Evolving Value Delivery in Utilities: Building the Fundamentals

By: Harish Hemmige, Rafael Desi, Justin Dean, and Buzz Maslov

Utilities are facing a set of unprecedented cost pressures in both operating and capital expenses. At
the same time, Procurement functions are often not being leveraged to their fullest extent, remaining
in their traditional role of executing tactical purchasing and ensuring compliance. However, for many
leading utilities, this is changing. Procurement functions are becoming a source of competitive
advantage by driving considerable cost savings in the short and long term, improving service and
reliability of suppliers, and pushing towards greater innovation. Getting to this new way of working is
complex and requires major changes across the traditional operating model; but those who pursue it
are seeing returns many times their investment.

This is the first article in a series focused on evolving Procurement organizations at Utilities. In this
first article, we discuss ensuring the organization has the right fundamentals of developing category
strategies in place. In our next article, we will look at the increasing role of digital procurement to
create an even greater step change in productivity.

Current environment trying for Utilities

[Big quote: “Reducing costs is becoming a central tenet for delivering against Utilities’ mission of
providing cost effective energy solutions”]

It’s no secret that utilities have faced considerable business pressures over the last five years. From
April 2012 to April 2017, the industry has significantly underperformed the S&P 500 See Figure 1. The
need for increased cash flow has become tantamount. Utilities are under considerable pressure to
increase investment to replace aging infrastructure and to add additional functionalities to their grid.
For example, most coal-fired power plants are more than 30 years old and covering these costs coupled
with depressed wholesale power prices have led to a more cost conscious environment than ever
before. See BCG: Rewiring Utilities for the Power Market of the Future.1 Further, in the US, recent
changes in corporate taxation are expected to further limit cash flows.2

1
https://www.bcg.com/en-us/publications/2016/energy-environment-rewiring-utilities-power-market-future.aspx
2
https://www.euci.com/moodys-downgrades-u-s-regulated-utility-sector-as-cash-flow-is-reduced-by-tax-cuts/
Figure 1

Facing these challenges, reducing costs is becoming a central tenet for delivering against Utilities’
mission of providing cost effective energy solutions. This is seen industry-wide in such broadly
adopted initiatives like the Nuclear Promise. However, despite the need to cut costs, utilities are also
pushing to avoid layoffs and retain their most critical talent. This tension to remain competitive while
maintaining staff has led many utilities to rethink their approach to managing third-party spend
through improving their Procurement and Supply Chain capabilities.

Benefits of strategically leveraging Procurement

We have seen effective use of Procurement as a core strategic enabler for delivering immediate and
sustainable cost savings. Historically at utilities, however, serving as a strategic partner to the business
has not been part of Procurement’s original mandate. Rather, in most utilities, Procurement has
focused on tactical purchasing execution versus strategic sourcing. Additionally, valid concerns about
risk and safety, have limited the speed by which Procurement can evolve, further maintaining the
status quo. This has left many utilities with an underdeveloped capability. By focusing on the day-to-
day activities, Procurement is unable to keep a strong check on supplier pricing and is not able to
build the strategic supplier relationships that help unlock even greater value (e.g., through increased
innovation or joint design).

However, when its mandate changes, and Procurement is leveraged to its full extent, we have seen
step-change improvements, with savings reaching 10-20%--all without having to sacrifice safety or
quality of operations or investments. These savings can often be implemented immediately with cash
accruing in the same year. Most importantly, these savings are achieved without laying off any of the
full-time workforce.

The benefits are not just limited to cost savings. Many of the organizational changes that occur to
empower Procurement also lead to more efficient processes and procedures, streamlining much of the
day-to-day work. This has the further benefit of allowing supply chain professionals to focus on
creating more robust sourcing strategies. Best of all, leveraging external support to help institute these
changes becomes self-funding, paying for itself may times over.

Getting there

But what is required to actually ensure the fundamentals are in place? Given the current capability
level of many P/SCM groups at utilities, we often see the need to transform the current operating
model across five core dimensions: Strategy and Role, Organizational Design, People and Skills, Value
Delivery, and Tools, Metrics, and Systems. [See figure 2]

Figure 2

Strategy and Role

[Big Quote: “’Seat at the table’ mentality, coupled with a deeper cost culture ensures Procurement
provides a competitive advantage”]

For most utilities, Procurement’s mandate is small and tactical: “Execute the agreements with
suppliers that the business dictates.” Too often, we see utilities maintain the status quo vis-à-vis
suppliers, having Procurement renew long-standing agreements with immaterial discounts at the
direction of the business. Where sourcing events are used, it is seen as a price check on the
incumbent, without a real threat of switching. It is rare that we see Procurement have a strategic,
“seat at the table” to help drive strategic thinking, and ultimately savings.

