The Discovery of Procurement Value
Procurement value demystified
Unfortunately, "procurement value" became another buzzword – everyone tells us to generate, capture, and sustain it.
This post attempts to provide the most comprehensive view on procurement value and practical methods of its realizations compared to many other web sources replicating slogans and mystifying logical and straightforward concepts.
The meaning of value
Value is not substantive. It is rather adjectival. It characterizes something or results from the application of something. It doesn't exist in its raw form; it's being created. It's a universal differentiator between good and bad things or actions.
This 1914 philosophical article defines value as the object of proper judgment. How easier does it make the explanation of value? The value is equally apparent for those who know the truth.
Therefore, we will give different definitions, not pretend to have found the unilateral value formula.
Value is paramount to procurement evolution.
The following pyramid of procurement evolution puts the value proposition at the chart's top.
What does this evolutionary pyramid give us besides intelligent visualization of the consultant slogan on value domination? It instead recites everything we need to become to get to the top but does not sufficiently explain how to realize that we reached there.
Yet, it is helpful to understand that we need to master the basics, then the cost, and, at last, the demand. It is agreeable that demand management is the sign of ultimate procurement professionalism.
This section suggests that value is paramount to procurement evolution.
Procurement value in the context of dynamic capabilities.
We have already touched upon the concept of dynamic capabilities that significantly impact a firm's competitiveness.
Therefore, value is the ability to contribute to a competitive advantage.
Value creation as the result of stakeholder engagement
The authors of the Stakeholder Salience model built their work around the value creation process.
The value creation process includes:
- quality and customer service,
- supplier relationship,
- employee enrichment,
- community benefit,
- stockholder reward.
The business must engage stakeholders to create, trade, and sustain value effectively.
Such engagement is achieved by applying the Stakeholder Work System, which consists of five activities: awareness, identification, understanding, prioritization, and engagement.
When this system works in harmony, which the theory calls a "consonance," the value is effectively created and distributed.
Best Value Procurement
Our post about the Best Value Procurement concept defined value as the layer of value-add opportunities beyond the layer of deliverables.
The fight for discounts will lead to applying either of three project management levers - Time, Budget, or Scope - and the inevitable quality deterioration.
Therefore, we need to seek value beyond the mandatory deliverables!
Value-based procurement
This is another concept where "value" and "procurement" create the title.
We explained value-based procurement in detail in this post.
Briefly, it is the next step from TCO-based supplier selection. It assumes that the winning bid includes solid commercials and non-material benefits, e.g., improvements in end-user experience.
Such an approach may be accused of subjectivity. Therefore, its adoption is still very slow, especially in public procurement.
Value as the downstream effect of procurement
Value is the downstream effect of procurement resulting in market changes, customer satisfaction, and social contribution.
Procurement value proposition
Due to the ambiguity of definitions, some people treat value only as monetary worth; others claim its delivery as soon as they enter the office.
In fact, the procurement value proposition includes both intrinsic (non-monetary, e.g., social and environmental) and extrinsic (economic) values.
Extrinsic values
Traditionally, procurement is perceived to deliver one type of extrinsic value – savings. However, procurement value offering could be much more comprehensive:
Cost savings
- Cash. To qualify for this type of savings, we need to generate an immediate effect on the P&L of the current fiscal year, i.e., reconcile such savings against respective business area budgets.
- Cost avoidance
- Future years. Any savings attributable to the future periods beyond the current fiscal year is treated as cost avoidance because future P&L will account for it.
- Different deliverables or service level improvement. You may have negotiated extra physical items or software licenses above the existing need, extended the warranty period beyond the default, or improved the SLA from Bronze to Silver. This outstanding achievement will only improve an immediate P&L, hence cost avoidance.
- The cost increase avoidance. Commodity or CPI index-related prices (e.g., labor-intensive services) can be reviewed periodically per the contract provisions. It is difficult to foresee the value of such an increase, so it's randomly being budgeted. If you managed to fully or partially waive it, then it's cost avoidance.
- Demand reduction. Arguably, the most essential type of saving was reconciling it against the budget. While a 5-7% year-on-year price reduction is perceived as a good result, you may eliminate up to 100% of wasteful demand.
- Cash flow improvement is achieved by negotiating favorable payment terms and using supplier or country-of-origin trade financing vehicles. Saving is calculated based on the cost of capital throughout a deferred payment period.
