Appunti Supplier relationship management

Purchasing impact on company performance

The context has changed

Ford was fully and completely integrated. It was the opposite of buy. Purchasing was completely irrelevant. Market and demand volatility – Difficult to plan and to pursue economies of scale in the long run. Product life cycle reduction: nowadays the life cycle of a car is very short, like 2/3 years. – Shorter investment pay-back. Product range – Mass customization. Multiple competences – Looking for different skills. Price competition – Cost structure (variable vs. fixed costs). All these reasons led to:

• Higher flexibility requested
• Outsourcing is becoming fundamental
• Suppliers participate in value creation, they could be relevant for the long-term success of the company.

Purchasing/sale ratio

This takes into consideration only the operational part, which is the one in which the supply chain management can have an impact. There is a reduction on the level of labour costs (because there is a movement to outsourcing) and there is an increasing on the relevance of purchasing costs. Also, the depreciation decreases because usually the big companies outsource the manufacturing activities to smaller companies. There is a movement to servitization, so you don’t hold assets in house anymore. The fil rouge is that purchasing is becoming more and more important. Here, there is a lot of the part of the value of the company (82%), so you can act on procurement to make a big change.

Global supply chain management

Taking the example of mobile phones (Samsung, Apple) there are a lot of suppliers to consider, around the world. Why do you believe that procurement is strategic for companies?

• Innovation
• Efficiency
• Alignment with the strategic goal of the company
• Sustainability
• Quality
• Risk management

In which of the following companies do you believe that procurement is more strategic? Esselunga, ENI, Amazon, Pirelli, Luxottica for several reasons each of them.

• Luxottica is vertically integrated: they start to collaborate with companies and as soon as they understand that owning the suppliers could be better, they buy them and so there is no more procurement.
• ENI: the procurement is supporting the development of the plants. Here procurement is not only purchasing oil and gas.
• Pirelli: the kind of variety, the complexity they have, lead to a strategic importance of procurement.

The link between news and procurement

Group work: It is important how to do things, how you can perform the activities you want, not only the what. You need tools! Extend the payment terms with suppliers, this can directly affect the cash flow. This is not to take as granted, it depends on the company (for you is more challenging the financial part?). After how much time you pay for your suppliers. You can act on financial performances of the supply chain. But the impact on suppliers is different, you have to consider also the impact on them. Your actions have implications on the companies with which you are contracting. There are tools to manage these financial performances. We will study them. Importance on visibility and traceability on the supply chain are important to reach sustainability. It is even more complex for global sourcing of course. Vendor rating is important in this case. Reputation of the company: here we have 3 big giants dealing with Brazilians beef providers without even a name! Company image is important. You have to avoid scandals. No one cares about the name of the suppliers, the company which is in damage usually is only the main company, the big company.

Link with supply chain management:

• Digital transformation
• Risk
• Visibility and traceability
• Global supply chain
• Differentiation

Procurement impact:

• Innovation
• Sustainability
• Financial cash flows
• Customer satisfaction
• Reputation
• Risk management

Levers considered:

• Supplier collaboration
• Technology tool
• Automation
• SCF
• Bargaining power
• Supplier evaluation

The economic impact of procurement is not mentioned because it is taken as granted, and not because it is not relevant.

The pervasive impact of procurement

Evolution of stock price of Amazon. Brown: evolution of stock price. Orange: evolution of the number of employees. Exponential growth of the value. The two curves are connected. They are linked to the same decisions that the company took. There is a connection between the market recognition and the choices of the company. Amazon Fresh Grocery: big relevance, really connected with the supply chain for all the decisions related to it. Stock prices follow cyclical trends over time. In the short run, their value mainly depends on the demand/supply ratio. In the long run, demand/supply ratio, and thus stock prices, depend on the firm capability to create value along the whole supply chain…

… what is the contribution of purchasing to value creation? Why is purchasing so important? Because…

• Increases Value and Savings: we cannot neglect that the economic value is relevant
• Builds relationship and drives innovation
• Improves product quality: you have to combine efficiency with effectiveness. You CANNOT focus only on the cost side! Quality is not sacrificable.
• Reduces time – to market: innovation internally can be done but you need investments and time you are able to wait for to have this type of innovation. You cannot wait years to have innovation in some sectors, it is not working like this. When it is necessary you have to find a faster way.
• Contributes to competitive advantage

Consequences

The ”three-way” of purchasing impact:

1. Economic: Leverage Effect. Impact on the economic side and ROA due to the decreasing of purchasing costs.
2. Financial: Cash Generation Cycle. Procurement choices have an impact not only in the economic side but also in the financial side. Sometimes 1 and 2 are in trade-off, because of negotiation and bargaining power.
3. Image and reputation:
   • Sustainability and risk management
   • Innovation
   • Presentation of ENI of next week

To sum up…which competences the buyer of the future should have

The buyer yesterday needed to be only a negotiation focusing on transactional aspects optimizing the quality/price ratio. Short term view. No matter of collaboration and partnerships. Maybe sometimes it is still valid for commodities and categories not so long term oriented. When you want to focus only on the price side.