However, fitting Procurement into the overall strategy is critical for success. Procurement’s mandate
must be broad enough to cover the vast majority of spend, and the business needs to see them as a
strategic partner. As the Procurement function develops its strategy, it should make sure to work
closely with its stakeholders to fully understand their strategic needs, and develop a strategy that is
intrinsically linked to them. At utilities where Procurement’s mandate has increased and cross-
functional collaboration is encouraged, we see them being brought in early in the process, to align
sourcing strategies with business strategies. For example, bringing Procurement in early in capital
planning meetings enabled the sourcing of multiple years’ worth of transformers and other capital
equipment that would have otherwise been sourced one-off, and drove a 15% savings. This increased
“seat at the table” mentality, coupled with a deeper cost culture ensures Procurement provides a
competitive advantage to the business.

Organizational Design

At most utilities there is no clear organizational distinction between tactical purchasing and strategic
sourcing. At one client, where the two roles were blended, the Procurement teams were so over-
whelmed by the day-to-day execution (e.g., purchasing new cable rolls to improve inventory levels),
that they were unable to spend sufficient time building out the factbase for a robust category strategy.
Teams deprioritized these activities so that they could address the here and now, and as a result, when
the time came for sourcing, the impact was much lower than what should have been expected. Having
a clear distinction between strategic and tactical roles allows dedicating the best resources to the most
critical, value unlocking tasks. Further, by separating out the tactical roles, utilities position
themselves to better leverage technology and automation solutions.

At one client, the team worked to transform a disparate operating model into a defined, category-
based model. The new model was better aligned to the unique business needs and defined new
strategic roles that helped leverage scale. These roles included a new Supplier Relationship
Management group, which focused on building better partnerships with key suppliers; a Supplier
Development group, which worked to find new suppliers in low cost areas that could support the
business; and an Organizational Category group, which holistically managed categories that impacted
the entire company. Having these new groups better coordinate with the business and take a united
approach to market led to much better results than the previously siloed approach. Additionally, the
team created a shared service function that focused on operational sourcing and transactional
purchasing allowing the new global supply chain roles to focus on the most strategic work. As a result,
the new organization can focus beyond the day-to-day, and is now well-positioned to expand its digital
procurement capabilities.

People and Skills

[Big quote: “Successful Procurement functions need to be seen as a unit for top-performers that are
focused on delivering value”]

Given most utilities’ starting position, talent within Procurement is often one of the largest gaps we
see, and requires significant investment. Developing the right capabilities and having the right people
builds the foundation of a strong Procurement function. Part of a successful transformation includes
training teams to embrace new sourcing levers like best cost country sourcing, value engineering, and
supplier collaboration.

At one client, we focused on creating a strong platform for developing new suppliers in low-cost
countries. Along-side the Procurement team, we built a framework for assessing the highest potential
countries that had relevant suppliers for each category and drafted a playbook for developing new
suppliers in the alternative markets. Most importantly, we set-up cross-functional teams with the
business owners so that potential business case was clearly communicated. Once executed, we saw
savings of 8-10% direct attributed to use of low-cost country suppliers.

Long-term, successful Procurement functions need to be seen as a unit for top-performers that are
focused on delivering value. Attracting the right talent requires developing the right capabilities,
tools, and approach. This includes being thoughtful and clear about the career trajectory and
providing a path for top performers to succeed and be recognized. Leveraging robust incentives tied
to the right KPIs and metrics help instill a value-driven workforce that strives to deliver for the
company. Additionally, having regular trainings and career development ensures that the
Procurement team is approaching the cutting edge.

