Buying your way to the top

By Mark Keough

Too long the “forgotten” function, purchasing can—with the right strategic approach—powerfully enhance a company’s economic performance.

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After languishing as a managerial backwater for years, purchasing has finally emerged on the top management agenda at many companies. Although its new-found importance is frequently driven by a need to slash costs, some organizations are now treating purchasing as part of a broader effort to "re-engineer" such key processes as operations, quality, and customer satisfaction. Moving to such a strategic approach is not easy. It must begin with an honest appraisal of how far the function has actually evolved and of what is needed to push it on to the next developmental stage—and then the stage after that.

Even as recently as a couple of years ago, purchasing tended to be regarded as a managerial backwater. In some quarters, it still is: purchasing managers are paid less and are rarely promoted into general management; aspiring managers from other areas are reluctant to accept a stint in purchasing; and purchasing, for many companies, is simply not part of the senior management team.

Things are changing. Purchasing is thrusting its way to the top of management’s agenda, led perhaps by the automotive industry, as one of the most powerful ways to enhance economic performance. It’s easy to understand why:

  • During the past 50 years, the average cost of production-related goods and services in US industrial companies has nearly tripled, from 20 percent of sales to 56 percent.1 Indeed, in some industries, like consumer electronics, where companies source almost everything, the cost of purchased materials can be as high as 85 percent of sales.

  • Managers are beginning to realize that, while skillful contract negotiations could extract price discounts of between 1 and 5 percent from suppliers, today’s cost pressures for 10 to 30 percent price reductions require a totally new set of purchasing skills: challenging materials specifications, questioning products and their package designs, and influencing "make" versus "buy" decisions.

  • Increased outsourcing, particularly in developed economies,2 places a premium on the skills needed to identify and distinguish between strategic and non-strategic activities, to select and develop suppliers, to structure long-term supplier relationships, and to manage suppliers across a range of activities, from landscaping to manufacturing to customer service.

  • The renewed trend toward global sourcing creates a further challenge for the purchasing function: the management of geographically dispersed suppliers as a network, where quality and on-time delivery are as important as cost, if not more so.

Little surprise, then, that what was once labeled as the "forgotten" function is today receiving much more attention from CEOs. General Motors’ increased emphasis on purchasing as one of the key levers of its current turnaround program has attracted great interest. Less well known is that GM isn’t alone. Several major industrial and service companies, even in such unlikely industries as banking, are also taking a hard look at their purchasing functions. Many are reorganizing to wring costs out of their operations; others, which do not face immediate cost pressure, to position themselves for such longer-term benefits as improvements in design, manufacturing, quality, and customer service.

The starting point for the journey to strategic purchasing is to understand the current stage of evolution of the purchasing function. These evolutionary stages can be split into five parts, as shown in Exhibit 1).

  1. "Serve the factory." In this initial stage, purchasing’s job is to keep the factory running. Typically, the purchasing function exists only at site level, reporting to a materials manager or possibly the plant manager, and the buyer often has no relevant professional qualifications. The task focuses on clerical, logistical, and expediting duties. Purchasing of this kind can be found in the pharmaceutical and financial services industries, among others.

  2. "Lowest unit cost." As purchased items increase in importance in a company’s cost structure, purchasing is charged with minimizing materials costs. Cost analysis, competitive bidding, and negotiation become key skills. At this stage, purchasing begins to emerge as a separate function at the factory level, reporting to the plant manager.

  3. "Coordinated purchasing." As purchased items become yet more important, the search continues for ways to lower materials costs, usually through some form of cooperative purchasing across sites and profit centers. This might include lead buyers, buying committees, and even the centralization of purchasing. Key skills are collecting information about purchases in a common format, negotiating multi-site agreements, and monitoring compliance with national or regional contracts.

  4. "Cross-functional purchasing." The distinction between this and previous stages is the recognition that design, specification, and supplier development can have far more impact on cost than does negotiation. To be effective, such a broadening of the purchasing perspective demands cross-functional teamwork and a total systems cost mindset. Industries that are heavily reliant on suppliers, such as computer manufacturers, typically adopt a more cross-functional approach in their purchasing.

