Transforming the Procurement Organization for a New Era

An Oracle White Paper By Marc Weintraub, Senior Manager Oracle Applications Marketing April, 2006

Transforming the Procurement Organization for a New Era

EXECUTIVE OVERVIEW
The procurement function must be transformed from a tactical buying centerproviding minimal strategic value and little impact to the bottomlineto an advanced procurement entityproviding maximum strategic value and dramatically improving the bottom-line

Procurement can have a significant bottom-line impact. Organizations are improving profits by transforming their procurement organization and adding a strategic focus. This is done by making procurement organization changes in three key areas: structure, culture, and incentives. As a result, procurement organizations can demonstrate an increased contribution to profits.
INTRODUCTION: ORGANIZATIONAL DRIVERS ARE CHANGING

Five years ago, if you told a procurement professional that 53% of head procurement officers will report directly to either a CEO or CFO, you would have been ridiculed. Nevertheless, today that is exactly what is happening. 1 Executives are realizing the potential bottom-line impact that procurement can have. With this realization, the procurement function is now the focus of many executive discussions, and their expectations of the procurement organization are growing. The procurement organization charter is expanding beyond merely reducing unit costs, managing sources of supply, and effectively processing transactions. It now includes managing compliance, supporting product innovation, and expanding into new markets. The need for procurement to contribute more strategically is driven by: Increased regulatory oversight that includes compliance to both financial reporting guidelines (such as Sarbanes-Oxley) and environmental regulations. Increased outsourcing of non-core business processes and functions to third parties and managing these third-party relationships. Increased use of global suppliers and distribution networks.

Aberdeen Group, March 2005, The CPOs Agenda: Five Strategies for Procurement Transformation

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Volatile market conditions that include rising energy costs, tightening supplier inventories, and the need to plan for the contingency of offshore supply-market disruptions.

It is becoming clear that to meet and exceed these new expectations, the procurement function must be transformed from a tactical buying center providing minimal strategic value and little impact to the bottom-lineto an advance procurement entityproviding maximum strategic value and dramatically improving the bottom-line. A transformation like this takes time, technology, process improvements, and organizational changes. What organizational changes are necessary to transform procurement? It is becoming clear that the rigid, hierarchical organizational structure of the past must give way to a more adaptive, cross-functional structure that reaches beyond the traditional realm of procurement and into all company functions. Although important, structural changes to the procurement organization alone will not result in a radical transformation. After all organizations are comprised of people, and people need clearly stated goals and objectives in order to be effective. Therefore changes to the culture of procurement are also needed to facilitate this transformation. The procurement organizations charter must be revamped in order to align its members to its new role of delivering strategic value. Lastly members of the procurement organization and the organization as a whole, must have the properly measures and incentivesincluding both rewards and punishmentsto ensure procurement policy is implemented. Over the next several pages, these three procurement organizational changes (structure, culture, and incentives) will be explored in greater detail. The goal is to enable you to examine your own organization with a critical eye in order to identify and enact changes that will continue you on your transformation journey.
STRUCTURE THE ORGANIZATION TO ADD STRATEGIC VALUE

Every organization is unique and therefore how each organization structures itself is unique too. Organizational structures depend on many factors including: number of employees, geographical location, industry, and business philosophy. Although there is no one-size-fits-all, there are common characteristics in all high performing organizational structures. These characteristics include: Leadership and Executive Support Cross-Functional Teams Multi-Modal Organization Deep Domain Expertise

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These are key attributes that can transform a department from merely a cog in the machinery that is the business, to one that adds strategic value to the entire business and directly impacts the bottom-line. This is true of any organizational structure, whether that be for sales, human resources, or procurement.
Leadership Support Must Come From The Top

