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Five thingsGetting the basics right in procurement
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Many procurement functions put large savings numbers up inlights
when contracts are signed, then clock-off leaving theexecutive
wondering where all the money has gone. When donewell, contract
management can deliver on the promises madeand make sure you get
what you signed up for.John EvansExecutive Director, Ernst &
Young, New Zealand
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Five things you should expectfrom your procurement functionA lot
can be achieved by doing the simple stuff well
Has the desire to improve the efficiency andeffectiveness of
procurement created unnecessarycomplexity? Have we become
technology led ratherthan technology enabled? Do
procurementtransformations rely too heavily on complex processre
designs rather than focus on getting the basics right?
In many government and commercial organisationsprocurement has
now become recognised as a fundamentalenabler of business strategy
and a preferred method forachieving sustainable cost reduction. It
is often a source
enablement and a window into understanding what is reallygoing
on in operations through data and information.Based on our
experience in working with organisationsto improve their
procurement outcomes, we believe that
your procurement function right now. If you are unable to tick
these boxes chances are that money is being left on thetable,
commercial decisions are being made in isolation fromthe business
and antiquated processes and systems are abarrier to realising the
full potential that procurement candeliver. Furthermore, compliance
to strategy and processwill be encumbered by the increasing cost to
change.
It is our point of view that your procurement function
should:
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4
5
Have a detailed spend map across your entireorganisation,
updated quarterly.
Be a driver of sustainable savings (when, where,why and how)
across the organisation.
Be engaged with the wider organisation to understandhow
procurement can reduce costs across thevalue chain.
Ensure that value is realised through contractmanagement and
supplier relationship managementframeworks which are
operationalised.
Be delivering procurement within an operating modelthat connects
commercial and technical capabilityto drive optimal client
outcomes.
1Five things: Getting the basics right in procurement
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OneProcurement spendmapDo you understand your spend at an
organisational levelrather than just a divisional or geographic
level?
Most organisations do not have a spendmap and rely onpoor
quality information including summaries of generalledger categories
or spend by a supplier. A spendmapcan provide you with the basis
for identifyingopportunities and risks, providing the foundation
forcost reduction initiatives and improving the value youreceive
from your suppliers.
Mapping spend, and regularly updating that map, will give
youinvaluable insights which include:
Knowing what your total spend isWho is spending and on whatWhich
vendors supply multiple business unitsWhich business units buy the
same or similar goodsand servicesWhat portion of your spend is with
the core suppliers(e.g., top 10) and the total number of one off
and smallvalue transactions suppliersHow many transactions your
organisation processesand the associated administrative cost
The challenges in analysing spend and preparing thespendmap
should not be underestimated. The key is to ensureall data and
information repositories are captured and thatrules are in place to
establish cost categories and buckets .
time the information is surprising for many and is
quicklyutilised to assist with decision making and informs
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published I didn't know that and do we really spend that
procurement function to better manage up, down, in and out.Steve
Moore
Executive Director, Ernst & Young, Australia
Category Analysis Am I buying the same/similar goods and
services from different vendors or too many vendors?
We then categorise all of the spend transactions into the most
appropriate sub category. Our reporting then allows you to explore
your spend
Item Analysis Am I buying the same item from different vendors,
in different geographies or business units at different prices?We
can analyse your expenditure at an item level. Our analysis enables
us to explore situations where the same item is being purchasedfrom
multiple vendors, at different unit prices, by different
geographies or different branches of the business. Our item
analysis allowsus to focus on fragmented purchasing in the business
and identify spend leakage issues such as purchasing from
non-preferred vendors,
Payment Analysis Am I leveraging all possible discounts or
interest from my invoice payment process?Payment analysis enables
us to analyse payment practises and terms within your P2P process
to identify issues such as unrealised discountsthrough late
payments of invoices or unrealised interest from early payments of
invoices.
Vendor Analysis What goods and services am I purchasing from a
single vendor?
organisation structure, item, payment, contract (where
available) and historic spend over time. This process is designed
to provide a single viewof total organisation engagement with a
single vendor.