  5. "World-class supply management." Leading companies in the automotive and electronics industries have come to realize that competitive advantage is shifting from world-class manufacturing (10 to 20 percent of cost) to world-class suppliers (60 to 70 percent of cost). Once a company’s manufacturing operation attains a world-class standard, the task is to help suppliers get there as well, and thus dramatically improve the cost base. Purchasing at this stage is characterized by strategic supplier selection, long-term relationship design, supplier network management, supplier collaboration on new technologies, selective equity investment, and cross-functional supplier development teams.

Companies have realized savings of around 5 to 10 percent of spend by moving from one stage of development to the nexta level of savings that can sometimes double the bottom line. Progress from stage to stage, however, requires cumulative capabilities. It does no good to be a sophisticated manager of supplier networks if purchasing requisitions take three months to process and cross-functional teamwork is non-existent. Successful supplier management requires sound purchasing basics and internal teamwork.

Barriers to strategic purchasing

Managers must overcome several weaknesses before they can successfully adopt a strategic approach to purchasing:

Poor information

Most companies cannot answer the most fundamental question for purchasing: How much do we spend on outside goods and services? All organizations, of course, have some number that they say is "total spend," but it often overlooks smaller operations and non-traditional items. For example, a major firm discovered that its usual purchasing spend numbers completely missed "non-inventory" items: capital purchases, services (such as insurance brokerage or legal fees), and numerous administrative items (cars, marketing and promotional goods, office supplies, and so on).

The non-traditional spend in this case amounted to almost as much as the traditional spend on production items like raw materials and packaging. But most of it fell outside the purview of purchasing and was managed by the user functions, which were not always sensitive to professional purchasing practices like competitive bidding.

One useful check is to compare estimated total expenditure to sales less profit, overhead, taxes, interest, depreciation, and people expenses. The remainder (plus capital purchases) is what an organization really spends on purchasing (see Exhibit 2). It is often a multiple of the "official" number. In the case of the company described above, the total spend was estimated to be $4 billion, double the original figure.

Even if total spend were known, most large companies find it impossible to produce comparable corporate-wide information on spend by item, prices paid, and usage trends. Manufacturing sites often have incompatible systems because item and vendor coding evolved at the site or profit-center level. One organization operating through various trade names and operating divisions can appear to be several different suppliers. In fact, sophisticated suppliers often know more about how much and on what a company spends than does the company itself.

In sum, lack of information about what is spent on what item is one of the most common barriers to more effective management of the purchasing function.

Weak administration

While poor information is probably a near-universal barrier, many purchasing groups are overwhelmed by managing the day-to-day functions of the purchasing process. Even relatively senior purchasing managers spend considerable time on crises with service and suppliers. The need for senior purchasing people to spend such a high proportion of their time on day-to-day issues suggests there has been a breakdown in basic administrative processes. Consider the following:

  • At one mining company, managers had become so frustrated with the slow workings of the materials requisition process that they issued "emergency" requisitions to short-circuit the system as much as 30 to 40 percent of the time. This involved direct intervention from a buyer to expedite an item through the system in one or two days instead of five to seven days. Many of these requisitions were duplicates, since some of the more attractive items, like new pumps, often disappeared between warehouse and mine site because foremen thought it would be quicker to "borrow" an item off a pallet than file a request.

  • The system was so unreliable that one-third of total inventory took the form of private caches, hidden somewhere in the mine so maintenance workers could protect themselves against surprise shortages. Much of this hidden inventory was believed to be obsolete. Buyers estimated that half their time was spent dealing with emergency requisitions. The knee-jerk response—imposing some sort of ban on such requisitions—addresses only the symptoms. It does not deal with the underlying problem: poorly designed material systems.

  • At a hotel complex, the rush to open on time led to administrative chaos in the purchasing function. Local purchasing managers, new to the organization’s way of doing things, were unfamiliar with its food and service standards. Corporate executives, in turn, did not understand local suppliers and standards. The results were long delays in agreeing contracts, rushed ordering, and poorly implemented administrative systems.

Supplier invoices were found stuffed into desk drawers; purchase orders were issued without paperwork; invoices could never be matched. When suppliers threatened to stop shipment, an invoice "signing party" had to be organized to deal with the backlog. The conflicts that occurred between purchasing and operations managers during this period became so serious that communications broke down, and operations managers ordered directly from suppliers. Purchasing’s "market share" of spend declined to less than 20 percent.

Missing skills

Even if purchasing has good control over basic administrative systems and users—its "customers"—are getting the responsiveness they need, it is questionable whether the function has the skills and the people to shift quickly to a more strategic orientation. Companies that have made the shift have found that between 50 and 100 percent of their senior purchasing managers needed to be replaced.