Leadership and executive support must come from the top. Within the procurement department the top must be the chief procurement officer (CPO). The role of the CPO is critical in gaining executive support. CPOs must use their management skills and understanding of procurement to communicate to the executive team the value procurement can deliver and its impact to the bottomline, in terms the executive team can related to (such as business cases, EPS projections, cost-benefit analysis, and ROI). This will enable a CPO to obtain budget, resources, and support for procurement initiatives. In order to create sustained executive support, CPOs must report back to the executive team how well the procurement organization is delivering. In addition to gaining executive support, a CPO must be the procurement groups number one advocate. A CPO must drive awareness of procurement initiatives and spearhead change across the businesscommunicating the reasons for change and the benefits they will bring. Also with leadership comes accountability; the CPO must ultimately be responsible for the delivery of results and execution of both day-to-day procurement operations and specialized initiatives. For many businesses a position with the title Chief Procurement Officer simply does not exist. The CPO title is not as critically important as the responsibilities of that role. Truthfully, existing procurement organizational structures need not be entirely scrapped and redrawn from scratch just to accommodate a new title. Most likely the role of CPO (as defined above) already exists within most procurement organizations in one or more positions/titles. But in order to truly transform the procurement function and facilitate the success of the CPO role the following organizational structure changes must be made: Consolidate multiple existing positions into a single role. Include the CPO role as a member of the executive team.

It is critical that the top procurement officerregardless of their titlereport to a member of the executive team. As seen from the Aberdeen Groups research, 44% of top procurement officers do not report to C-level executives. This could compromise their ability to gain much needed executive support.

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Works Well With Others

In a survey, the Chartered Institute of Purchasing & Supply asked respondents how purchasing worked with other functions/departments within their organization.

Cross-Functional Cooperation Adds Value

Among all of its other challenges, procurement has the added difficulty of having the responsibility for delivering savings but having little or no procurement buy-in from the business that directly impact the realization of these savings. To remedy this, procurement organizational structures need to adopt the concept cooperating with other functions within their organization. A recent survey by the Chartered Institute of Purchasing & Supply found that over 56% of organizations have not reached the stage where functions outside of purchasing such as finance and IT as well as operational business units, work together with purchasing in a structured way 2 . To remedy this, highly matrixed, cross-functional teams should be embraced. Many of these teams should exist. These teams will vary in their membership and scope but are not redundant and mesh together to create value for the entire organization. For example, Purchasing Councils are teams that define overall procurement strategy based on enterprise-wide feedback. In contrast, Category Councils are at the heart of executing that procurement strategy. Category Councils are the best-known cross-functional team and serve as an ideal candidate to investigate further as a means for procurement to employ matrixed teams in its organizational structure. A Category Council is a cross-functional group of internal stakeholders from across the line of business for a given category, product, etc. The purpose of the Category Council is to involve these stakeholders in the procurement process before that process is executed. By involving stakeholders like, engineering, marketing, finance, manufacturing, and distribution in the sourcing process (such as event definition, bid evaluation, and supplier selection), their specific needs can be identified and addressed. By understanding the stakeholders needs and accounting for them in negotiated sourcing agreements, the procurement organization ensures greater compliance. That is because the business community, which holds the keys to realizing negotiated savings, is more likely to comply with sourcing agreements they have participated in via a Category Council than those the procurement department has established in isolation. When Category Councils are not incorporated into the procurement organizational structure, procurement professionals will tend to focus on negotiating lower prices when sourcing items. Unaware of the stakeholders concerns (such as quality or delivery timeliness), procurement professionals will be unable to drive compliance to the
2 The Chartered Institute of Purchasing and Supply, I-Innovate

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lower cost agreements because of the continued use of existing suppliers that the stakeholders know addresses their concerns. The procurement group should coordinate these Category Councils and balance the competing needs of the stakeholders with the need to reduce costs.
What? More Meetings! Key Organizational Entities
While the Category Council has a great reputation as a change agent, it is but one of many standing groups that can dramatically impact purchasing reform. Below are examples of others that have delivered great results
Name Charter Membership

Purchasing Council Regional Commodity Councils Purchasing Technology Councils Quality Improvement Teams Lead Buyer Networks Risk Management /Disaster Contingency Teams Supplier Councils

