(From Supply Chain Standard, September 2012)
With greater supply chain risks and increased complexity, do we have the right structures and people in place to realise the potential of intelligent procurement?
The commercial environment in which most businesses operate today is very different from the relatively benign and predictable conditions that existed just a few years ago – it is now a landscape characterised by great uncertainty.
A heightened exposure to risk throughout the supply chain is the new norm.
Volatility in commodity prices, low economic growth, currency issues and an increased potential for supply chain disruption are factors that the procurement function must contend with and manage if businesses are to remain competitive.
But are our supply chains attuned to the radical changes that have occurred? Is the way we procure goods and services correctly aligned and appropriate to the different markets we serve?
Prof Alan Braithwaite, chairman of LCP Consulting, sees a need for change.
“I’m profoundly depressed by some of the purchasing and procurement practices in relation to their failure to unlock value.
I think procurement is due for a really fresh look and I believe companies need to position it differently under organisational structures,” he says.
“Purchasing and procurement has really adopted the driving concept behind category management, and I don’t have an objection to that at all, because buying low pressure equipment for a hospital is a different market from buying stationery for a university and most organisations will need to buy across a number of different categories,” he says.
“So you need those category specialists who understand the supply base and understand the market. But if you look at the wider picture of the processes that are then adopted to identify and deal with suppliers, the argument is that category management isn’t the whole answer, because increasingly, procurement is not going to be about exercising a power relationship with a supplier, it is going to be about recognising the appropriate relationship for the supply market.”
Braithwaite acknowledges there are plenty of markets that are efficient due to good price visibility, such as with commodities like oil and food ingredients, but he says companies are still vulnerable to volatility.
“So you have got to have processes in place, right the way back into the business, to recognise that you are going to have to deal with that [volatility] and that requires a completely different mind-set from thinking that you can exert power which mostly, in those markets, you can’t.
“So you have got to harness the market to your best advantage to mitigate risk and you’ve got to make sure that the business is responding.” he says.
In areas of supply where the market is very narrow, Braithwaite believes that dealing with those suppliers on a power basis only leads to the lower common denominator as a result, where “both sides retreat to the trenches and value is left in the middle”, he says.
There is a need for closer collaborative arrangements with key suppliers that are critical to the business.
In advanced relationships the sharing of risk may be re-apportioned, but then too, so should reward.
Braithwaite cites a concept developed by Vargo and Lusch some years ago called Service Dominant Logic where suppliers play a deeper role in their customers’ supply chains, taking responsibility for system performance and charging accordingly, based on delivered value.
“You’ve got to decide what it is your supplier does, what you want your supplier to do, and how you are going to pay him for that,” he says.
By way of example, Hilti has generated a “use model” for power tools on construction sites.
“So this is effectively looking for completely new business models and new supplier relationships which take cost and waste out of the buyer’s chain faster than they add cost and waste in the supplier’s chain, and the consequence of that would be the supplier makes money and the buyer actually operates on a lower total cost,” he says.
Braithwaite sees the role for procurement going forward as one of supplier development, “Where you are encouraging the supplier to come up with new offers and you are transferring risk and payment – so it’s not just risk, it’s not just appropriating value from suppliers, it’s a question of understanding how that risk falls,” he says.
“My argument is that that requires a completely new skill set. It puts purchasing absolutely at the centre of business model design. And as yet, you are not hearing about businesses talking about it in a structured way and setting their organisations up to address those opportunities.”
However, the closer the collaboration with a supplier, the more dependent the buyer is on a particular supplier and, perhaps too, the greater the risk if anything goes wrong.
Dan Quinn, new sector development director at Achilles believes before entering into any such contract – and throughout the life of the contract – the buyer must be sure to conduct validated checks on supplier data, to ensure they are compliant across the many areas of potential risk – such as health and safety, insurance, corporate social responsibility and financials.
Reflecting this, findings from research conducted by Achilles and IFF Research into “Attitudes to supplier pre-qualification” indicates that chief procurement officers (CPOs) regard a supplier’s ability to deliver in terms of quality, timeliness and cost as their most important risk to manage.
Some 75 per cent put it in their top three risks. Quinn suggests: “Shouldn’t we be planning and mapping out our critical supply chains with regards their exposure to risk, both natural and otherwise? How aware are we of the full spectrum of issues – particularly from our suppliers – that present significant risk to our supply chains and to company share value? What is clearly needed is a more holistic view of supply chain risk,” he says.
“Supply chain risk comes in a multitude of forms, ranging from physical disruption due to natural disasters, transport failure or civil unrest to the financial impact of a supplier going out of business or damage to reputation from a supplier using child labour or failing to comply with health and safety standards,” says Quinn.
“Then, of course, there are risks surrounding exposure to fraud, litigation and corporate social responsibility issues. All these risks hold the potential to impact share value and frequently, they do.”
The Achilles research reveals that 43 per cent of businesses are aware of a high-risk supplier failing to meet compliance requirements.
In addition, eight per cent of organisations interviewed believe that more than half of their suppliers are “high risk” – defined as suppliers whose “financial failure, failure to deliver or failure to comply with relevant legislation or regulation would cause significant financial cost and/or reputational damage” to the buyer.
“There are plenty of examples of companies whose reputation and brands have been badly damaged by a supplier, or sub-supplier, being non-compliant with a buying organisation’s Corporate Social Responsibility (CSR) policies,” he says.
“In recent years considerable exposure in the press over the use of child labour at suppliers has affected major consumer and retail brands such as Nike, Primark and Gap.”
However, results of the Achilles research indicate that 62 per cent of buyers seem to be relatively unconcerned about the risks suppliers present to the reputation of their business, with only 38 per cent ranking it in their top three most important risks to manage.
Larger companies are more in tune with exposure to CSR issues, with 23 per cent of organisations with turnover between £250 and £999 million, putting their most important risk faced as managing their brand and reputation, while smaller companies are more focused on financial risks.
Mitigating the risks presented by suppliers is dependent on having accurate supplier data.
However, Quinn points out: “Most CPOs are unaware of the poor state of their databases and are consequently at great risk.”
Jason Adderley, a consultant with Expense Reduction Analysts, believes companies are now looking far more closely at procurement. “A lot of organisations have been through substantial “cost-downs” in the last four or five years, but largely these [activities] have centred on human capital rather than what they buy,” he says.
“And I think a great number have gone as far as they can on that trail without affecting the way the company operates.”
“What we are finding is that people are very good in their comfort zone, with their core purchasing,” he says.
But he believes there is scope for companies to push back into their supply chains and this is where Adderley has been helping companies, in removing unnecessary links in the chain and forging direct contact with suppliers further back in the chain.
“Essentially, we have been helping with direct sourcing from China,” he says.
“Virtually everybody is in that game at the moment. I work with an organisation that historically made brass castings in this country, but they are now sourcing everything from China – even if it means some reworking over here.”
However, is it still the case that outsourcing to places like China offers the most competitive overall solution for companies? Labour costs are rising and supply chain risks introduced by increased distances and complexity may create significant challenges. A great deal depends on the products in question and the responsiveness and agility the company needs in the markets they serve.
There may be other factors too. Adderley says, “Certainly a lot of organisations are taking advantage of the regulatory advantages of being off-shore, because there are not so many environmental regulations and nowhere near the same level of employment regulations.
We have a client that sources printed packaging from China – cardboard boxes and branded point-of-sale items – and you would never believe that it’s cheaper to ship that material in, but it is.”