The buyer of today (or last year better) becomes a problem solver: overall ownership perspective, it is solving problems. Also, this model started decreasing more and more because there is more trust on the technology than on humans. We are moving towards a data-driven economy. The solution to the problem can be offered by the machine!

So the buyer of tomorrow should be a creative thinker, focusing on innovation and systemic complexity, interacting internally and externally. Complexity driven by the fact that we have to align the internal and external perspectives. And we have a lot of parameters to consider (the quality, the innovation, the sustainability, the risk, the costs, the reputation, etc.)

In order to manage 80% of company value having impact on:

• Profitability
• Cash Flows
• Risk
• Sustainability
• Innovation

Dealing with a rapidly changing world in terms of:

• Geopolitics
• Technology
• Finance

Procurement strategy

Economic and financial impact of procurement

Economic impact: costs

Purchasing/Sales Ratio Managing strategically the procurement drives benefits to the business. For different businesses, there are slightly different numbers. The spend of a bank is primarily buildings, IT systems, consultancy, office materials. But the incidence of the overall turnover is limited. Otherwise, for the engineering and construction, the impact of the spend is larger (74.2% if you consider the ratio with the revenues, but there are many other KPIs that you can look at). Take attention to the fact that not all the spend of the company comes through the purchasing department. There can be some spend that there is not under the control of the procurement department: this depends on the emergency orders, or there can be a function (like Sales) that wants to use its own budget. Maverick spending is the part of the spend that is not under the control of the procurement department (this is the second KPI in the figure). Then there is a distinction between strategic and operational spend. When there is a high percentage of operational spend, it means that there is a lot of margin of improvement because the spend should be used better, and not only for operational (so not so important) activities. Average procurement return on investments (Supply management ROI) is obtained by dividing cost savings (reduction plus avoidance) by supply management operating expenses.

Difference between reduction and avoidance: Leverage effect ROS=EBIT/SALES TAR=Turnover Asset Ratio=SALES/TOTAL ASSETS ROA=EBIT/TOTAL ASSETS ROA helps you to understand how the company is able to generate profits from the assets it has. → With a 5% reduction of purchases in procurement what are the consequences? There are less inventories. So we are increasing the EBIT and reducing the assets. The ROA is increased. What is the actual increase of the ROA in percentage? 40%=(14-10)%/10% Another way to increase the ROA could be increasing sales. But of the 12% in this case!! And this is actually not so feasible. Let’s assume that the purchasing costs will increase of 12% and assume that the other costs will remain the same (even though usually they increase). The EBIT will be higher. Then you will have more inventories, so more total assets. The ROA will be once again 14%, but this time there is an extra effort!

How much is the leverage effect? For every 1% that the company is able to decrease in procurement, there is an 8% of increase for the ROA.

How to reduce 5% of purchasing costs?

• Savings on big and small contracts: depending on the tools used (digital for example in small contracts can make the difference).
• Purchases centralization and consolidation: centralize in a specific country like Ferrero and try to reduce the Maverick expenditures.
• Supply Chain Collaboration upstream and downstream: increase the visibility. Make the suppliers able to see the forecast of the demand for example.
• Development programs with suppliers (Purchasing Driven Innovation): decrease the initial investments, share with them, obtained discounts thanks to the collaboration.
• Better requirements and needs definition (Design to cost); Demand Management
• Process efficiency: driving further savings (e.g., eProcurement)

Esselunga case

Try to evaluate the impact of purchasing decisions on company performance, by answering following questions:

• Which is incidence of Purchasing Cost on company activities? Has it been stable along the years? (recreate the initial graph with the colors)
• How would company benefit of 5% of purchasing reduction? (From the last year available)
• How much sales should be increased to obtain the same level of performance?

Financial impact: Cash-to-Cash cycle

The Cash-to-Cash Cycle quantifies the number of days it takes a company to convert cash outflows into cash inflows and, therefore, the number of days of funding required to pay current obligations and stay in business. Time=0 a company buys something from a supplier. The company is not immediately buying this supplier. Maybe it has negotiated to pay after 30 days (Days of payables outstanding = 30 days). The higher the DPO is, the longest is the time window for which the company retains the cash. Then maybe that 60 days after the moment in which you got the goods, you sell the final product to the customer. But the customer will pay you some days before (for example after 30 days, so 90 days from the t=0), this is the Days Sales Outstanding (=30 days in this case). It is better to have it high or low? It depends. We will see why. The days of inventory holding is needed also. In this case it is equal to 60 days. The cash to cash cycle in this case is 60 days, so the company has to find how to finance itself within 60 days. DSO may be not agreed, but there can be some delay. The DSO takes into consideration the delay. You have to consider the contractual part of the agreement plus the delay.