The focus of the traditional purchasing approach is on "closing the deal"—that is, negotiating with suppliers to get a good contract. Purchasing heroics typically revolve around clever negotiating tactics. For example, a purchasing manager at a chemical company left the room in the middle of a major negotiation to find out exactly which flight home his supplier planned to take. It turned out to be the last departure from Mobile, Alabama on a Friday night. Armed with this single fact, the buyer delayed any serious discussions on the contract until mid-afternoon on Friday, by which time the supplier was ready to make some unwise concessions.

While negotiation tactics can play an important role, the degree of freedom in influencing the outcome is usually quite limited, perhaps between 1 and 5 percent. The real leverage is upstream from the negotiating process: where the product is designed and specified, where make versus buy decisions are made, and where supplier/customer operations linkages (size of shipment, frequency, scheduling, and so on) are defined (see Exhibit 3). These upstream activities can have a 30 to 50 percent cost impact or even more if, say, a material can be eliminated through an alternative product design.

Most purchasing functions are, however, firmly rooted in the negotiating mindset. Their managers do not usually develop the general business and analytical skills to challenge specifications or work cross-functionally. And their style makes it hard for other functions and general management to accept a broader role for purchasing. As one marketing VP said, "Purchasing is fine for getting yellow pencils with red erasers, but for Pete’s sake, don’t let them near anything important!"

Without the relevant skills, purchasing managers will undoubtedly have a difficult time convincing their colleagues in other functions to extend their view of what the purchasing role might be. Furthermore, there is always a tendency, particularly if there are difficulties with purchasing administration, to ask purchasing managers to focus on the practical day-to-day problems first, before tackling "intergalactic" strategic issues. Fire-fighting takes priority.

No performance measures

Purchasing’s credibility is not helped by the lack of good measures of performance and value-added. General managers routinely hear about purchasing’s claims to have saved the corporation "millions of dollars" through one clever deal or another. But such claims usually prove hard to verify. They also raise a number of questions. Could it have been $2 million instead of $1 million? Did it fall in the buyer’s lap? Did it result in higher costs elsewhere, especially in inventory?

Low status

The organizational standing of purchasing tends to reflect the skills of the traditional purchasing function, as well as the general manager’s view of them.

  • Purchasing is usually low in an organization’s hierarchy and certainly does not enjoy the standing of other staff functions such as finance. This translates into diffuse purchasing leadership: purchasing managers are sprinkled across SBUs, without a "friend in court" at the corporate center.

  • Purchasing often reports to key user functions, like operations, which can weaken its independence when challenging favored suppliers or make versus buy decisions. This is another reflection of management’s suspicion that purchasing would not make the right business decisions and would seek to optimize material prices at the expense of manufacturing cost and quality.

  • Career progression in purchasing is slow compared to other functions. At one German company, for example, the typical career path for purchasing takes twenty years to reach a level that fast-moving marketing managers achieve in five. What ambitious manager would look at a tour of duty in purchasing as a promising career move? How often do purchasing managers get promoted to general management positions?

  • Purchasing managers are paid less. Salary surveys in Europe and the United States show that purchasing managers and directors earn less than their counterparts in other functions.

Most of the barriers described here are of companies’ own making. As a consequence, they can be overcome with determination and vision—not just on the part of the purchasing management, but on the part of the entire senior management group.

Overcoming the barriers

Organizations that have chosen to develop a truly strategic purchasing function typically go through a four-stage process:

  1. Get the basics right. Even in relatively sophisticated companies, it is surprising to what extent purchasing processes simply do not work. Competitive bidding, responsiveness to user needs, and tracking of total spend often need a fresh look.

  2. Put money on the table. Using short-term cross-functional project teams to develop purchasing strategies invariably leads to dramatic bottom-line improvements. Because the teams are cross-functional in nature, they can share approaches and fresh ideas, thereby expanding the degrees of freedom available to purchasing.

  3. Develop the supporting organizational infrastructure. The savings that result from short-term purchasing projects often convince an organization that this new cross-functional method needs to be institutionalized. Organizational changes typically include the establishment of a corporate-wide purchasing leadership group, but not centralized purchasing; the upgrading of the skills of the purchasing organization; the establishment of relevant performance measures; and the development of a center-led structure that includes regular cross-functional project teams.

