Key Trends in Procurement
Carlos Alvarenga of Ernst & Young recently wrote a piece for Procurement Leaders outlining his vision of what procurement will look like in 2025 in the first installment of a series of posts. In this article we lay out our predictions for how strategic thinking will change as we move towards 2020, and how sourcing will unleash much greater efficiencies in the years to come.
In what is undoubtedly going to continue as a period of ongoing transformation, the main certainty we envisage is that the discipline will continue to become more professional, leading to procurement being increasingly recognised as a key function crucial to the bottom line of any organisation of significant scale.
The following represent some of the additional key trends we see emerging in the next few years, more will follow tomorrow:
1. Abandonment of Sole Supplier Contracts
Central bankers often describe loose monetary policy (cheap money) as being the ‘sweet poison’ of inflation. It can lower effective debt and provide increased economic activity because more people borrow, but it comes at a cost that is eventually realised should the borrower struggle to repay debts.
The drive for efficiencies and economies of scale in buying has lured sourcing professionals into a similar trap. Sole supplier outcomes can reduce costs initially, but it hands significant leverage to that supplier who gradually gains tighter control and dependency can become high. Buying organisations can find themselves becoming vulnerable in negotiations with no credible alternatives to turn to when prices tick upwards. Short-term gains can lead to long-term higher costs especially if the supplier pool is shallow. The risk inherent in sole supplier relationships also means that supply shocks can result in dire consequences. We believe more organisations will take a more strategic perspective looking to ensure competitive tension exists amongst a small number of suppliers.
2. CPOs to Receive Long-Term Contracts
A solution to short-term thinking among central bankers has been for top Central Bank officials to receive lengthy periods in office to encourage long-term planning. For example, Alan Greenspan was in his post for 19 years. One may argue that his monetary policy became too loose when he was in his final years in office and his successor Ben Bernanke would reap what was sown.
The current policy of bringing in CPOs to transform procurement practices in four to five years and to then have them move on means incentives are strategically misaligned with longer-term corporate objectives.
This practice has the effect of incentivising short-term price-gouging activities that harm supplier relationships, encourage supply consolidation and ultimately feed into higher prices (but this cycle can take time).
We believe that enterprises and governments will increasingly begin to appreciate that strong supplier relationships are essential, and that senior executives will need to be incentivised to plan over longer-term horizons of 10-plus years. This will result in an increased focus on win-win partnerships in place of a zero-sum approach where CPOs looked to squeeze suppliers causing quality to suffer.
3. Data-Driven Decision Making
Relying on intuition as a basis for decision-making has been resoundingly proven to be a poor substitute for evidence-based approaches. A simple experiment conducted highlights this clearly.
In Cohort A, participants were asked:
Question 1: is the average price of a German car above or below $100k?
Question 2: to guess the average price of a German car.
In Cohort B, participants were asked:
Question 1: is the average price of a German car above or below $30k?
Question 2: to guess the average price of a German car.
The results were amazing, Cohort A guessed an average price that was a full $35k above the average guess of Cohort B.
This above example illustrates how ‘anchoring’ can completely sway people’s decision-making skills, and makes clear the need for evidence-based approaches to determining whether value for money is being achieved in sourcing exercises.
Many suppliers use anchoring when pricing because many recognise its importance. Procurement teams often quote savings in terms of discounts off regular ‘rack rates’ or the percentage price decreases in an eAuction from the initial bids. These are both poor indicators of value and don’t offer worthwhile evidence of good performance, in terms of savings, yet examples of procurement professionals citing savings in this manner abound.
We predict that spend analysis will increase penetration levels as CPOs seek evidenced-based assessments of prices paid for goods and services within and outside of their organisations. The objectives will become clearer and more transparent.
4. Sourcing Optimization to Become Standard
For larger sourcing exercises, the predisposition of sourcing professionals to design arbitrary lots in the belief that it is possible to guess in advance how supply contracts could be divided efficiently will be phased out. The problems with this approach are numerous and include: inhibited market entry, poor access for SMEs, implicit cartel formation and higher costs. The lots never allow vendors to describe accurately their strengths or footprints so they can offer best value for money.
Sourcing optimisation involves subdivision into many small contracts and invites bidders to communicate their footprints across product lines or geographies with greater expressiveness. The finer ‘resolution’ and price revelation provided when bidders can price with precision (and describe economies of scale across these contracts using contingent discounts) unlocks more data and evidence as to how an award may be split among suppliers. This approach also facilitates the imposition of buyer-side business constraints (e.g. We need at most three suppliers in the South East and we can only switch 50 percent of contracts from incumbents). Once buyers try this approach they typically never want to switch back and we predict that this approach will continue to grow in popularity.
Sectors to Lead the Charge
The transformation in sourcing will be led by sectors with the biggest need, those most receptive to embracing innovation and those with the technical ability to deliver change. Mature industries and those that are heading for more turbulent times will be most incentivised to streamline processes. These include:
Overall, the main theme emerging within sourcing transformation will be increasing sophistication, and also rising recognition of the importance of the function within organisations. The organisations that retrain and re-tool in order to meet these challenges will be better placed to help their organisations become market leaders in their respective domains.
This post originally appeared in SpendMatters UK
Alan Holland is the CEO and Founder of Keelvar