- Balance sheet savings (inventory/working capital) are achieved by reducing inventory or capital expenditure. Procurement must work closely with the supply chain to optimize depreciation exposure to sell or dispose of slow-moving or obsolete inventories.
- Transactional cost savings should be claimed when the automation and/or process improvement resulted in decreased transactions, e.g., POs. Identifying the cost of the trade is crucial to claiming that benefit.
- Labor costs could be claimed if procurement efforts reduced headcount, i.e., decreased transactional workload. Just releasing an officer from PO generation duties and loading them with other tasks is not good enough – resources need to be removed or repurposed, and respective payroll costs should be eliminated or moved to another cost center, e.g., by transferring a procurement officer to customer service. In contrast, that cost center stopped a vacancy.
- Procurement could influence staff retention by creating favorable job conditions for own personnel or influencing staff satisfaction company-wide. There is a cost attached to the recruitment and onboarding of the new staff, and if the attrition in the procurement department is lower than in the company overall, you may claim the benefit. Affecting company staff satisfaction generally, e.g., delivering a special discount and promotional program from suppliers to company employees, takes a lot of work to measure. Still, you can work with HR to identify specific metrics.
- Future years. Any savings attributable to the future periods beyond the current fiscal year is treated as cost avoidance because future P&L will account for it.
- Different deliverables or service level improvement. You may have negotiated extra physical items or software licenses above the existing need, extended the warranty period beyond the default, or improved the SLA from Bronze to Silver. This outstanding achievement will only improve an immediate P&L, hence cost avoidance.
- The cost increase avoidance. Commodity or CPI index-related prices (e.g., labor-intensive services) can be reviewed periodically per the contract provisions. It is difficult to foresee the value of such an increase, so it's randomly being budgeted. If you managed to fully or partially waive it, then it's cost avoidance.
- Demand reduction. Arguably, the most essential type of saving was reconciling it against the budget. While a 5-7% year-on-year price reduction is perceived as a good result, you may eliminate up to 100% of wasteful demand.
- Cash flow improvement is achieved by negotiating favorable payment terms and using supplier or country-of-origin trade financing vehicles. Saving is calculated based on the cost of capital throughout a deferred payment period.
- Balance sheet savings (inventory/working capital) are achieved by reducing inventory or capital expenditure. Procurement must work closely with the supply chain to optimize depreciation exposure to sell or dispose of slow-moving or obsolete inventories.
- Transactional cost savings should be claimed when the automation and/or process improvement resulted in decreased transactions, e.g., POs. Identifying the cost of the trade is crucial to claiming that benefit.
- Labor costs could be claimed if procurement efforts reduced headcount, i.e., decreased transactional workload. Just releasing an officer from PO generation duties and loading them with other tasks is not good enough – resources need to be removed or repurposed, and respective payroll costs should be eliminated or moved to another cost center, e.g., by transferring a procurement officer to customer service. In contrast, that cost center stopped a vacancy.
- Procurement could influence staff retention by creating favorable job conditions for own personnel or influencing staff satisfaction company-wide. There is a cost attached to the recruitment and onboarding of the new staff, and if the attrition in the procurement department is lower than in the company overall, you may claim the benefit. Affecting company staff satisfaction generally, e.g., delivering a special discount and promotional program from suppliers to company employees, takes a lot of work to measure. Still, you can work with HR to identify specific metrics.
Revenue
- Sales of company products/services through reciprocal buying agreements with suppliers. This is among the most potent revenue generation sources in any sizable deal negotiation. Some companies run dedicated programs with their supplier base with revenue targets, standard contract clauses, and tailored SRM activities.
- Rent/lease of company assets could generate regular revenue streams. Some companies, e.g., telco operators or government entities, possess diverse property assets – offices, technical buildings, and warehouses. It is possible to optimize the internal use of those spaces and sublease it. Suppliers can rent small spaces in airport lounges, sales offices, and customer service centers to install their kiosks. They can rent a desk in your office for a sales agent if they run any dedicated staff promotion.
- Revenue share agreements are helpful for any third-party business that serves your clientele, e.g., visa or travel insurance for airlines, mobile devices, accessories for telco operators, office food catering for any large company, etc. Even a tiny car-washing company serving your employees in the office parking space could provide a revenue share.
