FROM PURCASING TO PROCUREMENT ‘FROM BACK ROOM TO BOARD ROOM’

1. FROM PURCASING TO PROCUREMENT‘FROM BACK ROOM TO BOARD ROOM’ Brian I. Connett, PhD California State University, Northridge November 14, 2012

3. FROM BACK ROOM TO BOARD ROOM Buying was historically seen as a clerical or low-level managerial activity – essentially required to process and execute purchase orders initiated ‘higher up’ in the organization. So what has changed? Several factors. The most basic factor has been the recognition of the substantial dollar ‘spend’ for purchases in a typical organization. The next is the potential dollar savings from a viable procurement strategy.

4. FROM BACK ROOM TO BOARD ROOM Purchased goods and services are among the largest cost elements for most firms. In the ‘average’ manufacturing firm in North America, purchased goods and services account for about 55 cents of every sales dollar! By way of contrast, the average cost of direct labor in the manufacturing process accounts for about 10 cents 0f each sales dollar.

5. FROM BACK ROOM TO BOARD ROOM • Let’s first go back to basics, and look at the economic utility to which procurement contributes: • First is place utility. That means getting the required products to the right place. This might seem logical, but we all know how much disruption is caused when products are delivered to the ‘wrong’ place! • The second is time utility. Equally important, particularly in, for example, a J-I-T manufacturing facility. Getting products to where they should be when they should be there is critical.

6. FROM BACK ROOM TO BOARD ROOM • Next, let’s have a look at the objectives of an effective procurement strategy: • The first is continuous supply. • Stockouts of raw materials or component parts can shut down or force a change in production plans with the attendant cost. • Downtime due to production stoppage increases operating costs, and may result in an inability to provide finished goods promised to customers.

7. FROM BACK ROOM TO BOARD ROOM • Objectives of an effective procurement strategy: • The second is to minimize inventory investment. • In the ‘good old days,’ downtime due to material shortages was minimized by maintaining large inventories of materials and components to protect against potential disruption of supply. “Just in case,” or J-I-C! • But this is expensive, and requires scarce capital. • This requires balancing the costs of carrying inventory against the cost of a production stoppage. A ‘delicate’ balancing act indeed! • The ideal, of course, is to have materials and components available J-I-T! But let’s face it, that’s a tall order.

8. FROM BACK ROOM TO BOARD ROOM • Objectives of an effective procurement strategy: • The third is quality improvement: • The part procurement plays in an organization is critical to the contribution to quality. • The quality of finished goods is dependent on the quality of materials and components used. • This means the firm and its suppliers must be committed to a continuous quality initiative.

9. FROM BACK ROOM TO BOARD ROOM • Objectives of an effective procurement strategy: • The fourth is supplier development. • Successful procurement depends on locating and developing reliable suppliers. • Further, it requires working with those suppliers to achieve continuous improvement, a basic ingredient for TQM. • Close relationships are essential not only to maintain supplies, but also when information sharing of a confidential nature is required. This requires TRUST, which takes time to develop. • This perspective on effective procurement is in stark contrast to the ‘traditional’ focus which was on price alone, which inherently created adversarial relationships with suppliers.

10. FROM BACK ROOM TO BOARD ROOM • Objectives of an effective procurement strategy: • The fifth is to access innovation and new technology. • Many firms seek active collaboration with their suppliers as sources of innovation and new technology. • This is particularly important in the development of new products, but equally important in the improvement of existing products.

11. FROM BACK ROOM TO BOARD ROOM • Objectives of an effective procurement strategy: • The sixth is a focus on lowest total cost of ownership. • Ultimately, there is a significant difference in perspective between a traditional adversarial perspective, with a focus on purchase price, and the more contemporary collaborative procurement strategy which focuses on total cost of ownership. • Procurement professionals recognize that although the purchase price of an item remains important, it is only one part of the total cost for the firm. • A classic example is that of volume discounts which typically require larger than usual order quantities. But consideration must be given to the impact on logistics operations and investment in inventory.

12. FROM BACK ROOM TO BOARD ROOM • Developing an effective procurement strategy: • This is a complex process, requiring in-depth analysis of the most appropriate means to accomplish its many different objectives. • The first decision is the classic “make-or-buy” issue. • Next, alternative strategic approaches to dealing with external suppliers must be developed. • Finally, the appropriate strategic approach for the different types of products and services the company buys must be determined. • This will result in a procurement strategy portfolio.

