The Importance of Procurement in a Global Environment
Until recently, procurement was a necessary, but seldom celebrated, component of multinational corporations. But times have changed: These days, procurement organizations within companies are playing pivotal roles in the success of global firms in ways that old-fashioned purchasing managers could never have imagined. In this special report, Wharton faculty and procurement experts at The Boston Consulting Group discuss why the procurement function has risen to such prominence in a highly competitive global environment, and how, as supplies of critical commodities tighten and prices rise, companies can strategize to mitigate these and other risks.
Part 4: Building Customer-Supplier Relationships
In the never-ending quest for cost savings, many companies have reduced the number of suppliers they use, consolidated their purchases, and negotiated better prices. So, where can chief procurement officers and other managers now turn for savings? In this interview, Bob Tevelson, a BCG partner and managing director, says firms must segment suppliers to identify those that can deliver what he calls “partnership value” by establishing relationships that move beyond the transactional level.
Knowledge at Wharton: Many companies have already reduced the number of suppliers that they use and consolidated their purchases and negotiated better prices. Where do you think the next level of cost savings will come from in procurement?
Tevelson: I think many companies have, in fact, reduced the number of suppliers they work with significantly, but I still think there is an opportunity to do more. I think what the next level of benefits will accrue from is looking at the suppliers that are used, the smaller subset, and really segmenting those.
What I mean by that is breaking them into different groups in terms of what we’re looking for from the suppliers and taking the supplier-relationship management to the next level, which is to segment based on what the suppliers can do versus our objectives, and then being willing to invest in those suppliers to be able to drive value.
Knowledge at Wharton: What are the biggest challenges that companies face today with regard to suppliers?
Tevelson: I think the biggest challenge is to be able to segment the suppliers into those that are really meaningful and can deliver partnership value. What I mean by that is moving beyond the transactional, moving beyond getting a better price, [and] moving to some of the more interesting areas around real collaboration [and] trust-based relationships.
Also, taking the focus beyond the transactional [and] beyond the day-to-day, looking at what the supplier can do from an innovation perspective to drive where the company is focused from a strategic perspective, and also focus on driving performance to the next level.
Knowledge at Wharton: You’ve raised some interesting issues, so let’s pause for a second and talk about how supplier relationships have changed over time and some of the changes you’ve seen happening. What has been the genesis for that? Why have companies changed their relationships in recent years?
Tevelson: I think they’ve been forced to change. If you take the automotive industry, for example, and the economics they face — a couple of years ago, when profits were up, the focus was all about partnering, tight relationships, and sharing benefits and innovation. Then, when the chips are down, the focus is more on the dollars and more on price.
And so, there’s a natural ebb and flow cycle to relationships. I think what companies are finding now is that margins are pushed down to where suppliers are making a reasonable profit and getting a reasonable return, [and] that they need to find other ways to get more value from the suppliers, and it goes back to segmentation. Who are the core suppliers you want to work with? Why do we want to work with them? What can they do?
What they can do is beyond price. It’s innovation, it’s helping us go to market, and it’s working with us to understand our business better and identifying best practices.
Knowledge at Wharton: Are there differences among industries? You’ve mentioned, for instance, the auto business, which is certainly one that we read about all the time in the press, trying to control costs through their relationships with suppliers. But are there differences, say, between the auto industry and other industries?
Tevelson: I think there’s a significant difference, and you’ll find relationships varying by industry. If you take the automotive industry, it’s more arm’s length. High-tech is more integrated. It’s more integrated because obsolescence happens so fast that we have to have tighter relationships. We also have to leverage the capability of suppliers to be able to drive product development, innovation and the fast cycle times in the supply chain.
Knowledge at Wharton: Does that mean that, necessarily, things are more difficult, say, for high-tech firms as opposed to autos, or is it just a matter of difference and not really levels of difficulty in managing these relationships?
Tevelson: I think the value is different and what the suppliers can do is different. But also, history is different. So, the automotive industry is starting from a base where there’s less trust because there’s been this great focus on price and making agreements and then pushing suppliers further. With the high-tech industries, for example, there’s more collaboration.
Another example would be the pharmaceutical industry, where some partnerships are emerging even in mundane categories like packaging. Companies are working with their packaging suppliers to differentiate not only based on marketing opportunities, but [also] based on the customer experience with the package from a safety perspective [and] from an information perspective.
And ultimately, what the pharmaceutical companies are interested in is the patient using the prescription, persistence and compliance.
Knowledge at Wharton: You mentioned trust, which is something we want to talk about in a moment, but how can companies prepare for the changes you’ve described, and what will these supply relationships look like in the future?
Tevelson: I think companies can prepare by undertaking some basics of understanding their supply market and then understanding from that where they need to go with the business. So, how can procurement contribute to the company goals? And therefore, what do our suppliers need to do? Then, setting kind of a baseline as to where we are from the starting perspective, what are we securing from a value perspective, and what do we really need to get from our suppliers going forward?
Knowledge at Wharton: What will those relationships look like, do you think?
Tevelson: I think the word “partnership” is always thrown out, so lawyers jump in and they get all upset about the implications of that. But I think what you’ll find are tighter, longer-lasting, integrated relationships that are based on trust [and] … information sharing, while the contract will sit behind and ensure the right incentives are in place on both the upside and the downside. I think you’ll see more integrated relationships [and] deeper investments by both parties with fewer suppliers.