Provide and receive direction Executive Sponsor, Finance, from entities creating Representative Line of business, and corporate strategy Purchasing Leadership Focused on the unique needs Commodity Council on a regional basis of geographies Focused on improvement of IT infrastructure needed to sustain Purchasing transformation Typically focused on improving the quality of end products, especially in manufacturing Improve the organizations price performance in and individual category Mitigate the impact of any unplanned business interruption Information Technology, Finance, Purchasing, Representative Suppliers, Independent Experts Production, Logistics, Finance, Purchasing, Engineering, Maintenance, and Suppliers Buyers for an individual category or closely related categories across several regions/purchasing groups Risk Management, Operations, Finance, and Purchasing

Make the organization a better customer

Representative across supplier tiers, finance, LOB, and Purchasing

Lastly, it should be noted that Category Councils need not only include internal stakeholders. Many companies involve their key suppliers early in the procurement process. By involving suppliers, their capabilities and suggestions can be factors in the procurement processthis can result in faster time-to-market, additional cost reductions, and product innovation.
Centralize Or Decentralize Based On Business And Category Needs

No discussion on the structure of a procurement organization is complete without touching upon the age-old question of centralization vs. decentralization. In the past, managers commonly believed nothing short of complete centralization of all spend would result in significant savings. Quickly it was realized that this model seldom succeeds. In many cases commodity, services, and market expertise only existed and was relevant locally. Upon this discovery organizations attempted to get the best of both the centralized (regulatory compliance, volume discounts) and decentralized (expertise in local suppliers, detailed demand knowledge) worlds by

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What Is Center-Led Procurement?

Center-Led Procurement (CLP) is a procurement framework that suits the needs of the business unit and the special characteristics of specific goods and service categories. CLP applies different purchasing modelsincluding centralized shared services, decentralized and hybrid buying depending on what is being bought, who needs it, and where it will be used. CLP decouples the physical and logical locations of procurement activities. Buying is executed where and how it makes the most sense, while the purchasing department contributes structure, expertise and measurement to the process. Major manufacturing components such as drive-trains for automobiles are usually centrally sources by purchasing. On the other hand, snow removal services are impossible to source on a strictly central basis because supply markets are highly localized. However, central purchasing organizations can still save money on snow removal by providing business units with best practices for contracting these services in local markets.

deploying various hybrid models facilitated by a shared-services procurement group and a complex system of inter-departmental charge-backs and account transfers. From these hybrid models a new procurement frameworkCenter-Led Procurement (CLP)has materialized and is rapidly being adopted by many organizations (see side bar 3 ). CLP allows the central procurement organization to influence buying regardless if of where it is executed (i.e. locally or centrally) by promoting best practices and process improvements. CLP also allows the central procurement organizations to focus their efforts on categories of spend that maybe more suitable to centralization and more cooperative business units. This results in greater compliance and savings, a more efficient use of time verses attempting to establish an all encompassing policy for all spend, and stronger credibility across the organization as a whole for not unilaterally pushing a single policy. CLP by no means is a panacea nor is it right for every organization. What it enables is a flexible, multi-modal organization structure. That flexibility will allow procurement organizations to determine the best procurement policy, structure, and process on a category-by-category and/or business unit-by-business unit basis that will allow them to add strategic value to the entire business and directly impact the bottomline.
Build Deep Domain Expertise

Deep domain expertise is another key characteristic that must exist in leading procurement organizations. Within the organizational structure commodity managers should be the keepers of this expertise for their specialized domains. Commodity managers must be expert buyers for specific niche of goods and/or services. Commodity managers need to have the following skill set: Deep understanding of the goods and/or services within their commodity. They should be considered an expert regarding the technical and functional details of these goods and/or services (such as the maximum torsion a galvanized, cold-rolled, piece of steel and withstand). Deep understanding of market conditions relating to good and/or services within their commodity (such as change in governments in a central Asia republic will increase the global supply of titanium by 5%) First rate negotiation skills.

Commodity managers play a central role in the Category Councils described above by providing their expertise to the cross-functional group. Because of their highly specialized and strategic role, commodity managers should not be leveraged for tactical transaction processing. World-class procurement organizations ensure that as much of the commodity managers knowledge is captured and is available for reuse even if that resource is not.