13. FROM BACK ROOM TO BOARD ROOM • ‘Insourcing’ vs. ‘Outsourcing’ • First, it must be implicitly understood that outsourcing does NOT mean that the company is purchasing from a foreign supplier! Let’s face facts – we ALL ‘outsource’ many of our purchases to local suppliers of a host of items and services. • The real issue here involves the question of whether or not there is a distinct cost advantage, all other things being equal. It’s not just a lower price! • The two most important ‘qualitative’ issues are the potential loss of control and supply risk factors. • Finally, and extremely important, is the issue of intellectual property protection.

14. FROM BACK ROOM TO BOARD ROOM • Alternative Procurement Strategies: • The first, and simplest is called user buy. • Essentially, this allows ‘users’ in an organization to determine their own purchase needs, evaluate sources of supply, and execute the purchasing proess. • For example, it is very common for clerical staff to purchase basic office supplies, or for janitorial staff to purchase cleaning supplies. • The main determinant here is the dollar value of the items being purchased, which typically are too insignificant to the overall success of the organization.

15. FROM BACK ROOM TO BOARD ROOM • Alternative Procurement Strategies: • The second is volume consolidation. • This is typically accomplished though the reduction in the number of suppliers. • By consolidating volumes with a limited number of suppliers, procurement managers are able to leverage their share of a supplier’s business. • The benefits are to both supplier and customer. It allows suppliers to benefit from economies of scale, while giving the customer more ‘voice’ with the supplier. • BUT, the extreme form of volume consolidation, i.e., a single supplier, will increase the risk exposure for the purchasing firm. So a ‘balance’ in the numbers is crucial.

16. FROM BACK ROOM TO BOARD ROOM • Alternative Procurement Strategies: • The third is supplier operational integration. • This is by far the most sophisticated strategy, and typically involve alliances with trusted suppliers to reduce overall cost and improve operational efficiency. • This integration takes a variety of forms. For example, buyers may give suppliers access to sales forecasts and promotional plans thereby giving suppliers a ‘heads up’ as to what will potentially be required. • Another example is buyers and suppliers working together to identify processes involved in maintaining supply and searching for ways to redesign those processes to their mutual advantage. • The primary objective of operational integration is to cut waste, reduce cost, and develop a relationship that allows both parties to achieve mutually beneficial improvements.

17. FROM BACK ROOM TO BOARD ROOM • Alternative Procurement Strategies: • The fourth and perhaps the most sophisticated strategy is value management. • This is an even more ‘intense’ aspect of supplier integration, going beyond a focus on buyer-seller operations to a more comprehensive and sustainable relationship. • It is a concept that involves closely examining material and component requirements at an early stage of product design to ensure that a balance of lowest total cost and quality is incorporated into new product design. • The earlier a supplier is involved in the design process, the more likely an organization will capitalize on that supplier’s knowledge and capabilities.

18. FROM BACK ROOM TO BOARD ROOMFlexibility and Cost of Design Changes

19. FROM BACK ROOM TO BOARD ROOM • Procurement Strategy Portfolio: • The ‘Pareto Principle’ applies just as much in procurement as it does in almost every aspect of business. • A small percentage of the materials, items, and services acquired amount for a large percentage of the dollars spent. • The point being that LESS time, effort and the resulting cost should be expended on small volume, relatively routine purchases. • The key step in developing an effective procurement strategy portfolio is to do a spend analysis. • This will identify how much is being spent on each type of product or service across all locations in the firm.

20. FROM BACK ROOM TO BOARD ROOM • Procurement Strategy Portfolio: • The basic approach to developing this portfolio of purchased items is to evaluate them based on two criteria, potential supply risk, and the value of the item to the firm. • Then the portfolio of purchased items is further divided into four main groups: • Routine purchases, which typically involve a low percentage of a firm’s total spend, and involve very little supply risk. The appropriate strategy here would be to minimize purchasing effort, using such methods as blanket purchase orders, or even EDI.

