INTERVIEW / EXPERT VIEW – ENTERPRISE-WIDE VALUE
INTERVIEW
1. Clearly define procurement’s purpose, ie. reducing costs, increasing innovation, risk mitigation and opportunity capture, business continuity, productivity increase and so on 2. Partner with internal functions to differentiate between savings and opportunities 3. Monitor tolerance ranges for different risk types and categories – particularly for markets that change rapidly 4. Design the procurement system with a view of the long-term business objective in addition to procurement efficiency – put a value on the risks taken through cost cutting 5. Run scenarios – suppliers and customers can be impacted by similar events. Carry out a 360° analysis and challenge traditional responses 6. Regularly reassess your risk landscape depending on business needs, ie. new risks due to new supplier operating models CAN YOU TAKE THE HIT? SIX STEPS TO MODEL, MONITOR AND MITIGATE RISK credit rating agencies, to identify and report potential problems. “Be aware that even if you have good suppliers they may be supplying your competitors and you may not be the customer of choice. If they’re in short supply they won’t be coming to you. You need another source of supply in case something goes wrong – and for that you need support from stakeholders to argue for extra budget.” Procurement needs to be clear. Is its mission only to cut costs or to help boost the enterprise-wide value of its organisation through good purchasing and supplier decisions? “If you do things right upfront everyone’s happy – your company’s image and reputation is improved and it will attract more customers." As new products enter the market and new competitors change the game it’s vital to have a management system that is flexible and able to be dynamic while remaining focused. “The kinds of risks and disruption we’ve been facing over the past 18 months will become the norm – so companies have to step up and make the change.”
Looking outside in
Stakeholder value driver tree
Another oversight by many, says Clements, is that they only look at the risks from an inside-out point of view without ever looking ‘outside in’. This means creating an extended strategy map through which the procurement function can include value generated through targeted decisions as opposed to reacting to the pressure of cutting costs. Yet the extent of globalisation now means whole sectors and industries can be affected by the same problem. Too few have, however, thought of this when crafting their business continuity plans. “When you take an isolated view of your own risk you may come up with a solution or create a continuity plan. But, if you discover your whole sector or industry is doing the same thing as you, that it has the same back up plan, then what you have is no longer a continuity plan, it's just another disaster waiting to happen.” He cites numerous examples of hot spots for this, including pharmaceutical production and call centres in India, cheap labour and supply from China, silicon chips from Asia and automotive components from Germany and the UK and challenges with internet bandwidth. “These zones have aggregated risk. A lot of companies are not looking at what’s happening in the wider sector and elsewhere in the world. They also need to look outside in and consider all kinds of other scenarios. If the whole world has gone to China and India and they both have problems, the whole world is hurting.” One tsunami in the computer chip hotspot of Taiwan, Korea and Japan could “cause hell” for those dependent on this component, which is why the smart companies are using venture capital to fund an alternative. The pandemic has highlighted the issue of these production hubs – like vaccines manufactured in India and the potential unreliability of back-up plans – such as businesses and academic institutions switching to home-working and schooling at the same time. “A lot of people were told to stay at home, so most companies switched to video conferencing tools. The problem is everyone did that at the same time. More than that, it wasn’t only businesses, but children who were homeschooling or watching streaming services. Internet providers and TV channels had to reduce the bandwidth, which in turn affected service and quality. This happened because everyone had the same solution. When you all run to the same safe harbour it actually becomes one of your biggest risks.” And it's not only these massive events that companies should consider. Disruptions could be caused by a fault at one supplier, much of which could be prevented through proper assessments and verification. “You need to consider the maturity of your supplier and your risk management of them. This requires you to have a risk management system that analyses risks and opportunities and measures them.” He recommends visits to suppliers and using third-party agencies, like
Potential Risks
Value Drivers
Profitability Breakdown
ECONOMIC, POLITICAL SOCIAL ENVIRONMENT
VULNERABILITY
RELIABILITY
COMMODITY PRICE
MARKET STRUCTURE
SUSTAINABILITY OF GROWTH
P&IDs
COST VOLATILITY
BUSINESS COMMUNITY
COMPETITIVE ADVANTAGE
EVA
OPERATING EFFICIENCY
GROSS MARGIN
QUALITY INDEX
AVAILABILITY OF ASSETS
UTILISATION
EBITDA
EBITDA / SALES
ROIC EBITDA/IC
RELIABILITY
SALES
REORDER POINTS
SALES / INVESTED CAPITAL
DEPRECIATION
SPARE PARTS
SG&A
AGE
CAPITAL ASSETS
SALES
TRAINING
INVESTED CAPITAL
WACC
WC/SALES
SUPPLIER VULNERABILITY
WORKING CAPITAL
EBITDA Earnings Before Interest Tax Depreciation and Amortization ROIC Return on Invested Capital EVA Economic Value Added or Enterprise Value WACC Weighted Average Cost of Capital SG&A Selling and General and Administrative Expenses P&IDs Process and Instrument Diagrams
At ArcelorMittal, his team enabled the head of purchasing to be able to defend a request for additional funds. “By saying ‘look, no matter what happens in the world – a pandemic, heavy snows in Poland that cause trains and trucks to stop, a blockage in the Suez Canal – we can still deliver our product to the customer. It may be a bit more expensive but we’re getting the quality and service, our reputation is good and we have the trust of our ultimate client.’ This is creating intangible, long-term and sustainable value. There are too many companies focused on EBITDA reduction and compliance. “Companies too often focus on things that should simply be the consequence of good management. Safety, quality, sustainability should all be outputs of the way the business is run, not the focus of it. By changing your perspective, you start to invest in a different way." Things are, however, slowly changing. “Some stock markets are starting to look at stakeholder instead of shareholder value. A number of financial institutions are establishing ESG indices (environmental, social and governance) and if you need a loan, some banks will not be willing unless you demonstrate you conduct business in an environmental and socially responsible way. The world is changing, but it’s taking time.”
Partner up
Clements says procurement professionals need to be able to request additional investment to buy better quality materials, keep additional stock or dual source to mitigate a potential problem that could halt production, but they typically have a hard time doing so. Instead, that additional investment is frequently given to other departments that can more readily demonstrate value from this expenditure, he says. To successfully argue for appropriate budgets, they need the support of the relevant internal stakeholder to persuade the business it shouldn’t be viewed as an additional cost but a means of achieving greater value. Buying better quality materials, sourcing from more than one supplier or paying slightly more in exchange for stronger supplier relations, a closer source of supply or similar, can actually add long-term value. “If they can partner with the head of operations, HR, environment, marketing – whomever works in the relevant department – they should find the purchasing budget goes up and together they can demonstrate where the value is created for that extra investment.”
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STATE OF FLUX
2021 GLOBAL SRM RESEARCH REPORT
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