  4. Build world-class suppliers. Generally speaking, even the most sophisticated corporations have not yet tackled the problem of building a world-class supplier network. This would include developing a vision of what the network should look like, benchmarking current suppliers against world-class performance, and having the skills to help suppliers achieve world-class standards.

Get the basics right

Getting the basics right cuts the time that senior purchasing managers have to spend intervening on an exception basis in day-to-day activities. It also defuses complaints about purchasing’s efficiency and responsiveness. If the everyday process does not work well, it is unlikely that general management will give purchasing the scope to take a more strategic approach.

It is surprising how often the basics of purchasing do not work properly, even in large corporations. Although there may be competitive bidding for major items, the diligence with which alternative suppliers are pursued declines significantly below the top half-dozen items of expenditure. At one extreme, a European furniture company had been buying wood from the same set of suppliers for over twenty years. Several of the suppliers were holding companies with private investors owning a share of the timber lands. The purchasing manager of the furniture company frequently socialized with the private investors in his suppliers’ holding companies. In fact, some of the purchasing managers were themselves investors in these companies.

It is also common in Europe for suppliers to be of the same nationality as the purchasing company. Such relationships are usually justified on the basis of responsiveness, but the facts often don’t bear this out.

As mentioned earlier, unreliable and unresponsive purchasing processes are often a sore point with users and lead to dysfunctional expediting. To overcome this deficiency, a number of companies have taken a "re-engineering" approach to the procurement process, eliminating paperwork and unproductive steps where possible.

At the hotel complex, for example, a re-engineered procurement process for fresh food indicated that vegetables could be made available to customers within six hours of a requisition, as opposed to the previous 50 hours. At Motorola, a purchasing team recently won a "gold medal" in the company’s annual quality competition. The team had focused its efforts on reducing the time the purchasing requisition process takes to make it equal to the "value time"—the minimum time required actually to execute the requisition.3

Many companies are beginning to realize the importance of non-inventory purchases. SmithKline Beecham, for example, has appointed a senior purchasing manager to review non-inventory purchases and has launched several projects on subjects like travel, cars, and electrical power. At Rover, suppliers for production items have been reduced from 1,500 to about 750. For non-production items, there are still over 5,000 suppliers, and Rover has had to assign some of its most talented purchasing managers to this area to work out how to deal with such fragmented expenditure. Some companies just get lucky: a German company sent a note to all its suppliers announcing that a review of purchasing was about to begin and asking for their cooperation. In response, about 10 percent of the suppliers wrote back offering to reduce their prices immediately.

Put money on the table

There is nothing like ringing the cash register to build credibility for a fresh approach to purchasing. Most organizations are willing to experiment with new ways of doing things through temporary projects and taskforces. These short-term initiatives can be effective in unfreezing existing attitudes about how purchasing is carried out. But experience shows that several elements are required for such initiatives to be successful.

  1. Formation of a cross-functional team. Under normal circumstances, purchasing managers do the best they can to optimize a company’s supplier relationships within the functional constraints of purchasing. A cross-functional approach relieves these constraints and encourages thinking about issues further upstream, such as material specification, strategic make/buy analysis, and development of new suppliers. The makeup of the teams will vary but will usually include engineering, manufacturing, and marketing, as well as purchasing.

  2. A fact-based approach. In the absence of good-quality information on a corporate-wide basis, the first task of these project teams is usually to assemble an agreed fact base of quantities purchased, prices paid, usage by location, and so on. In addition, teams should be encouraged to investigate supplier markets for key commodities and to identify such critical facts as the number of competitors, the amount purchased as a share of capacity, technological trends in the supplier industry, and alternative uses for materials. At Xerox, for example, full-time commodity teams are expected to understand supplier markets better than the suppliers do themselves. Estimating the cost structure of the supplier and its industry is often part of the teams’ brief.

  3. Vendor input. In traditional purchasing organizations, the dialogue between a vendor and the purchasing department centers on price. This is a considerable underutilization of the information suppliers can provide. For example, asking a supplier how your company can be a better customer, or what can be done to reduce costs for both your company and the supplier, can yield surprising answers.

    One team from SmithKline Beecham found, at a supplier’s suggestion, that changing a raw material specification from granulated to flake form saved about 20 percent of the total price, since it meant the supplier could cut out the granulating step in its process. Another suggestion—this one from a supplier to a UK chemical company—proposed shipping raw material from its Irish plant instead of its Welsh site so that it could take advantage of the tax regime in Ireland, sharing part of the savings with its customer.