Contract Analysis Am I complying with my existing negotiated
contract terms?
3
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There is a large body of evidence suggesting thatthe majority of
cost reduction programs fail to meetexpectations, often because of
poor planning,management and execution. Our experience suggeststhat
an effective cost reduction program considers thefull range of
procurement levers across demand, source,fulfil and manage using a
hypothesis driven approachwhere ownership and accountability for
achievingsavings are aligned with the business.
This means that the procurement team should not be the sole
owners of savings. Instead the focus of the team shouldbe on
facilitating and driving initiatives. They should also
beaccountable for the governance function through
recording,measuring and reporting savings. The importance of
thisdistinction should not be underestimated. As the focus of
theprocurement team moves from unit cost reduction to total cost of
ownership improvement many of the initiativeswill rely on process
and business unit practice changes.This means that business units
need to be accountable forchanges and the consequential savings.
Our observation isthat the procurement team needs to be rigorous in
makingsure that the savings are actually realised. In some cases
thismay lead to the procurement team ensuring budgets and cost
management practices.
TwoHave you got the right balance between shortand long term
savings?
4
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Another important challenge for the procurement teamis in
getting the right balance between shorter term savingsopportunities
and longer-term transformational opportunities.The typical mandate
for a procurement team is centred on aneed to produce savings in
the short-term to get buy-in .As a result, the short term
opportunities are often pursuedat the expense of longer term and
more strategic core servicedelivery improvement initiatives. Our
observation is thatthe most successful procurement transformations
splitand appropriately resource short term (quick win)opportunities
as well as longer term more strategic change.Whilst shorter term
initiatives provide good traction, more
and more transformational initiatives.
Demand
SourceManage
Category X
Cost avoidance
Cost reduction
Valu
e
Identify initiativeEvaluate anddocument Execute initiative
Measure, trackand report
addressable spendReview full range ofdrivers and
establishinitiativesEstablish countingrules
Evaluate anddocument initiatives
for annualised andtotal contract lifecyleEstablish costreduction
oravoidance type
Execute initiative
avoidanceor reductionUpdate budget and
Measure plan versusactual costTrack demand,cost and
complianceReport variancesor non variances
Identify andexplain variancesLeverageopportunities forfurther
avoidanceor reductionManage riskand report
Time
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If your procurement cost reduction initiatives arefocused solely
on achieving a price reduction fromcontracts, then the full
potential for benefits has beenmissed. The squeezing of profit
margins for manysuppliers means that the ability to extract
furthersavings through adversarial price-based negotiationsis more
challenging.
Instead of looking at price as the number one target,
organisation and a new way of working. Looking across theentire
value chain opens up greater opportunity, for example:
Demand: is there a mismatch between your wantsand your needs
?Source: are you getting the best value for your moneyor are their
alternative contract models or servicedelivery approaches?
have you balanced demand and supply and ensuredyour requisition
to pay processes enables complianceand risk management?Manage: are
you losing value, reducing the cost of doingbusiness with you or
asking your suppliers what could savethem and you money?
One of the critical drivers of spend leakage is the
mismatchbetween what your organisation and people want and whatthey
need. The (often) incremental creep towards wantsrather than needs
comes from a natural desire to do better
solution. A deeper understanding of demand drivers can beused to
develop initiatives that improve quality and time
whilsteliminating, reducing or shifting demand such that the
overallcost to deliver is reduced. The levers that should be
underconsideration include:
Eliminating demandReviewing volume requirementsReducing demand
frequency
Encouraging re use
Reducing portfolio range and complexity
ThreeDo you consider more than unit costs when
identifyingprocurement savings?