Knowledge at Wharton: Can you talk about the importance of trust in relationships and maybe even discuss the possible consequences that can arise when trust is lacking or is weak?
Tevelson: That’s very interesting because I don’t believe personally that a good, deep, collaborative relationship can exist without trust. I think it’s a table stake that one has to have going in. If you don’t, one is always holding back either information or opportunities. If you don’t have good collaboration, too much energy and focus is concerned with whether the agreement and the situation is fair. I think that undermines the ability to really drive forward and get after the most value.
So again, I think it’s a starting point that has to exist. You segment your suppliers. Are they important from a strategic perspective to the business, and where are they along the continuum on the trust matrix? What do we need to do [to] move it to the right place?
Knowledge at Wharton: Do you think, in general, that trust has eroded between suppliers and their customers in recent years, and if so, why do you think that’s happened?
Tevelson: I think it varies by industry, and in the automotive industry there has been clear erosion. In some of the high-tech industries there has been less. You also need to think about the whole movement of supply chains and supply sources overseas where these long-term relationships may exist.
Lower-priced suppliers, perhaps without the same sophistication, are brought to the fold. Then you get a conflict between the value a domestic supplier can provide around innovation, around speed, and around helping their customers operate more efficiently and effectively versus the offshore supply base, which has a great advantage around price but not necessarily leading-edge innovation or speed in the cycle chain, the supply cycle.
Knowledge at Wharton: What types of value — a word again that you mentioned a little while ago — can advanced supplier relationships offer?
Tevelson: I think value is really changing the rules of the game. If you’re effective at procurement, you’ve already pushed down pricing with your supplier to the point where they’re making a reasonable return. [If you] push it too far, they’re not going to be happy or a long-term supplier. It’s really around driving changes in supply chains — opening up the information-sharing and looking at how we can change the interface, how we can change processes to take out time [and] take out inefficiency and cost.
Also, how can we change what we buy so that we may be able to take advantage of specifying to needs versus wants and coming closer to what the customer needs versus overdelivering? Suppliers have a lot to offer when asked the question, and I think it’s critical that you have these types of relationships so that you leverage that insight. They have a good perspective, and it’s only a value if it can be leveraged.
Knowledge at Wharton: If we can try to pull all this together, what do you think the common themes are for success in these very important relationships?
Tevelson: I think there are a couple of things and I’d start with clear segmentation of suppliers. You can’t have deep, collaborative relationships with all your suppliers, and you need to really identify which ones are the players. The second issue is senior management buy-in. And while it seems obvious that in many corporate initiatives you need to have that, I’m talking about buy-in to the point of differentiated investment and investment in terms of dollars, investment in terms of senior management time, participating in conferences, [and] participating in discussions with suppliers directly and indirectly.
I think the other issue is developing a track record of success, being able to identify prior successes, perhaps pilots or case studies that can be communicated and provide justification to extend the program. Another key is treating the suppliers well. They have to have some vested interest in participating, so the benefits, the savings, the improved cycle times, [and] the opportunities need to be jointly shared.
I’m not sure if it’s a 25, 50, 75 sharing, but at some point the suppliers need to have an incentive to participate, which is my last point. [You need] common objectives — common objectives internally, common objectives with the suppliers, and [you need to] make sure they’re aligned incentives. We all know what we’re going after and we know why we’re going after it, and then there are incentives to support that.
Knowledge at Wharton: Are there any issues that we have not discussed that you’d like to bring up? For instance, I don’t know if we’ve really talked about price volatility and how that can affect supplier relationships. Maybe there’s something else you’d also like to bring up?
Tevelson: I can talk about the price volatility and also supply-chain risk, which is somewhat related. In terms of supply-chain risk, these tighter supply relationships enable companies to share and develop contingency plans. So, you may choose to go with one supplier, but work with that supplier to develop a contingency plan around what will happen if there’s a natural disaster. Then, from a price-volatility perspective, it’s really hard to have a collaborative type of relationship if the risk is disproportionately burdened or borne by one of the two parties.
So often, when there’s a lot of volatility in the pricing or economics of the relationship, you can establish some type of risk-sharing and the right level of divisibility so that no one is taking on an undue burden of that risk.
Knowledge at Wharton: Can you think of a real-world example where volatile prices have led to some kind of friction in a relationship, and how it was resolved?
Tevelson: Actually, I can think of a couple. The one I like the best was in the appliance industry and it was around the supply of some critical metals. There was a longstanding relationship in place and people were happy, in terms of the buyer side, with the ability to buy at a fairly low price historically. Then when the markets got tighter, things seemed to change. The partners were both happy, but when there was an opportunity to share what became a scarce capacity with other buyers who were willing to pay a bigger price, a conflict ensued.
You have a longstanding relationship focused on quality, service and delivery undermined because, on the margin, there was opportunism, and the relationship fell apart quite a bit, actually.
Knowledge at Wharton: Is that the exception rather than the rule these days?
Tevelson: I think in many cases the price-volatility issue, which is really topical at the moment, is addressed through transparency, so the commodity nature typically can’t be influenced by both parties. There’s an index and the price floats to that. And where there’s a reasonable way of resetting the price based on an objective measure, the parties can work together and not be arguing over something they can’t control.