Value Delivery

While utilities recognize the approach to value delivery has the potential to unlock the most value, we
still see most utilities using dated approaches for developing category strategies, relying on past
relationships and “what has worked before.” At one client, we were assured the long-standing
incumbent was already at its lowest mark-up for craft labor, and “there was no more room for margin”
given the current agreement. However, when we worked with the team to get greater pricing
transparency from the incumbent on their cost structures and subjected them to a detailed,
coordinated RFP process, we saw not only other players coming in much cheaper, but the incumbent
reducing their pricing by 10%, removing margin that was baked into other areas.

Creating a step-change in value means modernizing and better leveraging data-based approaches and
moving toward fact-based negotiations with suppliers. Also, not all suppliers are the same, and
rethinking how supplier relationships are managed holistically, across the organization, can create
opportunities, like increased innovation, that go beyond traditional cost savings. For another client,
we helped set-up catalyst sessions with a sole-source provider of waste management services to help
identify new way the two companies could interact that leverage the future technology pipeline, and
ultimately develop a longer term agreement that would lower costs for both companies.

Additionally, it is important that Procurement is able to flex all levers at their disposal and the
business is willing to consider the full range of options. This includes refining the risk culture within
the organization so that decisions are based on “true-risk” profiles that maintain the right safety and
quality for a given context.
Tools, Metrics, and Systems

Without the right enablers in place, sustainable change is not possible. Success requires Procurement
having the right tools at its disposal, ranging from the right templates and forms, e-sourcing
platforms, and contract management systems. Also, tracking the right metrics and holding all parties
accountable to them helps ensure the savings delivered actually reaches the bottom line.

Beyond the core transformational elements, we are also seeing new, cutting edge use of big data and
analytics to drive additional savings and create a more efficient supply chain. See BCG: Delivering on
Digital Procurement’s Promise.3 Specifically within utilities, we have seen an increased use data
visualization and optimization tools that allow for real-time pricing feedback and inventory
knowledge. Imagine a scenario where instead of having to restock redundant inventory, supply chain
professionals can have real-time inventory visibility across the full fleet and quickly transfer needed
equipment. Or, using robust logistics data to better understand flow patterns and optimize the
warehousing footprint to minimize downtime. Through big data, these scenarios are becoming
reality, but moving to this level requires having the right functional foundation. These topics and will
be explored more in depth in the next article in this series.

Transformation in action: Taking a holistic approach to change

While each of the core operating model dimensions can be tackled individually, given their
interdependency, we find taking a programmatic, transformative approach the most effective
solution—in particular, when it is coupled with an empowered PMO. We find this approach leads to
faster, more sustainable results.

One such example was at a client which was undergoing a large-scale transformation. At the start of
the initiative, their procurement function was similar to what we have seen with other utilities: An
organization that focused on tactical sourcing without being a strategic partner to the business.

Together, we focused on re-building their procurement function focusing on three key areas:

 Implementing structural changes into their operating model to support better value delivery:
This included redefining roles and responsibilities within the organization, dividing the
strategic work from the tactical, and increasing the level of engagement Procurement had with
its business customers

 Developing new capabilities within their core strategic procurement function: Introducing a
new set of capabilities from best cost country sourcing to should cost modeling to enable a
step change in value potential

3
https://www.bcg.com/en-us/publications/2018/delivering-digital-procurement-promise.aspx
  Executing hand-in-hand with the team to deliver value: Working hand-in hand with team to
embed the new capabilities and deliver tangible value through market events, negotiations
support, and supplier collaboration

Two years after beginning their transformation, the client is on track to deliver on their target goal of
15% savings. Further, the new organization is more focused on strategic activities and they have
improved relationships with their business stakeholders.

Taking the first steps

Figure 3

To get started, companies need first commit to the following:

 Recognize the competitive advantage of Procurement. Leveraging the function as a
tactical executor does not unlock value. Procurement must be seen as a strategic partner.
 Be honest about gaps across core operating model dimensions. Knowing where to focus
makes the transformation that much easier. Also consider leveraging third-party support to
take an unbiased view. BCG’s Procurement Excellence Monitor4 deep dives into the five
dimensions and can help diagnose what is most critical.
 Commit to change. Recognize that change is not going to happen unless Leadership supports
it.

Transforming the Procurement function into a competitive advantage is not an easy task and
implementing successfully can be quite complex. It requires time, dedication, and often external
support. However, the imperative is real and as we’ve seen, the potential impact is quite large.

4
https://www.bcg.com/en-us/capabilities/procurement/procurement-excellence-monitor.aspx