Supply management’s next evolution Maximizing value to remain relevant in a changing world
Contacts
Chicago
Cleveland
Florham Park
New York
Eric Dustman Partner +1-312-578-4740 eric.dustman @strategyand.pwc.com
K.B. Clausen Principal +1-650-353-1364 kb.clausen @strategyand.pwc.com
Al Kent Partner +1-610-291-8546 albert.kent @strategyand.pwc.com
Martha D. Turner Partner +1-212-551-6731 martha.turner @strategyand.pwc.com
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About the authors
Eric Dustman is a partner with Strategy& based in Chicago. He focuses on operations strategy as a source of competitive advantage for engineered products companies in industrials, automotive, aerospace, and high tech — with enterprise-level experience in manufacturing, strategic supply management, and supply chains. Al Kent is a partner with Strategy& based in Florham Park, N.J., and leads the firm’s manufacturing strategy offering. He focuses on cost transformations for industrial and infrastructure clients — with expertise in manufacturing, supply chains, and direct material sourcing. Martha D. Turner is a partner with Strategy& based in New York. She focuses on operational transformation and capability development for consumer and retail clients — with expertise in operations strategy, supply management, and supply chains. K.B. Clausen is a principal with Strategy& based in Cleveland. He focuses on operations strategy and strategic cost transformation for consumer product manufacturers and retailers, specializing in supply management.
Also contributing to this viewpoint was senior associate Jennifer Bhagwanjee.
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Executive summary
Over the years, many supply management organizations have evolved significantly, focusing not just on price but on total cost of ownership. But now they are being asked to do even more. We believe the next step is for sourcing organizations to move beyond “optimizing the buy” to “maximizing value” for the enterprise. For organizations accustomed to old ways of doing business, this won’t be as easy a transition as it may sound. Rather, it will require hiring new and retraining existing talent within the procurement organization to take part in strategic discussions and — critically — to become strong influencers within those discussions. We have observed four common practices among supply management organizations that are successfully making the transformation to focus on maximizing value. Each organization participates in (re-)architecting product and service designs, optimizing the supply base by tailoring suppliers to the demand profile, segmenting suppliers to better engage each in a distinct fashion, and, without fail, demonstrating bottom-line impact. What’s more, these sourcing organizations can contribute to a more strategic approach to cost management for the entire enterprise. We call this approach Fit for Growth,* and it is a proven method for focusing the enterprise’s resources on building the integrated capabilities necessary to drive growth and profitability in today’s business environment.
* Fit for Growth is a registered service mark of PwC Strategy& LLC in the United States.
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Maintaining momentum
Over the last decade, many companies have executed successful procurement transformations — driving enterprise-wide savings through a course of spend consolidation, pricing renegotiations, and demand management controls. The results were impactful and often exceptional, especially in “indirect” or support categories that netted double-digit savings. Yet today, even more is being asked of supply management organizations and many of them are running dry on new ideas for step-change improvements. We believe that in order to maintain the savings momentum, and to be recognized within the organization as a strategic driver of value, supply management organizations need to move beyond “optimizing the buy” to “maximizing value.” This might mean teaming with innovation and engineering, getting involved early in design decisions, creating tailored supply bases, establishing new relationships with true supply “partners,” and honing core supply management capabilities such as data analytics and value management.
Move beyond “optimizing the buy” to “maximizing value.”
This new way of doing business will require new skills, particularly the ability of sourcing leaders to influence and persuade executives within different lines of business. To this end, the organization may need to recruit new procurement talent and (re-)train existing talent differently. In fact, these news skills are sufficiently different from existing capabilities that some employees may not be able to adapt. But while introducing these capabilities into the procurement organization won’t be easy, the rewards are significant: greater sustained value than can be had from traditional price- and costfocused sourcing approaches.