Purchasing Magazine, February 2005, Why Center-Led Procurement Is Gaining In Purchasing Popularity

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CREATE A CULTURE THAT ACTS TO ADD VALUE

Merely changing the procurement organizational structure by adding key roles like a CPO and commodity managers or interacting with member of other departments in cross-functional Category Councils is not enough to transform the procurement function into an advance procurement entityproviding maximum strategic value and dramatically improving the bottom-line. A fundamental change in the culture of the procurement organization is needed as well. The charter of the procurement function must be re-evaluated and redefined. This new definition must focus on adding value to the entire organization and align procurements objectives with the objectives of the entire business. If procurement continues to only be focused on reducing costs through process efficiency and negotiating price reductions, it is destine to remain an isolated and insignificant component of the business.
Align Procurement With Business Objectives

The focus of the procurement function must shift from reducing costs to increasing value. More and more procurement organizations are participating in activities that increase value to the business as a whole. These activities include creating new revenue opportunities (such as expansion in to new markets) and improving profitability (such as managing supply availability)directly impacting the bottom-line. In addition, the procurement charter must be expanded to include product innovation, competitive differentiation, and managing customer demand. Procurement must understand how good procurement can increase revenue and profits; examining the true impact of procurement does this. For example, you might find that procuring a component from a new supplier at a increased per unit cost of 5% will increase quality and reduce the number of returnsand subsequent refundsby 20%, thereby increasing profits. Therefore, strategic procurement can be a value-adding activity. This is a radical change for most procurement organizations, because it dictates that procurement professionals often must define and execute policies that increase coststhe exact opposite of the prevailing procurement culture.
Educate Procurement Staff On Adding Value

Procurement is everywhere in the business; every employee is a member of the procurement organization. Beyond just the requisitions they may create, every employee, every day interacts with something that was procuredwhether that is the computer or telecom services they use or the sheet metal they stamp. Changing the procurement organizations culture to align its objectives with the objectives of the entire business has an additional benefitincreased responsibility for procurement objectives. Good procurement becomes everyones responsibility because its everyones responsibility to help the company meet its objectives and the procurement organizations objectives, now aligned with the companys, is how everyone can do that. Still the onus is on the procurement group to get this message out to the entire business. Procurement professionals must evangelize the

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role and objectives of the procurement organization. They must expand the involvement of non-purchasing functions in spend compliance by conveying the benefits of maximizing every dollar they spend and the negative impact to the bottom-line buying off-contract will have.
Educate Employees On How To Procure For Bottom-Line Benefit

In the end, the value created by the procurement organization is all that matters. Why? Because it directly impacts the bottom-line. The means in which procurement objectives and results are delivered is largely irrelevant (assuming it is cost effective and within corporate policy). Therefore, if the procurement organization recognizes that can achieve more of its objectives, more effectively using resources from outside the company (such as expert consultants) it should not be punished for its shortcomings in directly achieving its objectives. Focusing on results and measuring the value the procurement organization delivers goes hand-in-hand with changing the culture of the procurement organization.
THAT WHICH IS REWARDED GETS DONE

Economic incentives are the most powerful motivator in the business world. Typically what gets measured and rewarded, gets done (and what gets punished is not done). Measurements that are not rewarded may not get done, especially with competing priorities and ever-present resource constraints.
Measure Realized Savings, Not Just Negotiated Savings

Currently procurement organizations are measured and rewarded based on negotiated savings. These savings targets must be drastically revamped in order to transform procurements ability to impact the bottom-line. The adage a dollar saved is a dollar earned is still true, but enterprises are discovering that this is only true for realized savings, not negotiated savings. At a minimum savings targets must be measured based on realized savings.
Measure Additional Contributions

Measuring the procurement organization based solely on savings targets is shortsighted. Additional metrics should measure procurements role in: Increasing revenue Contributing to innovation Improving customer satisfaction and retention Managing risk

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Such measures must complement realized savings targets. The cross-functional stakeholders should define these additional metrics, as part of the Category Councils described earlier.
Define Objectives With Cross-Functional Teams

