As noted in my column on June 29, purchasing managers (CPOs) often find themselves limited in their work by short-term financial goals to which they had no real input. In these companies, the purchasing function is considered tactical and the purchasing manager is not, in practice, a full member of the executive group.
Below, I’ll present an example of how this works and then offer my take on how a senior purchasing executive might take steps to transform their supply management group into a more strategic function.
Some would argue that the above description of the purchasing position within a company is wrong. After all, don’t sales managers set the annual goal of reducing materials costs in supply management independently from other executives in the company. And similarly, isn’t there very little interaction with these other areas to get supplier price reductions? And if so, is it not quite appropriate that purchasing works in âsilosâ with respect to the overall organization?
Hmmm. The example below shows that this is not the case.
I used to work for a division whose organizational structure was such that purchasing was under product engineering, while product engineering was under manufacturing. In other words, purchasing was represented in the division president’s staff by manufacturing based on feedback from the vice president of product engineering.
Again, hummm. If that hierarchy doesn’t tell you that, at least in this division, purchasing was a tactical function, I don’t know what will.
Anyway, one year, the president’s staff set a target of reducing equipment purchase costs by 3.5%. The story I heard was that this goal had been proposed by the financial arm of the division, and manufacturing, of course, accepted it. The target was then passed on to product engineering and assigned to purchasing as the main performance measure of the department. (Note that failure to meet this target would not affect annual manufacturing performance metrics.)
At the time, corporate purchasing had set an annual cost reduction target of 5%. I asked my boss how this target should be viewed against the division’s 3.5% reduction target and was told that when it comes to our employees, they would be told that their performance would be measured against the corporate target of 5%. In fact, the divisional target of 3.5% was not to be communicated to divisional purchasing staff.
I took on the task of preparing a business case to both influence my boss to set our material price target at 3.5% and help him understand how difficult it would be to meet that target.
Below I present some of the points I raised:
1. Almost 50% of our annual purchasing expenses were for two main components needed to make our product. The price of each had already been set in long-term contracts – agreed to well above my quality of labor – with the average annual expectation of price reductions set at just under 2%. This essentially limited the scope of my department in relation to the impact of our cost reduction work, meaning we could only work on reducing material purchasing costs with about half of the annual spend. . This would mean, in effect, that they would have to offer a price reduction of 5% or 6.5%, depending on whether the objective was based on the annual objective of the division or the company, with the suppliers whose we were responsible for setting the prices. I stressed that it was not fair to base the performance of purchasing employees on what I considered to be unattainable goals, neither for the individual nor for the department.
2. Setting a target of 5% in all divisions did not make sense, as there were drastically different levels of competition in the markets in which each participated. In our division, which faced the most competitive pressure, we had to insist on getting a lower initial share. price just to make our product competitive. Not so much in the other divisions which had market shares of over 50% for some of their products. Our products have been fortunate to have single digit market share.
Read more of Paul Ericksen’s articles on supply chain management.
To support the above position, I had actually heard from vendors who were selling both to our division as well as to others in the company that other divisions tended to leave ‘more meat on the market’. os’ in the initial prices that we.
3. How to justify one or the other of these objectives when our internal objective of reducing operating costs was less than 2%?
Regardless of the overall goal, I didn’t think it was fair for our employees to think that all vendors should have the same hardware cost reduction goals. Why? For several reasons. First, the opportunities for cost reduction vary widely between different commodities and engineering products. Second, there is also a difference in the opportunity for cost reduction between lean and non-lean vendors. For this reason, depending on the types of products for which a particular buyer was responsible, they might have more or more difficulty in meeting their personal performance goal.
The response I got was that our target for reducing the prices of ‘public’ materials would be 5% and would be treated as a ‘stretchable’ target and that the division’s’ internal ‘3.5% would be our targets’ minimum acceptable â.
My factory reduced our overall spend from 1% to 2% that year and I felt pretty good about that result. But our VP of manufacturing was not.
What would I expect from the most senior purchasing manager in the situation described above?
First, bring a solid and detailed analysis of the opportunities for reducing the costs of purchased materials to the annual tax planning meeting, and based on this, come up with a practical goal of reducing the costs of purchased parts.
Second, compare that number to the cost reduction targets of other functional areas which, by the way, were all lower than what went to procurement. In particular, I would compare this to the goal of manufacturing, as it would represent the closest parallel to supplier operations, and I would emphasize that Lean Strategic Suppliers should be viewed in the same way as our internal operations.
Indeed, the division’s manufacturing cost reduction target was set at less than 2% and, let us remember, it was manufacturing that accepted a 3.5% target for purchases! It is interesting to note that I had done a âquick scanâ analysis of the realistic cost reduction potential of the equipment purchased and that it approached the manufacturing target.
Finally, based on the first point above, I would propose an aggressive but realistic hardware cost reduction target for the purchasing function. And if the function’s goal was still set at the 3.5% level, I would make sure that the inconsistency of that goal against the manufacturing goal was well documented.
Either way, no retreat was given to the 3.5% and 5% targets, and they remained the measures of our performance for that year.
I believe most purchasing departments accept material reduction targets given by executives from other functional areas who have no real understanding of purchasing or the current operational state of current suppliers. And that most purchasing managers take these goals as gospel, regardless of the realities of the supply chain. And for this reason, purchasing is seen as a second-level tactical function within many companies.
Paul Ericksen’s recently published book, âBetter Business: Breaking Down the Walls of the Purchasing Siloâ, is now available: https://store.IndustryWeek.com.
Paul Ericksen is IndustryWeek’s Supply Chain Advisor. He has 40 years of industry experience, primarily in supply management with two major OEMs.