The focus of much of this book has heen to establish the notion that new practice is needed within business with regard to its use of supply management and its position in the business. Today's uncertain and volatile markets make agility and change inevitable as well as essential, Supply management mind and skill sets must change. Many business leaders have ambitions to improve prof- itability by reducing costs. But to do so, they must also reshape their supplier relationships, aligning their sup- ply chain with a more progressive strategy and secur: Now we have an opportunity where in. 10 minutes you can find second- and third-tier connections in global networks, with people who know people you know Buyers and sellers are increasingly relying on digital trading networks and communities that allow them to quickly and easily discover each other, connect, and collaborate. Business intelligence has become critical to the sustainability of corporations wishing to compete in. slobal markets. Open pricing for goods and services is becoming increasingly transparent due to the Internet, e-sourcing, global trading networks, online commu- nities, and procurement’s intrepid scrutiny into still- ing a competitive advantage. So what are the new realities? Procurement — professionals need to get savvy. Their profes- sional credentials will be mea- sured by their ability to influ- ence, persuade, and provide vision. Their mindset must be strategic, global, collaborative, and, above all, commercial (see Figure 9.2). No strategy—whether it is business-as-usual or a radical shift—can now be implemented without listening to and working with stakeholders and suppliers [HOW TO ORDER] ‘CSCMP’s Supply Chain Quarterly read- ers in the United States may order The Procurement Value Proposition: The Rise of Supply Management from Amazon (www.amazon.com) ‘and Barnes & Noble (www.bn.com). Readers who are located outside the U.S. may order the book directly from ‘Kogan Page (www.kKoganpage.cor) at a 20 percent discount, using the dis- ‘count code Quarterly2016. This spe- cial offer is available for orders placed from March 1 through April 30, 2016. cloaked categories. Might nego- tiation become a lost art? We are beginning to see too some con: sensus develop around risk and complexity and how to model risk. This is helping to develop more standardized, readily avail- able third-party information and networked communities where people pool data for operational risk assessment. The emergence of intelligent data is reversing procurement’s reliance on looking backward at money spent or supplier past performance. The increased use We have seen how they fulfill the majority of a corporation's needs. How well they are mobilized will determine how well the organization can execute on its strategy. Procurement professionals have to be able to connect, network, and trade In Chapter 5 we looked at the impact of rechnolog- ical applications on business. Today everything starts with an “e”! Procure-to-pay, sourcing, contract man- agement, and other automated solutions are integrated up and down supply chains, fully adopted, providing ‘greater transparency and real-time insight. More and more we see people working “on the go.” ‘A new Intemet-savvy and technically confident gen- eration is entering the workplace, using smartphones, tablets, embedded chips, and other devices to create a mobile work environment for procurement profession- als and suppliers alike. This, coupled with the Internet ‘of Things, will change the shape and dynamics of sup- ply chains and our working lives To {keep up with those changes} we must connect and collaborate. For some considerable time we have been talking about dynamic supply chains and how networks are the way forward, hut actually manifest- ing that in our day-to-day work life has heen difficule ‘50. cscw's supply chain quarterly (QUARTER 12016}, of “big data,” the cloud, and ana- Iytics enables procurement to work with information, data, and models that predic. With analytics comes more visibility regarding spend, risk, and performance, which will be available when you need it. Ready access to accurate, timely, struc- tured internal and external business intelligence will create unprecedented capability regarding information| manipulation in support of decision making. 2 Notes: 1. For transaction-cost economics, see Williamson, ©. E. (2005) Handbook of New Institutional Economics, Transaction Cost Economics, Springer U.S., pp. 41-65. For interactions method, see Ford, D., et al. (2002) Understanding Business Marketing and. Purchasing, ‘Thomson Learning, London. For relational method, see Lamming, R. C. (1993) Beyond Parmership: Strategies for innovation and lean supply, Prentice Hall Harlow; Hines, P., et al. (2000) Value Stream Management: Strategy and excellence in the supply chain, Financial Times/Prentice Hall Harlow; and Christopher, M. and Towill, D. R. (2002) “Developing market specific supply chain strat- egies,” International Jounal of Logistics Management, 13 (1), pp. 1-14. ‘vn Supplychainquartety com