At this point in the procurement organizations transformation, cross-functional teams jointly participate in the procurement process to ensure it recognizes and balances everyones needs. These cross-functional teams are also jointly defining the metricsthat go beyond negotiated savingsto measure the success of procurement objectives and ensuring these objectives are aligned with those of the enterprise. Now, it is only fair that all parties involved with procurement (such as all business functions) are appropriately compensated based on the success and failure of procurement. When the procurement function performs well and meets its objectives it can only be the result of efforts from across the business. Monetary bonuses should reflect the efforts of all involved. In addition to incentives that reward good procurement across the enterprise, disincentives must also exist. When the procurement function does not perform well and fails to meet its objectives, the companies bottom-line will sufferadditional costs will be incurred, revenues decreased, and profits lost. In order for a company to maintain fiscal viability this monetary loss must be account for and should be extracted from corporate bonuses. Ideally, when specific departments can be identified as non-compliant with procurement policy, they alone should be punished. However, equally reprimanding all business groups even when a sole culprit exists creates a system of internal compliance watchdogs, thus adding another mechanism ensuring good procurement.
Hire And Compensate For Value-Adding Skills

What Do You Know? Key SkillSets For Procurement

Tomorrows Purchasing organizations are seeking out talent with qualifications and experience in: Finance Information Technology Design & Engineering Research & Development Sales and Marketing Logistics Manufacturing Business Process Reengineering Human Resources International Trade

The last transformation within the procurement organization focuses on the compensation of procurement professionals. Execution of the procurement function is critical and to execute it well the right people, with the right skills are needed. As discussed earlier, not only will procurement organizations need to include resources with deep, specialized knowledge in specific commodities, procurement professionals will need to posses a much wider range of knowledge and non-traditional skills (see side bar). Gone are the days when the procurement staff was recruited solely based on stonefaced negotiation skills. As procurement automation allows existing procurement professionals to focus on more strategic activities and the entire procurement organizational structure changes to become more value delivery based, new skillsets will be required within the procurement department. Existing staff will need to be retooled and/or new talent acquired. Already the educational requirements for new staff are changing and staff roles addressing non-operational purchasing are increasing.

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Just because procurement is moving into strategic activities, doesnt mean that your procurement staff is ready to make the transition. Most organizations find that they need to revise the existing skills pool and augment it with new talent. Leaders is supply management consistently take the approach of combing new and old skills from inside and outside of the organization. Resources from both inside and outside of the organization bring unique perspectives that are a prerequisite for eliminating waste, identifying best practices, and implementing policies. Procurement change agents should take pains to reassure existing staff members of the value of their contribution in order to ally fears of shifting cultures and eliminate resistance to change. Whether investing in training for existing resources or hiring new highly skilled resources into the procurement organization, enterprises must protect and maximize their investment in resources by ensuing high retention. To accomplish this procurement professionals should be compensated accordingly. For most organizations this will equate to a net increase to the compensation of its procurement professionals. This increase should be in relation to the value procurement will deliver and proportionally tied to bonuses and overall company health.
CONCLUSION

Procurement can have a significant bottom-line impact. Organizations are improving profits by transforming their procurement organization and adding a strategic focus. This is done by making procurement organization changes in three key areas: structure, culture, and incentives. As a result, procurement organizations can demonstrate an increased contribution to profits.

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Transforming the Procurement Organization for a New Era April 2006 Author: Marc Weintraub Contributing Authors: Charles Knapp Oracle Corporation World Headquarters 500 Oracle Parkway Redwood Shores, CA 94065 U.S.A. Worldwide Inquiries: Phone: +1.650.506.7000 Fax: +1.650.506.7200 oracle.com Copyright 2006, Oracle. All rights reserved. This document is provided for information purposes only and the contents hereof are subject to change without notice. This document is not warranted to be error-free, nor subject to any other warranties or conditions, whether expressed orally or implied in law, including implied warranties and conditions of merchantability or fitness for a particular purpose. We specifically disclaim any liability with respect to this document and no contractual obligations are formed either directly or indirectly by this document. This document may not be reproduced or transmitted in any form or by any means, electronic or mechanical, for any purpose, without our prior written permission. Oracle, JD Edwards, PeopleSoft, and Siebel are registered trademarks of Oracle Corporation and/or its affiliates. Other names may be trademarks of their respective owners.