A New Governance Role for Purchasing

I was recently asked by a team of people from one of our partner companies the following question:

We are moving to a governance role from a service role, with respect to the purchasing of materials and services. What advice would you offer in making that transition?

This is a very tough question to answer, particularly when it comes to purchasing involvement in the so-called “non-traditional” areas of spending. However, the fact that non-traditional purchasing spans areas which have been considered the domain of other functions for many years means that the process must be modified to include the input of these stakeholders, so that ownership of the process can be established across groups. This is a key requirement for successful deployment of this strategy.

In some organizations, an internal client department such as Finance or Information systems initiates the involvement of purchasing in non-traditional spending decisions. organizations may also initiate purchasing involvement via some form of control system. For instance, an internal audit of payments and matching purchasing orders may reveal a significant amount of “backdoor buying” occurring which bypasses the formal purchasing process.

Before any type of purchasing involvement can occur in the non-traditional spend area, purchasing must carry out a comprehensive spend analysis across all strategic business units and functions, that includes all forms of spending within the cost of goods sold. While most organizations have a good handle on their major commodity spends, capturing non-traditional purchase volumes may be difficult. Some organizations in the process of implementing Enterprise Resource Planning Systems (such as SAP, Oracle, and Bahn) are being forced to identify these levels of spending. These systems will aid in standardizing databases, and help automate the process of analyzing all purchasing data. However, before these systems can be used, a consistent understanding across all of an organization’s operating units is required to introduce value-added purchasing in non-traditional areas. A key activity at this stage should be to look for commonalities of activities and materials among using sites or sub-units to identify opportunities for leveraging. This may require a commodity classification coding scheme and an internal organization coding scheme to aggregate this information.

Some of the different approaches identified by benchmarked companies at this stage include the following:

“Through our accounting systems we can identify, measure and monitor large volumes of procurement spend based on general ledger account code, supplier, customer and dollar volumes. We identify this spend with various representatives of each SBU and determine if Purchasing can provide a value add to the current process. Additionally, this allows us to identify where the large spend is occurring and perhaps combine it with other areas within the corporation for greater discounts.”

“We utilize a bill payment database to identify areas that we may potentially bring value to. In addition we have identified through company publications, areas that were being outsourced and pursued those contract opportunities.”

“We have a summary database that shows our expenditures by supplier, commodity, business unit. We use that summary database to evaluate areas of spend where commercial / procurement might be able to provide improvement in total cost. We also keep abreast of changes in the business world to identify areas where recent legal or policy changes may allow us to leverage our business. Examples include deregulation of electricity, natural gas, etc.”

“The process followed to gather information on potential non-traditional areas was to review annual accounts payable data for each location including Corporate offices. Several databases were reviewed with suppliers and areas targeted where the purchases exceeded $100,000. Accounts payable data, which included location, supplier ranking by total expenditure, supplier name and annual expenditure, was sent to a Non-Traditional Supply Management representative at each location. The following information was requested: estimated 1996 expenditure type of purchase – non-traditional, production (direct), non-production (indirect), commodity department authorizing the expenditure agreement – yes or no if an agreement, divisional, regional, national, global expiration data of agreement.”

Once the data on total spend is aggregated, a team assembled from the relevant divisions perform a strategic analysis of spend patterns in non-traditional areas. The team may include key stakeholders from the different groups, who can help in identifying major areas of non-traditional spending which have potential for savings through purchasing involvement. It is important to note that this stage of the process involves considerable research on the part of purchasing and other functions, to identify these areas. Commodity / services groups should be “paretoed” according to two major categories: volume / potential return, and ease of attaining cost reductions / objectives. The deliverable at this stage is a portfolio of non-traditional purchases, with the objective of targeting those purchases that have a high potential for immediate savings (in the form of leveraging, headcount reduction, simplification, etc.) and which also have a high probability of success.

It is important to note that in assessing the different types of non-traditional purchases made by the organization, not all forms will be classified as “strategic”. Moreover, there may exist certain types of purchases which are best made by internal clients, as they are relatively standard, and the client is utilizing sound purchasing practices in awarding the business. In deciding which types of commodity/service groups to address, purchasing should target those purchases which exceed an agreed-upon baseline level, and which offer the potential for non-value-added reductions with the potential for significant cost savings and/or competitive advantage.