By: Vel Dhinagaravel -- CEO and President
18 March, 2014
Let us analyse two scenarios. In scenario one, Usain Bolt is running against all his competitors at the Bird's Nest Stadium in Beijing. He can see who is running alongside him and has a real-time view of his position at any given moment during the 100 metre dash.
And in scenario two, Bolt is running alone at the Beijing arena, while his challengers, too, are hitting the tracks separately at different stadiums around the world. In this case, Bolt would not know how fast Yohan Blake or Asafa Powell is running. Given the lack of real-time intelligence, Bolt will have to run as fast as he can, or in other words max himself out, in order to finish first.
In scenario one, as we all know, Bolt won the competition hands down under 10 seconds, and had enough time to slow down and turn back to look at his competitors while celebrating before the finish line. Bolt would know he would be crowned champion as long as he completes running 100 metres in less than 9.60 seconds.
The question is will Bolt would have done the same in scenario two? Would an internal benchmark of 9.60 seconds be enough for him to win the race? The answer is No as he wouldn't know how fast Blake or Powell is running in other stadiums. Given the lack of competitive intelligence, or an external benchmark, Bolt would be focused on running as fast as he can.
Now let us apply the same logic to the field of procurement. All the while, procurement managers are using Purchase Price Variance (PPV) as a baseline to measure the dollar value of savings.
What does PPV entail? You are benchmarking against your own performance over the previous year - essentially an internal benchmark. And at no point has there been a validation that that is necessarily a good baseline.
A company might have been buying very poorly last year and maybe buying somewhat better this year. So the improvement from previous year is acknowledged, but there is no acknowledgement from the CFO that last year's benchmark is something worthy to beat.
Will companies derive maximum cost savings in case of PPV, which is an internal benchmark? The answer is No.
Over the last three years, whenever an opportunity presented itself, I asked CFOs of many organizations for their views on procurement, the role of procurement, and also how they value procurement. One truth emerged from these conversations: PPV as a metric is being increasingly questioned.
Procurement has evolved over the years and will certainly continue to evolve to reach an optimal state. The old ways will die, giving way to new order, just as how pupa transforms into a butterfly. Procurement is on the precipice of change, which is as per natural order of things.
The metamorphosis of procurement will eventually lead to Category Management and "Benchmarking against Competition", as CFOs and CEOs will want procurement teams to validate their cost savings against an external benchmark.
What does Category Management entail? It would mean procurement managers will have to own the category and always be right on top of new developments. Also, their focus will have to shift from cost savings (as measured by PPV) to market competitiveness. They will have to rely on new external benchmarks to measure their performance.
Category Management is akin to Bolt running alone at the Bird's Nest stadium. Since this approach doesn't enjoy the luxury of an internal benchmark, procurement managers will have to constantly better themselves in order to stay ahead of the pack.
The move to Category Management denotes a phase shift for procurement. In this phase, the promise is not defined in terms of cost savings. Instead procurement should commit itself by saying: "I'll be buying better than my competitive reference groups or peers."
The overall metric shift from PPV to Category Management is going to drive procurement away from being "project focussed" to "category focussed." Considering the shift, there is also a need for market intelligence to change from being "discrete" to "continuous."
As companies move towards category management, there won't be many opportunities to run 100 discrete projects in order to meet the given cost savings run rate. Instead the procurement managers would be chasing a shifting goal post and would have to be in constant possession of real-time market information that would set them up well against external benchmarks.
Adopting competitive benchmarking would answer the following question: What is the procurement equivalent of "market share"? For example, sales growth is one dimension to capture the sales team's performance, but it'll also make sense for the company to capture the movement in market share. If a company's sales grew by 5 percent, but market share shrunk by 6 percent, how can the sales team justify the "sales growth"?
Similarly, it'll no longer be enough to measure procurement from cost savings perspective alone. The next phase would be ushered in when the CFOs and CEOs across major verticals asks the procurement team: what is the external benchmark to validate the delivered cost savings?Â The categorical answer to that is Category Management.
Yes, in one way, the pupa dies, which to some may not be a desirable outcome. But do not forget that it gives way to a beautiful butterfly."