Procurement leaders who had hoped that macroeconomic conditions in 2023 would make their jobs easier than last year are already disappointed. As the new year began, the volatility and inflation of the previous year showed no signs of abating (see sidebar, “Macroeconomic conditions straining procurement”). Some of the most important trends may persist well beyond 2023. What’s more, the procurement function itself continues to face major changes that have made its traditional operating models obsolete.
Front-running procurement organizations are increasingly distancing themselves from the rest of the pack, deploying their talent, capabilities, technology, and insights into the world’s complexity in ways that propel them far ahead of the rest of the pack, says McKinsey.
Understandably, the aggregate effect of these challenges has overwhelmed many procurement functions. Procurement can play a critical role in solving today’s most pressing business problems, but it cannot do so on its own. Winning now requires an entirely new level of resilience improvement and value creation built through a coordinated enterprise-wide effort.
Accordingly, success in protecting margins, containing cost escalation, and dynamically capturing opportunities requires an expanded mission for the procurement function. CEOs should consider positioning their procurement leaders at the center of the company’s response to the current context, tasked with a clear mandate to protect margins. CPOs can then mobilize executives for cross-functional impact and escalate investments in the talent and systems required to achieve and sustain outperformance.
A resilience toolbox: Ten core actions
Procurement leaders can combat volatility, inflation, and shortages and build resilience by taking ten core actions (Exhibit 1). They should start by gaining transparency into the pressures they face. Then they can apply this visibility to create value across the supply base. This requires mobilizing other parts of the business across supply chain, operations, and commercial capabilities. These efforts should be supported by a central nerve center, a control tower, and new capabilities. Building an agile procurement function with stronger links to internal and external partners is the key to success.
Create transparency to enable action
The transparency necessary to enable action includes a 360-degree view of vulnerabilities and real-time information delivered to a “resilience cockpit.”
Action one: Identify vulnerabilities with a 360-degree risk assessment. To decide on the right actions, CPOs need transparency about three types of risks:
- Supply. How are events affecting the end-to-end value chain? Which categories may be hard to secure in the foreseeable future?
- Suppliers. What vulnerabilities—including financial, fulfillment, reputational, and environmental—do suppliers face?
- Cost. How are suppliers’ costs of goods sold (COGS) trending? Can we quantify the inflation or deflation they face? What do the results mean for our company’s P&L?
To manage these risks, companies need to understand their tier-n upstream value chain. A digital twin can provide the insights required for scenario planning.
A European utility implemented a digital solution that continuously identifies and updates risks related to critical materials, key suppliers, and exposure to inflation. The solution is linked to external data sources, such as supplier intelligence and core indexes, and models inflation exposure. It notifies the company’s decision makers when any new risks emerge.
Action two: Gain real-time visibility. Leading companies have set up a resilience cockpit that provides real-time insights on customer demand, inventory, market pricing, and supply disruptions. The cockpit automatically enriches internal data with market data. The information is always accessible to CPOs and other company leaders.
An automotive OEM created a digital twin of its value chain and automated data flows using third-party databases, transport declarations, and news sites. The resulting cockpit monitored more than 1,000 components and 100 raw materials and integrated 60 data feeds across regions and specifications. It enabled sensitivity analyses of different sources of volatility, such as foreign-exchange risk and individual site operations.
Partner across the supply chain
In partnership with the supply chain, procurement leaders should refresh their category strategies and enhance their risk operating model.
Action three: Refresh category strategies to drive efficiency and resilience. For active management of costs and risks, such as those relating to labor and logistics, procurement needs to apply market feedback quickly to capture emerging opportunities and work differently with suppliers. New relationships need to focus on developing innovative specifications, improving sustainability, reducing emissions and waste, and building capabilities.
A specialty chemicals manufacturer partnered with top suppliers of inflating commodities to radically improve the total cost of ownership and reduce risk. This program was convened by procurement and included team members from R&D, operations, and finance. The internal participants worked with the supplier to rapidly qualify a lower-cost, lower-emission set of specifications that allowed the manufacturer to mitigate a double-digit cost increase.
For active management of costs and risks, such as those relating to labor and logistics, procurement needs to apply market feedback quickly to capture emerging opportunities.
Action four: Enhance the risk operating model. To thrive in the current context, companies must fundamentally upgrade their risk operating models. Priority enhancements can include the following systems:
- Sales-at-risk dashboards. These dashboards present data from weekly monitoring of risks that affect sales and profits.
- Supplier transparency. This analysis identifies suppliers and maps dependencies to assess network resilience and vulnerabilities (Exhibit 2).
- Supply and demand prediction. Advanced solutions can predict future capacity shortages and situations requiring excessive lead time, so the company can prestock inventory.
- Modeling of measures’ impact. Models can predict how well resilience measures are likely to achieve a defined set of objectives, such as those relating to volume and cost.
Procurement leaders can optimize operations from end to end as well as optimize the company’s energy consumption.
