Procurement Strategy and Enterprise Strategy – Bridging the Divide

We are delighted to bring you this thought-provoking post from Ashwin Kumar. For more interesting thinking on procurement, please visit the GEP Knowledge Bank.

September is a difficult month to get through; the painful and slow transition from experiencing to reminiscing about what was once a fabulous summer, the gradual realisation that things need to be put back on track to meet year-end targets, and that tedious and monotonous routine of planning for the next year.

Of course, at such a juncture, planning for next year is more of an academic exercise to secure the future on paper. Ambitious targets are set for the enterprise, which are then translated to function-wide targets. And here’s where the fault lines begin to emerge (think ‘Chinese whispers’).

When these targets are set by the CPO for the procurement function, they are still relevant and in-sync with the enterprise objectives. When they are broken down further into individual plans, all the way to the category management function, there is significant lack of contextual understanding. Whilst the collective performance indicators may point towards progress, it becomes difficult to ascertain whether it was progress in the desired direction.

Let’s take the cash conversion cycle (CCC) for example. This metric is the time taken for the cash to be recovered from the time it is spent; in short, it is a function of inventory, accounts payable and accounts receivable. The smaller this metric, the better it is for the enterprise.

In many instances, this rather meaningful metric gets lost in translation as it becomes an actionable target. The typical communication that the buyer on the ground gets is “Finance has made a decision to move all suppliers to 60-day payment terms; anything shorter than 60 days isn’t desirable and requires approvals from the function’s manager.”

This is where fault lines begin. Procurement folk should be trained on exercising discretion while driving this mandate – repetitive and large volume spend definitely are good targets for freeing up capital. However, say for a turnkey provider for a greenfield facility, working capital should take a backseat as postponement of payment may limit supply options in a tight timeline situation.

In the same CCC example, this metric is not very relevant for many companies in the software or insurance industries, for example. Flow of cash is important, but making suppliers agree to payment terms that are not going to impact the realisation of high-level enterprise-wide objective sends the wrong signals to the local business community.

In other instances, the due diligence involved in coming up with targets are not exhaustive, and don’t take into account the future direction of the company. For a retail company that is trying to move much of its sales online, the CCC metric drastically changes. Online retailers usually have a negative CCC because they pay their suppliers after the consumer pays for the product (assuming just-in-time delivery and no cash-on-delivery). Hence, benchmarking against the right peer group makes a huge difference in aligning with organisational strategy.

So, what’s the best way for procurement to affect CCC? What’s the right strategy?

For this exercise, let’s consider the CPG and Retail industry. In order to craft a procurement strategy that is in line with the enterprise strategy, let’s look at some high-level industry benchmarks:

In 2015, the median CCC for manufacturers was 48.74 days in comparison with retailers, whose CCC was, understandably, much lower at 21.70 days. However, the median CCC for manufacturers in the food sector was 57.52 days, which was much higher than the ones in the household segment, at 38 days. The size of the company and scale of operations (global vs domestic) further impacts the CCC metric.

As evident from the above estimates published by PWC (based on annual reports), it is clear that a simple procurement objective such as payment terms has many nuances, and executing a strategy in isolation may not benefit the enterprise as a whole. In the food sector, seasonality and crop cycle have a big impact on the raw material inventory. Partnering with a commodities supplier who is able to ensure lower levels of inventory might be more prudent compared to a supplier offering 120-day payment terms. There is no “one magic number” for payment terms – it should be used as directional guidance and should not be enforced at the cost of other important metrics.

Understanding the nature of the industry, the overall organisational strategy and the trickle-down effect on procurement are critical to executing strategies that are coherent, consistent and impactful.

 

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