The New Darwinism of Procurement: Turn Strategic or Disappear
Last updated Jan 30, 2022 - 5 min read
- Table of Content
2020 has been a year that's made companies across the world completely rethink the way they do procurement. As opposed to the common belief that the pandemic has made the environment more challenging, in reality it's made the need for procurement transformation all the more critical.
We at Ignite believe in the vital role strategic and data-driven procurement can play in helping organizations recover from the current economic crisis. If you ask where this belief stems from, the answer is simple: Procurement has done it in the past and can do it again.
To understand this better, let's take a look at this research from McKinsey and Company. According to this research, companies with robust procurement functions saw valuations return to pre-GFC levels an average of three years faster and were able to lower costs of goods sold (COGS) as a percentage of revenue. Both these factors resulted in improving EBITDA by three percentage points more in comparison to the bottom performers.
The research further highlighted that in five years following the global economic crisis, total return to shareholders (TRS) for companies with top-quartile procurement capabilities was 42 percent higher than for companies whose procurement operations were in the bottom quartile.
How COVID 19 Changed Procurement?
More than ever before, the current pandemic-related disruptions demand procurement professionals follow a flexible approach that focuses on value creation, innovation, and sustainability.
The needs and functions of the present-day procurement are no longer similar to those of yesteryears. Current procurement strategies demand a lot more than just cost savings. New words like sustainability, quality, innovation, and efficiencies are slowly cropping up - for all the good reasons - in the boardroom discussions.
The COVID-19 crisis has also lead to widespread supply chain disruptions and changes in the way consumers behave. And this isn't the end of the story sadly, the COVID pandemic isn't a short-term crisis. What we've experienced so far is an initial blow of the economic crash, the ripple effects of which will keep seismically moving through our economy in years to come.
These challenges point towards a new reality that calls for establishing a base to build long-term resilience capabilities to outmaneuver future uncertainties. This atypical risk event has triggered the need for adopting flexible and agile procurement functions along with resilient and responsive risk management capabilities to survive the recent crash and thrive as economies start to recover.
That said, though cost reduction might seem like the immediate and easy tool to fix the balance sheets, this pursuit of cost shouldn't come at the expense of quality. Additionally, to make procurement a strategic force, price should share the spotlight with other crucial criteria that support the implementation of the overall company vision.
Using Goodhart's Law to Move Beyond Cost
Still, a majority of the procurement functions across the world are obsessed with the cost KPI. But the fact is, cost KPI has become one of the most misunderstood concepts in the procurement industry.
For instance, take this scenario: A company with aspirations of moving up in the market has a procurement function that's driven entirely by the cost KPI. Keeping this KPI in mind, this company was able to achieve its motives by switching to a lower price but at the expense of compromising the quality of its providers. Considering the overall organizational goal of this company, wouldn't you instead term that KPI as the reason behind making the company's overall performance not up to snuff.
That is precisely what Goodhart's law states, "when a measure becomes a target, it is subsequently no longer a good measure." Charles Goodhart was a British economist who observed that when an indicator becomes a target, it inexorably ceases to function as that indicator because people start to game it.
Instead, what can be done is moving away from a fixed rule and towards a forward-looking or key KPI that covers multiple criteria and can drive decision-making.
How to Plan and Prioritize Your Procurement Initiatives?
Procurement involves multiple steps that require a lot of preparation, coordination, and collaboration techniques. Naturally, the sheer volume and complexity of the processes involved in the function ask you to sit back and look within to figure out what the organization really needs. It's only then that you can look up and say: "We know how to fulfil that need best."
Thus, the procurement strategy should take into account the overall organizational need to figure out the right way of moving forward. These initial steps set the stage for creating a system that can regulate the overall direction of activities for achieving key organizational goals.
The foundation of any procurement strategy depends on a comprehensive understanding of spend data and how you slice and dice it. Kraljic Matrix is one such effective analytical tool that identifies areas of improvement in your procurement strategy by classifying spend categories depending on two key factors: strategic importance of procurement and complexity of the supply market.
This simple yet significant concept delivers an initial framework to prioritize purchases and accurately segment them for the category management process.
Category management is a circular exercise that involves many internal an external decision-makers and processes. When managing categories, procurement must follow a structured approach that considers factors like risk assessment, value levers, latest market developments, and strategic supplier relationships, to name a few.
These fact-based analyses tend to spark your thinking and help you formulate strategies to guide procurement activities. The strategic classification also lays the foundation of transparency, and the initial insights for creating value beyond the cost savings soon begin to emerge.
Now you have all the strategies and insights your need, but the real work only begins when you list the initiatives, tactics, and action plans to deliver the results. Here, a Prioritization Matrix helps you to plan your project and efficiently implement your initiatives to see progressive results.
The current market landscape is complex and competitive, to say the least. While embracing this reality, procurement must show readiness to listen to what the situation demands. The way forward is a structured and well-defined approach to recognize and lever potentials.
This transformational journey asks procurement to emphasize what more it can do and how it can remove the roadblocks to growth and innovation. Today's conversation is all about making the world realize the crucial part strategic procurement has in driving this solution forward.
Want to learn more about how you can plan and prioritize your procurement initiatives? Watch our instant on-demand webinar on Setting Procurement Up for Success in 2021.