Proxima Report – Corporate Virtualization and the central role of suppliers in business (part 3)

One of the most startling findings in the Proxima report (see here for our previous posts) comes from the interviews undertaken as part of the study.

"Corporate Virtualization - A global study of cost externalization and its implications on profitability" (download it here) shows that the average organisation spend 69.6% of its revenues with suppliers, compared to just 12.5% on staff costs.

When interviews were conducted with 44 Board level executives, as part of the study programme, they were asked what percentage of their revenue they thought was attributable to supplier costs. Only one executive estimated the number to be greater than 40 percent. And all 44 "expressed surprise" when they were told just what the real number was.

So senior people are vastly under-estimating the scale and therefore presumably the importance of suppliers in their business - indeed, they're often something like 100% out in their estimates, guessing at 30-40% instead of 60-80%!

That's a worrying fact, yet one that clearly shows an opportunity as well, both for organisations generally to increase focus and for procurement leaders to use this to drive better performance. But it is worth considering for a moment why this situation has arisen.

It's not a great reflection on the board people frankly that they don't understand their own cost base. But maybe that is in part down to how firms generally budget and run their financial management processes. Costs are generally looked at on a cost centre basis, with less emphasis on how that money is spent. So the CFO would (we would hope) have a good grip on spend by cost centre, and perhaps by major project, but has less visibility on where that money goes, and how much to suppliers as opposed to staff.

So one question we might ask is whether CFOs need to look at some different reporting mechanisms that might come part of the standard suite of reports and would give them that better visibility of supplier spend?

The other point emerging from this lack of current visibility is the relationship between the CPO (or equivalent), the CFO and the Board. An effective CPO should make sure their top management understand the importance of the supply base, including the scale of the spend. Clearly, in the firms surveyed here, that isn't happening well enough. Either the CPO isn't aware of the scale of the spend either, or they don't communicate it to senior colleagues. That could be because of lack of skills, opportunity, or desire.

One other thought around the lack of awareness, and that is the question of what we consider to be third-party spend. At one level, it may include areas that clearly fit into a conventional definition of supplier spend, but have not been within scope for the procurement function - perhaps banking services, or even marketing in some organisations.

Then there is spend that some don't consider as "procurement"- I had an argument with one organisation recently about financial "grants" they were making to individuals and businesses for specific purposes. They did not consider this to be anything even vaguely related to procurement; my argument was that they were choosing entities to perform a certain service on their behalf. Whatever they called it, to me it certainly sounded like "procurement"!

Then we have some areas such as rent and property taxes, which are definitely third party spend but with some justification may not be considered under the procurement banner. All of this can lead to some confusion, so a good starting point for CPOs is to define clearly what the organisation considers as third--party spend.

Anyway, what is crystal clear from the Proxima report is that procurement leaders, CFOs, CEOs and others should understand their cost base, where the money is going, who the most important suppliers are, and other key metrics. And communicating that to the Board should be an absolutely fundamental priority for procurement leaders.

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