6
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Historically, procurement has used sourcing methods toreduce
unit costs on an initiative by initiative basis. This oftencomes at
the expense of the wider portfolio of spend orneglects the life
cycle cost of assets. Your procurementfunction should use a
category planning process to drive amore holistic view of spend
prior to undertaking discretego to market activities. We have
observed many instanceswhere this approach has changed what an
organisation goesto market for, for example examination of internal
coststhrough category planning may lead to an outsourced (or anin
sourced) solution rather than a discrete sourcing exercise.
Another aspect of the procurement value chain where
furtheranalysis can yield potential rewards is the requisition to
payprocess. Does your organisation manage these processes
opportunity to improve the effectiveness of the accountspayable
team by reducing the number of transactionsor reducing the number
of incorrect invoices received?Detailed process mapping and data
analytics can highlightthese issues instantly and can save in terms
of value leakageand shifting resourcing to more value adding
tasks.
Eliminatedemand
Demand levers
Reviewquantityrequired
Reducedemand
frequency
standardise
alternative ways
reuse
unbundle
Source levers
Supplier
and paymentmechanism
Incentives
Risk
Paymentterms
Manage levers
Paymentmechanism
Financial
Risk
Demand
Data capture
Procurement professionals continue to push the line
standardisethe spec, reduce suppliers and cut unit costs without
considering the
value chain. Procurement can deliver a lot more that unit cost
reductionincluding value generation, cost reduction and speed to
revenue.
Noah CostelloeExecutive Director, Ernst & Young,
Australia
Procurement value chain levers
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FourToo often we see organisations fail to manage their
contractsand suppliers, typical symptoms include:
Excessive effort managing transactional suppliersInformal or
issue based management of strategic suppliersPutting the contract
under the table until a legal issuearises and then calling the
legal unitLack of a balanced approach to performance
managementoften focused on time rather than value and costFailure
to include continuous improvement as part of thecontract management
processInability to have conversations with suppliers
aboutstrategic issues affecting the market
An effective supplier management framework thatappropriately
aligns risk, effort and reward is a key enabler ofongoing
sustainable value creation. The framework needs toinclude
segmentation (i.e., strategic, operational and
tactical),performance management framework(s) and a
cleararticulation of organisational accountability and
responsibility.
Vendors are not psychic. They require demand information tobe
effective. The integration of key suppliers into longer termdemand
planning processes will yield value.
Another observation is that supplier risk assessment is
assessment is not only a parameter that should be assessedduring
the sourcing phase but also continuously monitoredand managed. The
position of many suppliers may varyconsiderably from the time at
which you contracted withthem, especially if you signed a long-term
contract. As theeconomy changes, so too does the position of your
suppliers.Understanding their position in the market can provide
thebasis for identifying opportunities to mitigate your risk
andensure that those areas in your supply chain that are exposedand
might cause disruption can be effectively managed.Where
appropriate, you may be able to rebalance risk through
be assessed include:Financial stabilityEthical
performanceQuality controlTechnical skillDepth of skills and supply
chain
management frameworksAre you ensuring that value is not lost due
to the lackof a comprehensive contract management process
thatcovers performance and manages risk?
8
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Another aspect of supplier risk assessment that is oftenmissed
is the understanding of who is best place to managerisk your
organisation or the supplier. For example, are youor your supplier
best placed to manage inventory risk?In addition, some suppliers
may be prepared to reduce cost inreturn for a longer term
commitment. For those suppliers that
exchange for a longer commitment or changed terms of trade.Many
suppliers will be looking for commitments from theirclients and
opportunities for improving relationships andshifting contracts
from an adversarial model to a more
re negotiation should be done selectively, looking for
thehighest impact opportunities that do not increase longerterm
risk.
Contract management planning (continuous cycle)
Plan Execute ExpireManage and report
Contract management reporting
Governmentand compliance
Financialmanagement
Riskmanagement
Performancemanagement
9
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Many procurement teams operate under an informalmandate that
does not clearly articulate what theyare accountable for. In the
absence of a procurementcapability and operating model, a team is
fundamentallylimited in their effectiveness.
