Procurement efficiency: Learn How This Company Achieved It
We are all too aware of how Procurement teams have always had to yield to Finance’s whims. This has, for too long, been the Chief Procurement Officer’s (and not to mention the Purchasing Manager’s) biggest grievance. And it’s a grievance that has never quite been addressed. About thirteen years ago, while I was working as a sourcing manager, my colleagues and I sensed an opportunity to turn this time-honored tradition on its head, and engineer a change. It was a rare opportunity. And we seized it.
Before going into the how, let’s very briefly go into the why: indeed why is it that Procurement sits under Finance.
The common perception that Procurement efficiency is Finance’s underling goal may be explained by several factors. The most significant of these factors, however, can be ascribed to semantics. When Procurement was in its infancy (Read our highly popular primer on the history of Procurement for more context), it was referred to as a “commercial” operation. And so the procurement department wasn’t called the procurement department, but the commercial department. And the word “commercial” was understood to be associated with money. And so it was obvious that Procurement would become directly answerable to Finance. Another factor, equally grounded in semantics, was that procurement departments (or rather, commercial departments) were always seen as “spending the money.” This impression was enough to situate Procurement within the Finance function.
Most CFOs like to maintain tight control over cash flow, and therefore over expenditure. It therefore suited them to have reins over the CPO to ensure that the procurement expenditure was aligned with the budget and forecast. This way, the business could create maximum procurement efficiency. Any unforeseen expenditure would have to be budgeted for and, in cases where it could not be avoided, the CPO would receive very clear instructions on the payments terms to be negotiated.
While this approach of the CPO reporting into finance is not completely wrong in any way, it may not be optimal either. As with most decisions of this nature, there is never a definite “wrong” or “right”, but the optimal point lies somewhere in between a few options.
Now, let’s get down to what actually happened
In 2004, I joined a London-based global mining company that had embarked on a bold and ambitious project to rethink and redesign the Buying function. Several options were considered to transform Buying into a world-class Supply Chain Management (SCM) function. The new sub-structures of SCM were Procurement, Category Management, Contracting, as well as Logistics and Warehousing. On all of the company’s 10 mines, these functions had historically reported into finance. The onsite buyers, as well as the so called “stores personnel”, reported to the mines’ financial managers. These managers ultimately reported to the CFO.
Whilst the newly established SCM structure still reported to the CFO, the then CFO and Head of Engineering were both very progressive persons who were more than willing to challenge the status quo in order to further improve the overall performance of the SCM function. Around 12 months after the SCM implementation, serious discussions about the reporting lines ensued. Following a number of detailed white board discussions and a series of structural considerations, the decision was made to move SCM to engineering. New roles and responsibilities were quickly drafted and these were discussed personnel.
The decision to proceed with implementation was met with uncertainty at the mines, where some finance managers (FM’s) saw this as losing control of a key function. They would no longer be in a position to dictate who purchased what, where it was purchased, how it was purchased, payment terms, stock levels, or procurement efficiency etc. I must immediately add that some FMs similarly saw opportunity in this arrangement, as they would no longer have to face the music when items were not on site in time, budgets were overspent and account for “nil in stock” scenario’s. In all honesty, they had enough to deal with on a daily basis and could really do without this added distraction.
On D-day, the switch was made and it commenced with a series of road shows and information sessions, including communicating this to the trade unions, as it would impact the employment conditions of personnel. As the supply manager, it was my privilege to host these sessions which were demanding, but actually ran quite smoothly. There was some initial resistance, but persistence paid off, and we managed to implement and entrench the new structure within a few months.
All of a sudden we experienced benefits that we had always idealized, but had battled to realize. Procurement efficiency went through the rook. The head of engineering introduced us at his meetings with the engineers and we became part of his formal team and meeting structures. I must mention at this stage that many of us were engineers by profession, so it was easy to interface with the engineers as we “spoke the same language”. This marked a new era where engineers would invite us to visit them, whilst prior to this, we had to battle to get an appointment to visit.
On the finance front, it was important to still maintain good relations and I ensured that I attended all the Financial Manager meetings. I also had a monthly meeting with the CFO to discuss any critical issues. There was initially quite a long list of complaints at these meetings, but, within three months, “supply chain” was the first agenda item, after which I was free to leave if I so chose. It quickly became part and parcel of “business as usual” as the initial uncertainties were resolved.
Because we were close to engineering, we were also close to production. We were now really in a position to add significant value to a mine’s profitability, whilst still keeping sound financial governance close to our hearts. In important decisions, we would always take the cross-functional approach and involve engineering, finance, production and safety. On occasion, we would also include HR, Projects and sometimes Security. This ensured early buy-in, which helped a great deal in avoiding problems and opposition that could have cropped up later.
A key benefit of this structure was that sound decisions could be taken to ensure optimal reliability and availability, which in turn led to optimal mine efficiency and improved production levels. This fact could not be denied by anyone, as performance measures were put in place and the figures proved this.
To summarize, the benefits I experienced with the CPO reporting into Engineering are as follows :
- Significantly easier access to engineers on site and a true willingness to collaborate. Engineers were more keen to buy into proposals as we attended the same meetings.
- The immediate focus was less on money and more on reliability, availability and safety.
- We followed a Total Cost of Ownership (TCO) approach, which implied that sometimes you would have to spend a little more initially, to save a lot later. Part of the TCO approach was Life Cycle Costing (LCC) which focussed on the total life cycle of items purchased, and a ‘cheap’ product or piece of equipment often proved to be very expensive over its economic life. Once the LCC cost drivers were understood by all, it was relatively easy to reach consensus on purchasing decisions.
- Joint strategy sessions ensured perfect alignment between procurement efficiency and engineering. We became mutually responsible for decisions in engineering purchases and this gave procurement the right set of conditions to become truly strategic.
- A critical part of any purchase decision would be ongoing service and the availability of spare parts to aid availability; this had a hugely positive financial impact over time.
- The Finance department was significantly more cooperative regarding sound decisions around expenditure and was more willing to adapt our rules to ensure strategy execution;
- The Head of Engineering would intervene in important/complex deals and get the CFO’s buy-in if there were ever any serious bottlenecks or opposition.
- Budgets became extremely easy, as engineering now supported budgets and the “fight” was thus half won;
- Everyone understood that you can save ten dollars on the initial purchase price, but lose thousands in lost production in a short space of time, and this shifted the focus from initial purchase cost reduction to trying to understand TCO and LCC. Gradually, cost reduction became an automatic outcome over the short to long term, depending on the material or service purchased.
Procurement efficiency is the end goal
In conclusion I should mention that now, 13 years later, this model has still not changed and I believe the spirit of undertaking and courage of the two key leaders at that time had a hugely positive impact on the company in terms of procurement efficiency. Both moved into higher roles soon afterwards. One has since retired and the other is now the Finance Director of another large global company. I look back at both of them with great respect! So although this proposition may sound like a step backwards to some, it can certainly work very well. It all depends on the company culture, risk appetite and the ability to follow through on tough decisions.