- Marketing revenue is achieved through sales of company marketing assets. The company may sell the naming rights, brand an aircraft to promote a computer game or sports event, or serve beverages to service center visitors in supplier-branded paper cups. Nowadays, one of the most valuable marketing assets is your digital ones – website, mobile app, social channels, and customer e-newsletters – all of which could be monetized through your suppliers' targeted campaigns.
- Sales of obsolete assets can generate small revenues and help to offload the balance sheet. You may sell significant technology assets to specialized brokers, old company cars, retired IT devices, and unused campaign promotional materials - to the employees or the general public on e-auctions.
- Time-to-revenue is another uncommon benefit that could be measured and reported. Suppose a business case forecasted a new technology platform's delivery, generating $100,000 new monthly revenue in 12 months. Procurement completed the source-to-contract cycle one month earlier and worked with a preferred supplier to optimize the delivery and deployment time by a further two months. Then, procurement may lawfully claim a $300,000 revenue benefit from achieving the commercial launch three months earlier than planned.
Intrinsic values
Intrinsic value refers to an investor's perception of the inherent value of an asset. Procurement is one of the company's assets, so this section will discuss procurement's perceived value. Apart from the monetary values identified above, we must analyze what makes us valuable or essential to the company.
- A relationship is the number one value of procurement. We sit in the center of the network formed by our suppliers, stakeholders, employees, and customers and effectively influence them.
- Support. It is expected by stakeholders and suppliers as the default value of procurement. We must smoothen and optimize the operational processes, orchestrate the supply chain, and carry the mandatory paperwork burden.
- Moderation. Procurement is expected to resolve conflicts between stakeholders and suppliers and balance the continuity of contract obligations and performance requirements by end-users. Procurement needs to act as independent arbitrators that do not take sides and pursue the interest of the business as such, not a business unit.
- Advice. Procurement should advise on mandatory processes, commercial viability, supplier relationships, and supply chain management and support their advice with comprehensive data and logical structures. Procurement opinion should complement subject matter expertise to independently provide a holistic view of a subject.
- Satisfaction. Procurement performance should be primarily measured by the joy of the value chain actors – stakeholders, suppliers, employees, and customers. Our role is somewhat like air traffic dispatchers – we do not operate the individual elements of the value chain but interconnect, orchestrate, and align those, and, therefore, we need to maintain everyone's involvement, security, and satisfaction at an acceptable level.
- Risk management and relationship management are the future of the procurement profession. We need to aggregate multiple streams of information – global economic and political trends, market and industry dynamics, supply base analysis, and local specifics - into a single dashboard and provide early warnings, mitigation plans, and operational overhauls to various types of risks. There is no other company function better suited for these tasks. We have the most extended reach within the supply chain and can aggregate and analyze multiple views from the inside and outside the company.
- Brand. Procurement directly affects brand values, especially
- Quality. Whatever the company's business strategy requires – premium materials or low-cost yet reliable ingredients – we ensure the best fulfillment of quality requirements.
- Affordability. Procurement has the most substantial influence on the cost competitiveness of company products and services.
- Availability. As long as procurement is not detached from the supply chain management and S&OP processes, we are the ones to orchestrate the inflow of materials and services into the production process to maintain the required availability standards.
- Social.
- Sustainability
- Integrity
- Community support
- Charity and disaster recovery.
Let's not forget that value generation is the top expectation of the business regarding procurement contribution.
We must provide diverse intrinsic and extrinsic value offerings to secure our place in the future business model of Industry 4.0.
The evolution of procurement value proposition
As the evolution of procurement as such goes on, so does the procurement value.
In the last decade, we expected procurement to source high-quality products and services at the lowest cost and ensure timely supplies.
Presently, the procurement value composition has become way more complex. Procurement is expected to
- satisfy demand,
- deliver on the plan,
- accommodate that demand within the budget,
- follow the right process,
- ensure compliance with corporate standards (technical, environmental, social, etc.)
- manage supply and reputation risks.
Such complexity dictates the path for procurement evolution as a function, which leads it well beyond the comfort zones of governance and savings.
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More information on this and other exciting topics can be found in "The Technology Procurement Handbook." It represents 23 years of experience, billions of dollars worth of successful sourcing projects, and 1000s of hours spent on research, analysis, and content creation for the most demanding professional readers.
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