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INTRODUCTION: Why Procurement, and Why Now?

What Follows Is a True Story

Many years ago, I was at a cocktail party hosted for expats in London, with my wife. Many of those present were from the big New York investment banks. At one point, I started chatting with one of these individuals.

"So, what do you do?" he asked.

"I'm a consultant." I replied.

"Consulting in which field?" he asked.

"Procurement" I replied, at which point he looked at me with an expression of disgust and said, "Excuse me while my eyes glaze over," then turned around to signal that the conversation was over.

Now, that's very rude behaviour, but that's not the point. The point is that Procurement has such a poor image that it's not even deemed worthy of a conversation by those who consider themselves to be at the top of the business food chain. Procurement is just not exciting, and it's certainly not sexy.

Well, how exciting does it have to be? How about having the potential of increasing your EBITDA by a third? How about having the resilience to keep your supply chain up and running during a global pandemic? Procurement is an enormous profitability lever, and it should be a core competence-especially in modern times, in which companies accomplish more and more through outsourced relationships.

Yet in the majority of companies, Procurement is far from optimized, and there is a massive prize to be had if we could only do a better job. Since Procurement represents between 50 and 80% of a company's costs depending on the industry, and since most savings extracted from that spend flow straight to the bottom line, then I'd say that makes it interesting!

In this chapter, we will set the scene for the book, by examining why there is an opportunity in Procurement, what the size of the prize could look like, and why many companies have failed to cash in on the promise to date. At the end of the chapter, we provide some background to the book, along with an overview of what you can expect from the remaining chapters.

Let's now step right back and examine why there is an opportunity associated with Procurement. There are, in essence, two reasons: (i) Procurement is typically a company's largest cost bucket, and (ii) in most companies, that cost bucket is not optimized. Let's look at each in turn.

Procurement Is a Company's Number One Cost, Making It a Huge Profit Lever

Procurement represents between 50 and 80% of a company's total costs, depending on the industry. That feels like a big number, but that's just because external spend is not usually counted in one place. A company's external spend contains so many things (from office supplies to raw materials to factory maintenance services to energy, fleet, marketing, and IT), fragmented across so many business units, geographies and budget lines, that it's rarely seen in aggregate (see Figure 1.1).

OK, so the spend is big, but how big is the opportunity? In many companies that have not yet optimized Procurement, it can be very significant. Figure 1.1 looks at a typical manufacturing company, with revenues indexed to 100. Well, if you simply subtract from that 100 your EBIT (or add back in your losses), then take out depreciation and your whole salaries and wages bill, then what's left of the 100 is by definition externally procured. In this example (see Figure 1.2), that amounts to 60.60% of the revenue!

Figure 1.1 Procurement Spend as a Percentage of Total Cash Outflows

The next question is, how much can you take out of that 60? Well, a common mistake is to assume that "10% should be possible." Maybe 10% is possible, but not on the whole 60 of spend, at least not in the medium term, because some spends will be non-addressable or locked in, and there is always a "tail" of specialist one-off suppliers. These non-addressable spends can be significant, so it's safe to assume that maybe 60% of the 60 is addressable in the medium term. If your organization is global, you may also have a collection of very small, remote geographies whose spend may be too small to merit addressing in the medium term, which could reduce the 60% further.

In terms of how much can be saved, this of course varies by category and by company. But, long story short, a company that has not optimized Procurement, can look to take roughly 10% out of its addressable spend. In the worked example in Figure 1.2, that equates to a saving of 3.6 from an addressable spend of 36 (60% of 60). Given that the company had an EBIT of 10 going in, then that's a 36% uplift on a 10% margin. And that's before you factor in any Capex savings (which of course hit EBIT only indirectly).

Figure 1.2 Procurement's EBIT Impact

The beauty of Procurement is that this opportunity (or your spend) is spread across some 40 or so spend categories. This comprises a very diverse set of things (from Office Supplies to Logistics Providers to Raw Materials to Components.), each with totally different suppliers and its own internal stakeholders. Since a Procurement effort is best structured around category teams (see Chapter 3: Sourcing Execution), then this creates a natural portfolio effect across your target-one category may fail, but another will over-deliver. This portfolio effect is critical in Procurement economics, in that it significantly mitigates the risk of non-delivery.

At the end of the day, it would be difficult to find opportunities with as much potential impact on EBITDA as Procurement, without the need to reduce headcount, close offices, or make major investments. So, at least on paper, the Procurement opportunity is significant.

That's all very well in theory. But what about in practice? How do I know that the 10% is actually there? Why is there an opportunity in this cost base? Answer: Because in many companies, Procurement is not optimized. Let's examine why that is the case.

Why Is Procurement Not Optimized?

The opportunity in Procurement exists because in many companies, Procurement is not optimized. There are a number of reasons for this:

• Procurement comes from an administrative background, and oftenlacks the remit to take a strategic or proactive approach.
• Procurement therefore doesn't have the right cross-functional operating model, and sometimes adopts unhelpful mindsets.
• This results in an under-investment in people and tools, creating a vicious cycle of under-performance and under-investment.
• The end result is a spend base that's not optimized-not aggregated across locations, and with inconsistent specifications and dated supplier relationships.

Let's explore some of these points in a little more detail.

Remit

The point regarding remit is fundamental: it asks the question, what is expected of Procurement? Unfortunately, many Procurement functions do not have a remit to "work with the budget holders to proactively optimize their cost base using the full suite of supply and demand levers." Rather, the expectation is that Procurement will come in at the last minute to negotiate and execute the contract. That remit will allow Procurement to achieve maybe 25% of its potential. And therein lies the problem, or the opportunity.the Procurement function is probably doing a good job-but based on an overly narrow remit.

The root of this problem is that Procurement's history lies in administration. The function started life as a mechanism to legally procure goods and services on behalf of the business and is therefore seen as a support function-one that ensures that supplier contracts get signed and materials show up. Over time, Procurement teams have been built on these administrative foundations as their functions have evolved. In many organizations, the budget holder actually makes most of the decisions-from deciding what part is needed, to deciding to go with the OEM (Original Equipment Manufacturer) part to, very often, talking to the OEM and agreeing to a price. Only then is Procurement brought in, to close the deal, sign the contract, and order the part. And that's the typical remit.which ensures that probably 80% of the cost is already locked in by the time Procurement comes to the table, thereby severely constraining Procurement's potential contribution from the get-go.

Given this restrictive remit, it comes as no surprise then, that Procurement often hasn't developed anywhere near the right cross-functional operating model: see Chapter 5: Operating Model, for a more detailed discussion of this. To make matters worse, in the absence of a clear role, buyers can sometimes adopt unhelpful mindsets. Instead of adopting a service mentality along the lines of "I am here to help you with your spend," there is often a mindset based on perceived authority.

Mindset

We've seen unhelpful Procurement mindsets at countless companies; the most common ones I would describe as "the policeman" and the "Procurement professional."

The policeman is a historical legacy. Most Procurement organizations were set up to help get control of external spend, with a focus on purchase orders and necessary draconian policies of "if it doesn't...