21. FROM BACK ROOM TO BOARD ROOM • Procurement Strategy Portfolio: • The second main group is referred to as bottleneck purchases. • These represent a unique procurement problem, since they typically involve a small percentage of a firm’s spend, but the supply risk is high and lack of availability can cause significant operational problems for the buyer. • These are typically only available from a small number of alternative suppliers. • The appropriate strategy here would be to maintain multiple sources of qualified suppliers, and, if feasible, use long-term contracts to ensure continuity of supply.

22. FROM BACK ROOM TO BOARD ROOM • Procurement Strategy Portfolio: • The third main group are called leverage purchases. • Similar to routine purchases, leverage purchase involve little supply risk. • However, since these are often commodities, and alternative sources of supply exist, the dollar spend on these items is usually relatively high. • There is thus potential to consolidate purchases with a limited number of suppliers to obtain savings. • The appropriate strategy therefore is to concentrate purchases with the ‘best’ suppliers and seek operational integration where possible.

23. FROM BACK ROOM TO BOARD ROOM • Procurement Strategy Portfolio: • The fourth and final group are called critical purchases. • These are typically the strategic items and services that involve a high dollar spend, and are vital to the firm’s success. • Because of their importance and the risk involved, there is strong emphasis on concentrating purchases with a preferred, strategic supplier. • Needless to say, this is a prime example of where supplier operational integration and value management procurement approaches are advised.

24. FROM BACK ROOM TO BOARD ROOM • Organizational Procurement Process: • Organizational procurement is not an isolated act or event, it is a process. As such, it progresses through eight distinct stages. • Although each stage is distinct, and essentially every purchase decision progresses through each one, what happens in practice is that some stages are ‘abbreviated’ as a result of experience. • And in some situations, some of the stages are even ‘skipped,’ again as a result of experience.

25. FROM BACK ROOM TO BOARD ROOM • Organizational Procurement Process: • The eight stages are: • 1. Problem Recognition • 2. General Description of Need • 3. Product Specifications • 4. Supplier Search • 5. Acquisition and Analysis of Proposals • 6. Supplier Selection • 7. Selection of Order Routine • 8. Performance Review

26. FROM BACK ROOM TO BOARD ROOM • Organizational Procurement Situations: • Procurement executives will typically encounter three distinct types of procurement situations. The first is: • New Task: When the decision-makers in an organization perceive that the type of purchase being considered is totally “new” or different to anything they have experienced before. • Decision-makers then operate in a stage of decision-making known as extensive problem solving. • The decision-makers lack well defined criteria for comparing alternative products and suppliers, as well as any strong predispositions toward a particular solution. • This leads to the highest level of strategic procurement behavior.

27. FROM BACK ROOM TO BOARD ROOM • Organizational Procurement Situations: • The second is: • Straight Rebuy: When there is a continuing or recurring requirement, buyers have substantial experience in dealing with the need, and require little or no new information. • Evaluation of new alternative solutions is unnecessary and unlikely to yield any appreciable improvements. • This is routine problem solving, where buyers apply well-developed choice criteria to the purchase decision. • The criteria have been refined over time as the buyers have developed predispositions toward the offerings of one or a few carefully screened suppliers.

28. FROM BACK ROOM TO BOARD ROOM • Organizational Procurement Situations: • The third is: • Modified Rebuy: When organizational decision-makers feel they can derive significant benefits by reevaluating alternatives, or when technical issues mandate that such review is necessary. • This can also occur, of course, when the performance of present suppliers “slips.” • This situation involves limited problem solving, and usually requires somewhat more attention until the solution to the problem has been found.

29. FROM BACK ROOM TO BOARD ROOM Q: What has contributed to the phenomenal changes in the contemporary approaches to procurement? A: Rapid advancement in information technology has dramatically increased the ability to identify and understand trade-offs to enhance logistical and supply chain initiatives. The shared goal is to develop procurement relationships that meet internal service requirements at the lowest total landed cost.

30. FROM BACK ROOM TO BOARD ROOM • In sum, the benefits of an effective procurement strategy, working as part of the supply chain are: • To get the right product • To the right place • At the right time • In the right quantity • At the right cost • In the right condition • And with the right information

31. FROM BACK ROOM TO BOARD ROOM In the words of that well-known phrase: “You’ve come a long way, baby!” THANKS!