Strategy: establishing the vision, objectives, strategies
andperformance scorecard for the team.Governance and control:and
how procurement interacts with the wider business.
are going to be measured and monitored.Organisation and
skills:relationships, organisation design and
determiningappropriate role and responsibilities. Determining the
rightmix between commercial and technical skills and identifyingthe
key skills gaps.Procurement value chain: what are the key
operatingprocesses that support the procurement function?Data,
information management and reporting:what information is required
to improve the managementof third party spend and what reporting is
required?
FiveProcurement capabilityand operating modelIs your procurement
function set up for successand do those involved have the talent to
succeed?
10
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Our observation is that many organisations do not recognise
implement effective governance and control. Without thesekey
enablers procurement leaders and staff are often unable
Experienced procurement professionals are a scarce breedand are
worth their weight in gold. We have observed thatthere is a
mismatch in the supply and demand of high qualityprocurement
professionals in the market. This has been thecase for a number of
years and we believe that the marketfundamentals will not change in
the short-term. Our pointof view is that high calibre procurement
professionals needto be grown rather than sourced. We believe this
is best donethrough coaching, experiential learning and clarity of
rolesand responsibilities with a clear career path.
Underpinning the procurement operating model is the needfor a
strong process framework, enabled by technology.In addition,
procurement needs to be supported by a robustperformance management
framework that includes:
Voice of the internal customer and external supplier
Data and informationRisk and compliance
We often see organisations attempting to improve one aspect of
Procurementand being frustrated by poor results because the other
elements necessary to
holistic approach, building on the strengths of your team and
doing what yousay you will do is central to delivering sustainable
procurement outcomes.
Mark NixonPartner, Ernst & Young, Australia
Procurement vision
Procurement strategy
Governance
Organisation
Performancemanagement
Capability
Policy andprocedure
Technologyand data
Process
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Procurement health check
Key questions
SpendmapUnderstand what (and how) your organisation spends.
How much does your organisation spend and who is it spending
with?
What is your unit cost for purchased items and how much does
this vary?
How much of your spend is associated with the top ten
suppliers?
How many suppliers do you have supplying the same or similar
items?
SavingsGet the right balance between short and long termsavings
initiatives.
Have you got the right balance between short and long term
savings?
Do you link the forecasting, budgeting and procurement savings
programs?
How effective is procurement at achieving savings and improving
service delivery effectiveness?
Procurement value chain
not just unit costs.
Are your savings initiatives focused on unit cost or total cost
of ownership?
Do you understand the difference between needs and wants ?
Are you a collaborative client for your suppliers are you
working together to take cost out?
Contract and supplier relationship managementRealise the value
of your contracts by managing themand your strategic suppliers.
Are you getting what was promised when you signed your
contracts?
Have you integrated your strategic suppliers into your longer
term planning and reporting processes?
Are you addressing your transactional processing issues?
Operating model
of your team, commercial and technical.Do you have blended teams
delivering procurement outcomes?
Does your procurement function have credibility within your
organisation?
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Author
Noah CostelloeTel: +61 2 9248 [email protected]
John EvansTel: +64 9 308 [email protected]
Ernst & Young representatives
Australian Capital TerritoryMark NixonTel: +61 2 6246
[email protected]
South AustraliaMark StewartTel: +61 8 8417
[email protected]
New South WalesNoah CostelloeTel: +61 2 9248
[email protected]
VictoriaLiz BryantTel: +61 3 9288 [email protected]
QueenslandSeelan NaickerTel: +61 7 3011
[email protected]
Fraser StowersTel: +61 7 3011 [email protected]
Western AustraliaNathan RoostTel: +61 8 9429
[email protected]
New ZealandJohn EvansTel: +64 9 308 [email protected]
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Ernst & Young
Assurance | Tax | Transactions | Advisory
About Ernst & YoungErnst & Young is a global leader in
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167,000 people are united by our shared values and an unwavering
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2012 Ernst & Young, Australia.All Rights Reserved.
This communication provides general information which is current
as at the time of production.The information contained in this
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disclaims all responsibility and liability (including, without
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