    Suppliers can also be surprisingly forthcoming about the practices of a company’s competitors, since they may do business with them too. Reputable suppliers do not, of course, pass on confidential information, but they are in a position to judge industry best practice in areas like product design, logistics, information systems, and manufacturing.

  4. Challenge product design. By one estimate, 50 to 60 percent of the cost of an automobile is decided at the design stage. The influence of product design on material cost is substantial—not only in the automotive industry, but across a wide range of manufactured products. For example, one automotive component supplier discovered it was making 47 varieties of a component, using three different metals—and this was at only one of its dozen sites. Other sites had a similar approach, adding even more complexity. A Japanese competitor, by contrast, manufactured three varieties of the same component worldwide, and all were aluminum-only products.

    Similarly, a consumer goods company discovered it could use ink-jet printing on food packets, thereby saving the cost of customized printing and packing for its various flavors. Switching to ink-jet printing saved 15 to 20 percent of the material cost and even more in the packaging process, eliminating changeovers attributable to packet design.

  5. Impose tight deadlines. It is useful to make sure that project teams are indeed temporary in nature and that they are forced to come up with an answer in about eight to twelve weeks. This discipline forces teams to focus on the problem and gives them a sense of urgency.

    In our experience, the savings realized from short-term projects aimed at specific commodities average about 10 percent of the spend under examination. Savings can be as high as 100 percent when the need for a commodity is eliminated. There are, however, cases where the price of material actually increases, and savings are instead realized elsewhere in the cost structure.

    At a mining company, for example, the purchasing project team discovered that by using a higher-priced premium explosive, secondary blasting—which is necessary when the rocks broken up by the first blasting are too big to be worked with—could be totally eliminated. This cut 25 to 30 percent from the total spend on explosives—not to mention the savings in mine operations.

Organizational infrastructure

When general managers see the impact of a cross-functional approach to purchasing, they inevitably ask, "How can we do this on a more systematic basis?" Such questions pave the way to making the changes in organizational infrastructure needed to support a strategic purchasing approach. Companies usually focus on five elements of organizational support for strategic purchasing: leadership, organizational structure, people development, performance measurement, and information systems.

Establishing a single point of leadership is often the first clear signal that an organization is committed to a strategic approach in purchasing. Usually this involves appointing someone with a combination of general business skills and functional credibility. Often from outside the organization, this individual reports to the highest level, sometimes to the chief executive. Without a single point of leadership, it is difficult for an organization to sustain the vision of a strategic purchasing function over a period of years.

The head of a strategic purchasing function is usually highly paid, with broad analytical and strategic capabilities. A recent search for the purchasing vice-president of a global consumer goods company specified that the position would "include a total compensation package of about $300,000 and would have as direct reports directors of analysis, strategic alliances, performance measurement, and key commodities." Many companies have started to call such positions "Chief Purchasing Officer" (CPO) to emphasize the intended analogy with CFOs.

These CPOs do not necessarily control all the purchasing activity of an organization. But the organizational structure and decision making are usually modified to permit them to build an effective network. A center-led purchasing network is superior both to decentralization, which can leave money on the table, and to centralization, which often leads to a bureaucratic and unresponsive purchasing organization. The network might consist of a small group of high-powered purchasing managers at the center, with the actual buying done within the profit centers.

The central purchasing group has responsibility for establishing performance measurement, articulating the vision for the strategic purchasing function, developing the purchasing staff, managing the career paths of purchasing managers, forming cross-functional teams to address key commodities, and developing a plan for upgrading suppliers. In essence, the senior purchasing managers lead on the basis of vision and expert knowledge, with the support of the entire senior management group. Some companies have decided to give the senior purchasing manager solid line authority over all the key purchasing managers in the organization, at least in the early days of a strategic purchasing initiative.

The transition to a strategic approach often results in a dramatic change in the skills required to be successful at purchasing, which has important implications for people development. Some companies have introduced non-purchasing managers into the purchasing organization to broaden the group’s general business skills. In general, although negotiating skills continue to be an important asset, they are no longer the only thing that matters. Several organizations that have made the transition to strategic purchasing have found that it entails a high turnover of relatively senior purchasing managers and/or extensive people development.