Action five: Optimize operations from end to end. The upward pressure on input prices has increased the importance of partnering with cross-functional peers to address end-to-end levers, such as reviewing specifications, challenging demand, and streamlining internal processes. Procurement leaders have strengthened their teams’ abilities to design to value, collaborate with suppliers, and reduce complexity. These initiatives generate value regardless of market context, help relieve upward price pressure, and can generate a sustainable competitive advantage when the market stabilizes.
The benefits are especially valuable in energy procurement, where the category manager’s role has dramatically changed. To gain transparency on the risks and opportunities arising from the rapidly changing energy cost curve, procurement can pursue multiple partnerships. With the finance and risk functions, the partners can update risk–reward profiles and enhance hedging strategies. Procurement, manufacturing, and related functions can collaborate to better understand the deeper forces shaping demand and response management. Sales and marketing can help procurement continuously track and update the company’s cost position versus that of competitors.
Action six: Optimize energy consumption in the short, mid, and long terms. Most companies are taking short-term actions to optimize energy demand in response to market disruptions. This context also offers an excellent opportunity to optimize the future energy mix—for example, introducing new technologies, entering into power purchase agreements, or implementing self-generation capabilities. Such efforts allow companies to pursue sustainability and cost targets simultaneously.
One global materials producer conducted a 360-degree assessment of its energy-sourcing strategy. The team analyzed the producer’s energy mix under different market scenarios, evaluating the impact of different energy strategies on costs, emissions, and portfolio risks. The company has established a road map to revamp its energy sourcing over the next three years. The plan decreases exposure to fossil fuels while reducing CO2 emissions by more than 30 percent and costs by 20 percent relative to the base-case scenarios.
Partner across commercial
In partnership with commercial capabilities, procurement can address integrated margin management and the company’s portfolio and product design.
Action seven: Coordinate responses for integrated margin management. Enabling effective pricing and contracting strategies for the business requires tight integration of COGS and pricing. Beyond providing real-time information on costs, procurement can feed insights about the market and competitors to sales teams to bolster their efficacy in customer price negotiations.
A packaged-foods manufacturer used a coordinated, cross-functional approach to offset inflation’s effects on its business portfolio. First, it secured alternative sources of supply and increased its internal inventory of constrained raw materials. Then it leveraged derivatives to manage price risks for principal ingredients and energy costs, and it reinvested approximately 4 percent of COGS into value-creating opportunities. Taking these steps enabled the company to create new offerings that met customer needs while controlling costs and protecting revenues. It also helped the company improve service in seven of its top ten categories and reduce lost sales resulting from stockouts by 20 percent compared with competitors.
Action eight: Redefine portfolio and product design. Companies should scrutinize their product designs to identify those that rely heavily on scarce materials and a few suppliers. They can then take steps to reduce dependencies wherever possible and push for rapid qualification.
A consumer-packaged-goods manufacturer reviewed its product designs to identify ways to avoid stockouts and offset price increases. It used advanced analytics to assess design changes in relation to consumer tolerances. This made it possible to equip sourcing and R&D teams with alternative specifications and formulations that had little or no impact on consumer perception or acceptance.
Two additional actions can serve as enablers for countering inflationary pressure.
Action nine: Coordinate a holistic response through a central nerve center or control tower. Companies should establish an agile team composed of representatives of various functions with a mandate to take action to protect margin. The team would create transparency, monitor markets, and identify risks. It would also provide additional capacity for rapidly staffing projects or supporting supplier negotiations. Some nerve centers report daily to the CEO to enable rapid decision making.
Anticipating a recession, one global materials producer set up a process and team to rapidly track commodity markets and the implications for the company’s purchasing portfolio. The company equipped the team with an automated price analytics dashboard to track and interpret market updates. With information from the dashboard, the company could move faster than competitors to get price concessions from suppliers looking to secure their volumes amid uncertainty.
Action ten: Build new capabilities for resilience. Procurement’s chief asset is its talent. More than ever, procurement leaders need to build a team with the advanced skills required to compete in today’s volatile environment. These skills include enhanced use of analytical tools and capabilities—for example, value-at-risk assessment, should-cost analysis, and input-cost monitoring (Exhibit 3). Companies must also attract people for new roles, such as data scientists, data translators, and scrum masters, so they can win through insights.
However, CPOs note that attracting and retaining top talent is a chronic challenge. Companies are therefore developing exciting career paths for procurement leaders and positioning procurement as a function where high performers come to sharpen their leadership skills and executives sponsor the trajectory of emerging talent.
An opportunity for procurement to lead
The challenges we see across supply chains are, in many cases, structural and may take years to resolve. This makes transformative action the only option for addressing volatility and disruptions. However, there is a silver lining: the resulting improvements to practices and ways of working will permanently upgrade operating models. The current context is a career-defining moment for CPOs. Procurement leaders who demonstrate value to the enterprise can become full-fledged strategic partners to CEOs, CFOs, and COOs. No longer should CPOs be merely guardians of a portion of enterprise costs. Now is the time for procurement leaders to step into a new horizon of value creation.