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A Fit for Growth foundation
A sourcing organization with this focus on maximizing value becomes the foundation for a more strategic approach to cost management across the entire enterprise. We call this enterprisewide approach Fit for Growth.* The outcome is an adaptable, highperformance culture positioned on an accelerated path to sustained growth thanks to the institutionalization of capabilities that keep resources flowing to “good” costs and away from “bad” costs. In today’s business environment, every function is being asked to do more: drive out costs, promote growth, and handle complexity. Most organizations are finding that simply doing better within each function is no longer a reliable source of value. In fact, further “optimizing” within silos can be counterproductive since it sometimes limits flexibility to deal with the increasing complexity in the business and risks suboptimizing the whole. In other words, the key to unlocking more value is not just doing better in each function, it’s doing better across functions. Supply management is in a unique position to drive the creation of integrated capabilities and start the company on its Fit for Growth path for two main reasons. First, it sits at the nexus of internal stakeholders and external vendor relationships. Second, the supply management organization possesses a diverse set of skills that span business management and technical disciplines. Supply management is also a pragmatic place to start a transformation. Given that it oversees upward of 60 percent of the cost base, it has opportunities to deliver both near- and long-term sustainable value.
The key to unlocking more value is doing better across functions.
* Fit for Growth is a registered service mark of PwC Strategy& LLC in the United States.
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Four key practices to maximize value
While every company is different, we have found that supply management organizations that have moved beyond traditional sourcing to maximize value follow four common practices. They participate in (re-)architecting product and service designs and contribute to sourcing-related design changes in clear, quantifiable ways. The lion’s share of product and service costs is locked in at the design and specification stages. Too often these critical longterm decisions are settled before supply management is involved. Worse, many products and services can be overengineered and suboptimized for value — frequently because the true costs of the design choices are not fully understood upfront and not explicitly weighed against the value created. That creates inefficiencies across the value chain. Total cost of ownership is still important, but in today’s business climate taking a more holistic perspective is critical. Supply management needs to approach product and service design from a life-cycle return on investment (ROI) perspective — and participate in design decisions that factor in supply chain and value-based assessments, not simply unit cost performance. Strategy& uses our proprietary “ISSR Cost Driver Framework” to ensure all underlying drivers of cost (and value) are holistically considered (see Exhibit 1, next page).
Approach product and service design from a life-cycle ROI perspective.
The focus has historically been on the more transactional “realized” and “systemic” levers — for example, how we buy and how well we buy. While important, these levers can unlock only a finite amount of value. Moving farther up the spectrum to address what and from whom a company buys (the so-called inherent and structural levers) can allow a supply management team to tap far greater and deeper value. But these decisions require both earlier and broader engagement with internal and external stakeholders. Unlocking inherent and structural cost levers implies a new way of working. Supply management cannot simply demand to be part of the discussion. It must earn its seat at the table by working in conjunction with the business and functional units to deliver value, build its own credibility, and elevate its influence. Strategy&
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Exhibit 1 Strategy& ISSR cost driver framework Savings/ value impact Market requirements
“What (and how much) do we buy?”
Product / service design Supplier location, scale and utilization
“Whom do we buy it from (and why)?”
Supplier specialization
Inherent costs and value
Structural costs and value
Product / process technology
15–30%
Service requirements / SLA
Make vs. buy
Supplier factor costs and efficiency
Traditional procurement focus Policies and procedures
“How do we buy it?” Measurement and reporting Negotiated price
“How well do we buy it?” Volume discounts
Systemic costs and value
Realized costs and value
Tools and processes Re-bidding approach Timing of the buy
Compliance
2–10%
Source: Strategy&
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The results of supply management’s deeper involvement in product design can be dramatic. For example, in a departure from its typical redesign approach, a major industrial company decided to include suppliers and supply management in the redesign of a rail vehicle from the start. It was an experimental model. During this collaborative effort, supply management honed in on a slight “curve” in the design of the vehicle and calculated that this “curved” look was increasing the overall inherent material cost by more than 20 percent. A survey of customers revealed that few valued (or even perceived) the curved body design element. Ultimately the vehicle was redesigned with “flatter” side walls, lowering material, assembly, and life-cycle costs. The lower cost design enabled improved profitability and, notably, increased wins in the market. They optimize the supply base by tailoring suppliers to the demand profile. Historically, supply management would seek to consolidate and rationalize the supply base to drive greater economies of scale and negotiation leverage. This implies a one-size-fits-all model where cost is the only relevant parameter and demand requirements are uniform across each category of spend. However, a tailored supply structure within each spend category is often the best way to meet demand and extract the most value from the supply base. For example, the company might choose a large, efficient supplier for the highvolume, very predictable, and simple part of the category demand. But for parts that are lower volume, more unpredictable, and complex, the company might opt for a smaller supplier that is more flexible and can help innovate.