Purchasing cost + personnel cost = COGS Cost of good sold (in teoria bisognerebbe prendere solo la parte di purchasing cost e personell cost direttamente impattante, ma lo prendiamo per buono)

• Companies with a C2C > 0 have to find a way to finance their operations, with an associated cost of capital
• Companies with a C2C < 0 mean that they get cash before paying their suppliers (but with which consequences at supply chain level?)

Esselunga has a DSO quite low (it is selling not just to final customers but also to some business so it is not very low but quite low). It aims also to keep low days of inventories. The days of payables outstanding: Is it sustainable? There can be potential issues in the long term. Your DPO will always be the DSO of another company. Days of inventory holding for real estate is high because in order to build a building, we need a lot of time. Construction: the DPO is the highest because the government’s payment terms are one particular issue. The timing is very long, longer than the normal standards, at least in Italy. Information and communication: the DIH is basically none. You do not have inventories.

Continue the Esselunga case

• What is the value of the Cash-to-Cash cycle (and its components) of Esselunga
• How much procurement decisions impact the Cash-to-Cash Cycle of Esselunga? What happens if procurement cost decreases of 5%?
• Do you believe that Esselunga results are consistent with the industry it belongs to?

Allowed their supplier to. Because Esselunga for a given reason decides to keep their payables steady, increase the purchasing cost, Decreasing the payment terms can be a way to decrease the purchasing costs. Do you believe Esselunga is ….. Short or very close to 0 DSO because the customer pays immediately most of the time. Most of the sales of Esselunga are done by cash. This is common for the mass retailers. 60+ days to pay the suppliers usually. This usually should be regulated by a legislative entity.

Managing and optimizing company spending

The purchasing process and portfolio management

The purchasing process is executed for each relevant purchasing category: To know what you buy and to identify which are the leverages to optimize your spending. Strategic sourcing: Definition of the category strategy: structure of the supply network, suitable suppliers, type of relationship, performance measurement approach. Sourcing: Finding the specific supplier able to satisfy the rising need for the category. Tactical decisions consist of the selection of the suppliers, the negotiation, the contract. Supply: Managing administrative and physical activities: delivery, order, invoice. It is not a black box, it is dependent on what you are buying! The unit of analysis is the product category.

• Execution can’t be stand – alone!
• Category managers and buyers cannot decide independently (local optimization)
• There is the need to manage the whole purchasing spending (or portfolio) in a consistent way

Portfolio management

The first question is: Do we really know what we are buying? It is fundamental because you have to know what you are buying in order to define the proper strategy that you want to use for the specific items. You have to have a clear picture. Definition of supply strategies for each category of goods/services.

• Different purchased items have to be managed in different ways
• It is necessary to classify purchases
• Suppliers performance must be constantly measured
• Different actions for improvement according to the purchasing category and the supply base

Example of relevance of portfolio management: Scientia potentia est, Sir Francis Bacon 1597. It is impossible to manage and improve what is not known and measured… John Deere used to buy 424 different typologies of gloves across its plants worldwide with an overall spending of 1.4 mln $. From a needs analysis emerged 20/25 typologies were enough. Rationalization and consolidation brought 490.000$ saving (35%)! Without impacting on the quality of the component (requirement: keep the same level of quality), they reduced the number of suppliers, reducing the categories and with a lot of savings. The savings at the balance sheet are seen in the purchasing costs (direct cost) and so it is impacting on the EBIT, improving it. Direct impact on the profitability of the company.

The portfolio management process

Purpose: understand what you are buying, measure the performances, identify some actions for improvement.

• Data collection: identify the data proper data of course. Data collection and integration.
• Portfolio scope: (which information I have? Where do I want to focus?). The tool that I can use is the category tree.
• Spend analysis and spend classification: purpose of to have a picture of what is the situation I have at the company level. Where and how I am spending money?
  • Data analysis in terms of volumes, frequencies, suppliers fragmentation, ABC analysis…
  • Spend classification in terms of strategic relevance, supply complexity, supplier dependency,…
• Performance management: you have to combine the data with some performance metrics. Merge spending with performances (Data Enrichment)
  • Vendor rating and market scouting: Suppliers performance, market benchmarks, …
  • Purchasing KPIs: Purchasing process KPIs, compliance, order lead time, …
• Actions: actions for improvement derived by the analysis (how can I improve?)

Data collection

Kind of documents: order