In many cases, recruitment processes also need radical revision. When one leading automotive company interviews applicants for the position of buyer, it gives each candidate an automotive component during the interview and asks how he or she would determine its cost. If the candidate suggests referring the component to three reputable suppliers for quotes, the response would be considered disappointing. The company is looking for buyers who are prepared to disassemble the component, determine which metals have been used and how much they weigh, and identify the manufacturing processes involved. In other words, it seeks purchasing managers who have the analytical skills to reach an independent point of view about the cost of a component.

Measuring the value-added of the purchasing function has always been a difficult task. The usual approach to performance measurement for purchasing has been to compare actual spend to budgeted spend. Material price variations are another way to measure effectiveness. The trouble with these measures is that purchasing’s actual role is often unclear.

External factors frequently determine whether prices go up or down; purchasing may have little to do with it. Furthermore, traditional measures of performance put heavy emphasis on purchase price. But, as mentioned earlier, a higher material price can sometimes lead to lower overall costs or better service for the customer. Conventional measures of purchasing effectiveness often fail to capture this total systems cost perspective.

Although no single effective measure of purchasing performance has yet been devised, leading companies frequently evaluate purchasing’s contribution to the organization by a "triangula-tion" process in which a number of measures are used:

  1. An overall measure of spend. Many organizations measure how much has been spent this year against last year (and this is often preferred to measurement against a budget). The definition of "spend" may be dubious, but leading organizations find this measure useful as an overall discipline on the purchasing function. Companies generally recognize that purchasing sometimes has little control over price movements, but the discipline to stay within a fixed total expenditure can force it to seek ways to reduce costs elsewhere if prices have risen unexpectedly in one area. This is really no different from the budget discipline imposed on profit-center managers.

  2. Measures versus market indicators. In some industries it is possible to compare prices paid for key commodities to external market indices. Although a price paid on a contract basis can differ substantially from the spot market price, many companies find it useful to track the gap.

  3. Purchasing initiatives. An important task of the strategic purchasing function is to organize cross-functional teams to pursue high-priority items of spend and to uncover creative new ways to reduce cost or otherwise benefit the corporation. Ferro Corporation, for example, asks each purchasing manager involved in such initiatives to write a one-page summary of recommendations and results obtained. These summaries are signed by the managers responsible, and the savings reported are analyzed each year when purchasing is reviewed. The figures capture not only savings on purchase prices (which in Ferro’s case are by far the largest portion), but also savings in manufacturing or other costs, as identified by the cross-functional teams. Polaroid also has clearly-defined rules for calculating the savings from such initiatives.4

  4. Total systems cost. Some organizations manage the total systems cost for a purchased item—that is, the cost associated with using a particular material throughout the corporation, and even at the customer’s location. This might include, say, the cost of field failure associated with the item. Such an approach is selectively used in the Swiss machine-tool industry. Deriving a total systems cost for every purchased item would create too great an administrative burden, but doing so may make sense for high-leverage and high-cost components.

  5. External benchmarking. Many organizations use some form of benchmarking to assess the efficiency and effectiveness of their purchasing function. The Center for Advanced Purchasing Studies at Arizona State University in Tempe, Arizona, conducts regular benchmarking of the purchasing function in about twenty different industries. Although standalone numbers need to be interpreted with caution, many companies use this information to compare data such as buyers per dollar spend, roles of the purchasing function, reporting relationships, percentage use of electronic data interchange, and so on.

In addition, some companies survey their supplier base regularly to generate feedback on the effectiveness of purchasing. In conducting a similar benchmarking exercise, one aerospace company discovered that its suppliers thought the company’s competitors managed suppliers better than they did. The results of the survey suggested that the difference in supplier management skills translated into a 10 to 15 percent cost disadvantage.

Traditional manufacturing, inventory, and accounting information systems are not terribly useful in providing the information a corporate-wide strategic purchasing function needs. Even though the quantity of an item purchased is usually known, it is often not comparable with data produced by other sites. Moreover, manufacturing-driven systems rarely capture important information about suppliers, prices paid, and quantities shipped.

On the basis of a strategic purchasing vision, some companies have justified major systems investments (on the order of $2 to $3 million) to upgrade the information available. With the advent of powerful new front-end technologies, the cost of providing such information may decline. Equally important, the information may be supplied without the need to rewrite long-established manufacturing and accounting applications.

Building world-class suppliers

Many organizations are still trying to come to terms with the challenge of becoming a world-class manufacturer. The bad news is that those that have already succeeded are now turning their attention to building world-class supplier networks. Many believe that supplier networks will become the next important source of distinctive competitive advantage.

