Centralized, Decentralized or Hybrid Sourcing Structure: How Do We Decide?

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Today’s Ask Spend Matters question came from Piyush Shah, a PhD student of supply chain management at Arizona State University:

“Centralized, decentralized or hybrid sourcing structure? How do we decide?”

This is a classic question and one that has sparked decades of passionate debate. Proponents of centralization point to the potential for higher savings. Defenders of decentralization argue that regional procurement teams can bring about better supplier relationships.

The easy answer is “It depends” or “A hybrid of the two.” But what does a hybrid structure look like? And how do factors like purchasing category, industry and stakeholders play into the assessment?

Moving Toward Centralization

Before diving into the current discussion and Spend Matters recommendations, here’s a quick history. The standardizing of purchasing as a function was a gradual process. In recent decades, the term “sourcing” has grown in popularity, encompassing not only purchasing but also activities related to risk, supplier management and sustainability. But despite these differences, the terms purchasing, sourcing and procurement will be used interchangeably for the sake of this article.

So as purchasing and sourcing came into their own as professions, as opposed to a part-time responsibility across functions, more organizations have formalized sourcing, adopting e-procurement and consolidating the supplier base. While organizations tend to centralize sourcing and then decentralize as they become more mature, the overall trend in recent years has been to centralize, with help from technology.

“Certainly in the public sector the trend is still very much towards centralized purchasing and framework agreements, as the current economic situation means public sector funds are limited,” says Dr. Katri Kauppi, an Aalto University assistant professor of logistics whose dissertation had focused on public procurement centralization.

“It is my understanding that centralization and hybrid are also very much still in use in the private sector,” she says. “Better e-procurement solutions and purchase-to-pay tracking solutions may enable more center-led and hybrid approaches to also offer efficiency that was previously mostly doable with centralization only.”

Peter Smith, who spent three decades in private and public procurement before becoming managing director of Spend Matters UK/Europe, describes it as a three-year cycle. “After the 2008 financial crisis, there was a trend towards control. It comes and goes. I’ve seen that relaxed again in the past few years.” Smith explains that mass communication, the internet in particular, has made centralization possible — thus enabling this very debate on centralization vs. decentralization and this article.

The Debate in the Real World

Shah, the PhD student who posed the question, has heard gripes that country heads are bypassed in favor of reporting directly to the global head of purchasing.

“These days we keep hearing of firms changing structures, and different firms are taking different routes,” he says. “This made me think — why are so many firms reconfiguring the purchasing structure? And if they are changing, why are they not changing in the same direction? So obviously there is something about the suitability of different structures in different situations.”

How does an organization decide which structure is suitable? “The good academic answer is procurement has to be aligned with wider strategic objectives of the organization,” Smith says. “Not just the strategic objectives but also the culture and style of the organization.” Being aligned with what stakeholders want is especially crucial.

Smith backed this up with a number of real-world examples, first from his own career. He started out as a purchasing manager at Mars Confectionary, a family-owned business till this day.

“Mars had a very particular style, both very ahead of its time in terms of corporate social responsibility and [yet] very competitive and aggressive,” Smith says. “We could literally be fired if Mr. Mars thought we were treating a supplier badly.” That did not mean going easy on the competition. “His first question would be ‘How are you buying packaging better than Nestlé?’ And if I didn’t have an answer for that, I’d be fired for that as well!”

An organization’s culture isn’t always immediately apparent. Smith brings up the case of a friend who had become CPO for a global top 30 company. He was told centralize procurement, which he did for two years until he was fired. “He upset too many of the country directors,” Smith explains. “[The question is] what does the really top management want procurement to do? My friend was told to centralize by the CFO, but he didn’t check out whether the other people were on board. The answer is clearly they weren’t.”

Centralize or Decentralize?

The vast majority of procurement organizations are somewhere in between completely centralized and completely decentralized, Smith says. Company size, location, expansion rate, purchasing category and industry are all factors that affect whether a more centralized or more decentralized structure is better.

For large, global companies, more decentralization is generally recommended. It is also a matter of practicality. If a company has offices all over the world, it is simply not realistic for purchases to go through a single central office.

Then there is the question of industry. “Once an industry gets more mature, there is more competition and pressure on margins,” Smith says, “Rightly or wrongly, procurement starts standardizing.” In industries like automotive or oil and gas, where products are more or less the same around the world, centralization is a better fit.

“Typically purchasing categories where standardization is easy and purchasing needs differ very little are suitable for centralization,” says Kauppi. “For example, raw materials, commodities, MRO goods, IT equipment — at least basic office IT — and standard services [such as] cleaning services are often centralized with good outcomes.”

In contrast, consider the case of a friend of Smith’s who was CPO at WPP, a multinational advertising firm. “A lot of what they buy is specialized marketing and creative services all around the world,” says Smith. “For a Venezuelan soft drinks company’s ad campaign, we’re going to find a graphic designer from Venezuela. [Therefore] procurement needs to be more flexible.”

If your company is undergoing rapid growth, the flexibility of a decentralized model may be more important than cutting costs. “[The] same applies for more project-based industries,” says Kauppi. “Again, the question may be more purchase category- than organization-based, so complex service purchases are often more suited for decentralized purchasing.”

Kauppi believes that purchasing category matters more than organizational type, but as far as the latter goes, a hierarchical organization works best for centralization. “The implementation is easier, and contracts will have a high usage rate, [with] very little maverick buying,” she explains. “Someone once told me the military is ideal for centralized procurement because everyone will use the centralized contracts as told!”

Do You Need a Sourcing Structure Reboot?

Out of all of these factors above that should go into determining an organization’s ideal degree of procurement centralization, Smith emphasizes stakeholder opinion as perhaps the most important.

“The biggest single measure of success is [whether] your senior stakeholders think procurement is doing a great job,” Smith says, “I’ve gone from believing in [objective measures of procurement success] to this subjectivity.” Lack of procurement success is not always due to a structural problem, of course. But one indication that procurement needs to change its structure is if other people in the company do not know who to talk to in procurement, Smith says.

That is not to say changing the procurement structure is necessarily worth it. “There’s nothing that is guaranteed to make procurement fail than constant reorganization,” says Smith, who recalls joining a company that had undergone three major organizational restructures in as many years.

“I came in, and not only did I have a staff turnover rate of about 40%, the stakeholders were totally confused,” he says. “You need to think hard about your structure, and unless you find out quickly that you got it horribly wrong, I would say give it three years.”

Both Kauppi and Smith underscored the potential of e-procurement and other technologies to offer the benefits of centralization with fewer of the disadvantages. With centralization, Smith explains, often senior procurement professionals simply just wanted to know what was going on.

“[They would have] no clue what other procurement people in other countries were doing. If I used e-procurement, I would have been able to see what was going on. I would have gotten visibility,” he says.

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