The thought of restructuring your supply base can drive tremendous impact.
While the thought of restructuring your supply base may sound daunting, it can drive tremendous impact. Supply strategies should be based on demand requirements, supplier economics, and capabilities specific to each spend category. This requires a deep understanding of cost drivers in the category (such as scale, utilization, factor costs, efficiency, and freight), as well as a segmented view of demand (such as volume, volatility, seasonality, and complexity). The intersections of supply economics and demand segments define the tailored supply models for each category.1 This process creates a more nuanced view of the types of suppliers your company needs to optimally serve different “slices” of demand in each category. They segment suppliers to better engage each distinctly. Most companies conduct supply-base analysis based on the size of spend and many even segment suppliers by dimensions such as risk and strategic importance. Surprisingly few, however, use the segmentation to inform how they engage, monitor, and collaborate with their supply base. As a result, companies tend to treat all suppliers in the same way even though their value to the organization can be vastly different. Strategy&
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A rigorous segmentation process can help to identify and differentiate price-based transactional suppliers, for example, from strategic suppliers that deliver products and services core to the company’s ability to deliver value (see Exhibit 2, next page). The best suppliers — and only a select few — are more than order takers or service providers; they are also innovation partners with a shared mutual destiny. These suppliers possess mission-critical capabilities from which the company needs to extract more value. For the small number of truly strategic suppliers, a company’s dialogue should not just be about price and service. To maximize total value the company should collaborate more closely, sharing business goals and objectives, understanding a supplier’s cost structure, sharing the innovation agenda, and, importantly, working together to drive efficiencies in the end-to-end value chain. Conversely, working in a more efficient manner with nonstrategic suppliers can free up limited resources to better focus efforts. The benefits of better engagement with suppliers are enormous. A few examples include: • A U.S. auto company engaged key suppliers to get their upfront design and technology guidance for a hands-free lift gate and active park assist; this collaborative process was instrumental in the company being first to market. • A global consumer packaged goods (CPG) company uses supply base segmentation to select a set of innovation partners who are incentivized to bring forward new concepts and solutions. It also uses its segmentation to inform broader sustainability and responsible sourcing initiatives.
The best suppliers are more than order takers or service providers; they are also innovation partners.
