Supply Management: The ‘Hidden Lever’ to Improve Business Performance

In this period of earnings and business surprises, it is timely to highlight a hidden opportunity for CEOs and their executive teams.

What do the best performing companies know that the rest of the business world hasn’t yet realized? Or, to ask the question differently, what is the hidden lever that can impact the total business performance of your company?

The answer may surprise you: supply management. In its modern incarnation, world-class procurement and supply management offers the potential for enormous benefits, both to the top and bottom-line. This  factor is behind some of the biggest success stories in business, such as Proctor & Gamble, United Technologies, Dell, and the Chrysler Corp. of the early 1990s. Furthermore, as studies by Aberdeen, Hackett Group, AMR Research, Greybeard Advisors, and others have shown, there is a widening performance gap between the companies that practice world-class supply management, and those who don’t. And that performance gap applies to companies of all sizes – large, medium, and small.

What is truly amazing is that – after all these years of talking about corporate performance – many companies still don’t recognize and pursue the enormous performance lever that supply management offers. Why? The thinking at many companies is stuck on a conventional use of “purchasing” to lean on suppliers primarily to reduce prices. That limited role for supply management (and suppliers) leaves a lot of shareholder value unrealized – and makes the job of top management that much more challenging.

Leaders of world-class supply management organizations adopt aggressive objectives that directly relate to improving total business performance. They focus on key categories of actions that make a profound difference, both short-term and long-term.

• They set revenue enhancement goals, and work with suppliers. Improving the cycle time from new product concept to delivery to the marketplace can provide a significant competitive advantage. If you could get your new product to market well ahead of your competition – and at a significantly lower delivered cost – would that be significant for your business? Supply management, working closely with key suppliers, is a necessary ingredient to make this happen. The Chrysler Viper story is a classic example of inviting suppliers into the process, with enormous impact on ability to go-to-market, at good costs.
  
  On the other end of the spectrum, a global consumer products company surveyed its major suppliers and was surprised to learn that its raw materials suppliers viewed its procurement function as focused entirely on purchase price, and having no interest in joint efforts on innovation. Some of the surveyed suppliers indicated a willingness to lend their R & D skills to the customer’s New Product Development effort, but were discouraged from doing so by the customer’s tactical perspective about their potential role.
   
• They pursue true, year-over-year cost reductions. Cost savings continue to be a central focus of supply management functions. In the best companies, aggressive, quantifiable cost reduction objectives are based on world-class, benchmarked results achievable with best practices, such as Strategic Sourcing and Negotiations Management (SSNM). Companies that are setting the standard in this area include Hewlett Packard and Commercial Metals Company, aided by top management’s involvement and commitment, as well as the involvement of cross-functional teams spanning functional silos.
  
  Furthermore, leaders encourage their teams to strive for genuine, year-over-year cost reductions, which make it to the bottom line, as opposed to the easier-to-achieve and sometimes fictional cost avoidance – which offers little real value.
   
• They develop expertise in commodity risk management. This can deliver significant value during periods of price run-up and volatility, as the last few years demonstrate. World-class companies often insist that their supply management and finance groups work together, combining the commodity market knowledge of supply management, with the risk management talents and toolset of finance.
  
  Leaders in commodity risk management include global giants Procter & Gamble and Cargill. You would expect that these two companies would be leaders in this area, given the sheer size of their business and commodity exposures. But it’s not the sheer size of commodity dollars at stake that make this an imperative – it’s ultimately the “earnings at risk” for the company. And the earnings at risk can be relatively large even for smaller companies.
  
  
• They focus on working capital. Initiatives on payment terms and inventory programs, if properly designed and thoughtfully rolled out to the supply base, can be large sources of value. A word of caution on payment terms:  be careful how planned changes are implemented, there are lots of pitfalls. In one case, a procurement department wanted to make a quick win by “demanding” new payment terms of net 60 days from all of its suppliers. At least one supplier, though, was also a large customer that bought more from the first company than it sold to it. That supplier/customer, in turn, demanded 60-day terms from the first company.  Result: the first company ended up with a net disadvantage.
  
  Bayer Corp. is an example of a company that approached suppliers thoughtfully, and reaped significant improvements in payment terms in the early part of this decade, well ahead of other companies. AB InBev, the global brewer, is an example from the other end of the spectrum. As reported in European and U.S. media, its recent aggressive shift from Net 30 day terms to as high as Net 120 day terms has generated ill-will, controversy and negative publicity for the company.
  
  
• They institute “asset recovery” programs. The objective is to identify idle plant and equipment at each company location, and use that information to avoid hard cash outlays at other locations for similar needed equipment. If no internal use is found within some period, then the idle assets are monetized, often with the help of specialized third parties who can help obtain fair, not distressed, value for the asset. Multi-plant, capital-intensive businesses offer the greatest opportunity for asset recovery value.
  
  Companies such as Alcoa, Bayer and Bethlehem Steel (prior to it being absorbed into International Steel Group) set the bar in this area. Companies like Consol Energy are newly focused on this opportunity. In our experience, most companies have little discipline with regard to asset recovery, and are leaving real value on the table.
  
  
• They optimize capital project costs (both dollars spent and time to ramp-up). Optimization of the costs and timeline is achieved when engineering, plant operations, R&D, supply management and even suppliers are involved together early in the project’s conception and design. This flies in the face of “close to the vest” project management, but it works. Rio Tinto Alcan is a leader in this area, involving procurement and suppliers early in the process to identify creative strategies that drive cost and schedule.
  
  What do most companies do with capital projects? The engineers and plant operators go running down the path of conceptualizing the new project, and designing the equipment, before seeking any involvement from their professional procurement colleagues.
  
  Getting procurement and suppliers involved early in the process, even at the concept stage, makes it more likely that the best ideas are surfaced and considered before it is too late, and that the commercial foundation for success is established before too many “technical details” are locked in.

The total impact from a comprehensive supply management transformation involving all of these core initiatives can be enormous. (see Chart) A fairly typical manufacturing company might have a Return on Invested Capital (ROIC) of 8 percent or less if it doesn’t pursue the actions described above. But if it does take the actions I’ve outlined, the company has the potential to transform itself into a 20 percent ROIC performer. That’s not fantasy – it can be done.

Executives at the most successful companies recognize that the supply management organization cannot succeed in achieving these results alone. So view this opportunity as you would the introduction of any change initiative or innovation: give it executive-level support, dedicated and talented resources, great leadership, and a mandate to develop a transformation roadmap and implement best practices. Finally, make sure that the goals and objectives are not created in isolation, but are shared across the entire corporation. In our experience, the foregoing are not discretionary actions; they are essential for success.