Some companies just don’t get it. One defense manufacturer boasted of its accomplishment in reducing the number of its suppliers. As it turned out, the company was locked into exclusive purchasing agreements for many of its high-tech components, with no option for switching to other suppliers. Furthermore, not one of the company’s buyers had ever visited the supplier’s manufacturing site. Sole sourcing does not bring world-class benefits unless there is leverage with the supplier and a deep understanding of the supplier’s business.

Leading strategic purchasing organizations have surprisingly similar approaches to developing their supplier networks. First, companies like Honda and Xerox develop an estimate of "should be" cost. This is the world-class cost for components supplied to the organization, adjusted for the supplier’s factor costs (so that, say, a US manufacturer would not be expected to have Malaysian labor rates). This "should be" cost is compared to the actual price offered by the supplier. If there is a difference of more than 5 percent, the supplier is asked to account for the disparity. This procedure helps to pinpoint areas of the supplier’s business that do not meet world-class standards.

A second aspect of world-class supplier management is the demand for continuous improvements in cost, quality, and throughput time. Long-term supply contracts can be agreed as long as these performance targets are regularly met. Targets may also include timeliness of shipments, an important factor for retailers and assemblers.

Demanding ever-increasing performance targets, however, is not sufficient for world-class companies. Leading purchasing organizations have the skills to show suppliers how to perform better. For example, one automotive company has 10 full-time engineers on its purchasing staff in one of its assembly plants. These engineers have deep experience in "lean manufacturing" techniques and are constantly on the road investigating suppliers’ facilities and upgrading their manufacturing practices.

World-class purchasing organizations take a deep interest in their suppliers’ manufacturing processes, even to the point of assessing a supplier’s suppliers. Behind the phenomenal increases in productivity levels in the UK automotive components industry lie the active supplier development techniques of Japanese transplants.5

Most of the leading purchasing organizations now have full-time supplier development teams. In Honda and Rover, these are known as BP teams. At General Motors, they are known as PICOS teams—Program for Improvement and Cost Optimization of Suppliers. Worldwide, over 200 people are working full time on PICOS teams.

Before a company embarks on the development of better supplier networks, an important first step is to stabilize internal company processes, such as product development. One major European component manufacturer complained that dealing with European and American OEMs was far more costly than dealing with their Japanese counterparts. The Western companies had less stable design processes, and design information was late and often inaccurate. Design changes were made very late in the overall development process.

Furthermore, Western manufacturers often insisted on using slightly different variants of the same components for every model in their range. As a result, R&D man days for the European OEM were more than double what was needed to support the Japanese OEM—and the Japanese version was ready in less than half the time.

Impact

In a survey of more than 150 recent purchasing initiatives, four key points emerged:

  • The amount of money saved by cross-functional teams in short-term projects ranged from 3 to 50 percent of the spend under examination, and averaged about 9 percent.

  • As might be expected, the percentage saving was higher on lower-priority and more fragmented items than it was on important and closely watched product categories.

  • The size of the saving varied according to the type of thinking employed by the project team. Simply shining the spotlight on a given product category and ensuring good professional purchasing practice typically resulted in savings of 3 to 5 percent. Challenging specications and modifying product and package designs led to savings on the order of 7 to 15 percent. But completely rethinking the way of doing business with a supplier, for example outsourcing assembly to Romania or administrative activities to Bombay, yielded savings of 30 to 50 percent.

  • Total savings for companies making the transition to strategic purchasing are typically in the range of 5 to 10 percent of the total real spend (including non-inventory items). These savings are usually realized over a three- to four-year period.

These numbers merely confirm the obvious: few, if any, other activities can have the bottom-line impact outlined above. Beyond realizing this short-term—but important—economic impact, companies need radically to upgrade the role of purchasing to deal with the exploding complexity of strategic supplier relationships. Purchasing managers should increasingly be viewed as the architects of an organization’s supplier network, responsible for the selection, development, measurement, and, ultimately, competitiveness of the supplier base. Indeed, these days a high-powered purchasing manager has more influence on the value-added across a company’s supply chain than does the head of manufacturing.

As the battlefield moves from the world-class factories to the world-class supplier network, the question is, are the purchasing functions of most corporations ready for the shift?

About the author(s)

Mark Keough is a principal in McKinsey’s London office.