• A national retailer’s efforts to better engage suppliers has improved supplier performance, and shown the retailer where its own processes and requirements could be made more efficient. The company has reaped a step-change savings of about 10 percent. They demonstrate the bottom-line impact. Supply management organizations create value in many different ways. It’s not just about costs. The reality, of course, is that many CFOs tend to measure value based on this metric. And many organizations don’t adequately track costs or supply management savings — certainly not well enough for finance to sign up for them without considerable debate. Yet, for supply management to earn its seat at the table, it must demonstrate tangible and measurable benefits to internal customers. Savings should be tracked at multiple stages: targeted savings (run rate goal), identified savings (as shown through an initiative), planned savings (approved by 10
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Exhibit 2 Example of supplier segmentation
High
Core
Strategic
“Drive for efficiency and performance”
“Drive for value and advantage”
Partners that represent a large portion of spend but have more limited value creation potential and limited risk
Partners that provide products/ services that are core to Company’s ability to deliver value and manage risk
Transactional
Niche
“Drive compliance and minimize efforts”
“Tailor based on objectives” (mitigate, invest, grow)
Total spend / revenue impact
Partners that account for a small portion of the spend and have little or no value creation potential
Partners that can significantly affect Company’s ability to deliver value yet are small in spend
Low Low
High Business criticality and potential strategic impact
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Source: Strategy&
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the business unit/finance), and fiscal year savings impact (realized inyear). Ultimately, what matters is how much cash is pulled out of the P&L/budgets and falls to the bottom line.2 That said, cost-avoidance benefits should also be tracked since they can generate real value to the company. To demonstrate its bottom-line impact credibly, supply management needs to articulate total costs and profit impact, not just savings. A common refrain of one chief operating officer to supply management was, “You keep talking about all these savings, why do my costs keep going up?” Supply management couldn’t answer this question until it developed a cost bridge to demonstrate that the savings were real. More important, the bridge also highlighted cross-functional opportunities. Supply management launched an initiative with sales and marketing to ensure raw material inflation was considered in the pricing strategy, and teamed with product development, marketing, and engineering to drive design-to-value efforts (see Exhibit 3, next page).
What matters is how much cash is pulled out of the P&L/budgets and falls to the bottom line.
Supply management organizations should remember that internal stakeholders are often less interested in the specifics of how much any one initiative or sourcing event yields, and more interested in how their competitive cost position is improving. Focusing on total cost management and “bending the cost curve” are the best ways to measure the impact of sustainable supply management.
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Exhibit 3 Example of cost-to-cost bridge Total DM cost
Market drivers Business drivers
$11.7MM
$2.9MM
Procurement drivers $1.4MM
$3.9MM
$699.4MM
Other
2014 Realized DM costs
$21.8MM $24.6MM
$3.9MM $36.9MM
$641.6MM
2013 Realized DM costs
Volume effect
Mix effect
Design changes effect
Market price effect
F/X effect Compliance Procurement effect initiatives
Source: Strategy&
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Seize the opportunity
The opportunities for maximizing value are not theoretical. Some companies are already leveraging these techniques. A Strategy& client recently set out to make supply management a source of long-term competitive advantage. A leader in the furniture industry, the company had a long history of excellence in sales and marketing, but had always treated operations as an afterthought. By collaborating with suppliers across functions, supply management evolved from focusing on routine request-for-proposal (RFP) events to developing differentiated strategies for each spend category and building the right supply base and relationships. Internally, supply management became the catalyst in thinking differently about product design, in involving supply management (and key suppliers) early in the design cycle, and in making explicit, rigorous cost-value trade-offs. Within a year of launching the program, the client is on track to deliver a 20 percent reduction in cost of goods sold (COGS) while improving customer service. Over half of the savings are driven by supply management. This next step in supply management’s evolution is critical in today’s business environment. Consider this: While more than 90 percent of large companies grew revenues over the past five years, 50 to 60 percent of them did so with declining profit margins. This performance gap creates a dual imperative for operations. Companies must build the capabilities required to enable growth and manage more complexity while simultaneously reducing costs across the supply chain.
The logical place to start building integrated capabilities is often supply management.
To meet these challenges, the entire enterprise must build new integrated capabilities and become ready for growth. The logical place to start is often supply management because it sits at the nexus of internal stakeholders and external vendor relationships, and because it possesses a diverse set of skills that span business management and technical disciplines. What’s more, since supply management controls up to 60 percent of the cost base, opportunities often exist for relatively quick wins. These early wins can build momentum for — and sometimes “self-fund” — the broader enterprise-wide transformation. 14
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Endnotes
For additional perspectives on this idea, see “Smart Customization: Profitable Growth through Tailored Business Streams,” www.strategy -business.com/article/04104?pg=all. 1
For more information, see “Off the Table, into the Pocket: Capturing Procurement Savings,” www.strategyand.pwc.com/global/home/what-we -think/reports-white-papers/article-display/table-into-pocket-capturing -procurement. 2
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