Use Procurement to Add Shareholder Value
29th September 2015 | Jonathan O'Brien
Jonathan O’Brien discusses how effective procurement can dramatically impact shareholder value, and why companies need to rethink their approach to procurement to truly realize this value.
It’s hard to work in a modern global business without being touched by some sort of corporate edict to add shareholder value, a modern obsession that seems to have begun back in 1981 when former CEO of General Electric, Jack Welch, made a speech in New York where he revealed his aim was to be the biggest or second biggest market player and return maximum value to stockholders.
So who can add the most shareholder value? The traditional view might suggest the onus for meeting this challenge lies with the sales team - the more you sell, the more money you make and the more value that can, in theory, be returned to those who own the business, driving up the share price. True in part, but if margins are low or if the business is inefficient, then great sales figures have little worth and we become ‘busy fools’. Furthermore, it takes effort to make a sale. In the ever increasing global market place packed with hungry players just a click away, ready to provide just what we want, things are pretty competitive out there. Customers need to be found, convinced and then we need to get them to part with their money and hopefully retain them. Unless we happen to have a unique differentiated offering that everyone knows about and must have, we have to work hard to make a sale and maintain market position.
So shareholder value is in fact much more than high sales figures or a great share price (a theme that Jack Welch returned to some years later). Shareholder value is in fact all the factors that create sustainable long term success and that might include brand value, available capital, agility and preparedness for change or to withstand challenges, all enabled by an effective organization and of course the profit the business turns.
Sales isn’t the only game in town when it comes to shareholder value. Effective procurement within the organization can make a dramatic and sustainable contribution here also, but demands a new approach. The traditional view of procurement as ‘the function that buys things’ contributes little to shareholder value beyond fulfilment of need; responding passively to demand created by sales, perhaps securing good rates or prices wherever possible. However, world leading organizations have long since recognized that procurement can in fact contribute much more, but only if the company can organize itself so procurement plays a more strategic role and this operates at three levels:
1 - Increasing sales margins - Effective procurement increases the organization’s profit potential. Remember profit is sales less costs. Most businesses are pretty efficient in terms of people and overhead costs these days so that leaves cost of spend with third parties. Some of this may not be addressable (spend we cannot influence), but for the remainder of third party spend, if we can reduce this, then this saving will go straight to the bottom line. The proportion of third party spend to sales turnover will of course vary according to what a business does. In a manufacturing company, third party spend is typically around half (more in automotive, less in professional services). So if we could reduce this third party spend by say 5%, then this goes straight to the bottom line. In contrast, consider the sales effort needed to create the equivalent 5% increase in profit - if the company has sales margins of 10%, then sales would need to increase by 15% to realize the same impact. So turning attention to procurement would seem to be a no-brainer to adding shareholder value! So why isn’t everyone slashing their third party spend and maximising their profit? The answer is simply because it is really difficult, but not impossible. It is the supplier’s job to maximise their margins and maintain their position and they are, on average, better resourced, better trained and better incentivized to do so than those who buy from them. However, modern strategic procurement approaches such as category management and supplier relationship management can, if well deployed, turn the tables and shift corporate buying from a tactical subservient function to a strategic contributor, challenging what has gone before and using the full extent of the organization’s available leverage to secure new dramatic price reductions.
2 - Building brand value – Brand value creation is not confined to the marketing team, procurement has a role here too. The supply base is often thought of as a detached entity, but it is far from this. Our supply base is an extension of our business with value from our suppliers flowing through our business, being transformed in some way to create new value that flows to our customers and onto the end customer. That means that the value the end customer gets is shaped by what our suppliers do. Obvious perhaps, but the functional nature of organizations means this perspective is frequently missed. Procurement has a role to preserve this value by managing supply chain risk, but it can also help build this value and indeed build the brand. The future innovation that could create a winning differentiator or add value in some way might not reside in our organization, but might come from the supply base. Unless we are organized to find and secure supply chain innovation, it will be missed, or worse, it will end up with a competitor. Here procurement can identify those suppliers who hold future potential and instigate the right relationship and contracting mechanism to unlock this value.
3 – Shaping strategy – Shareholder value demands a business strategy to realize it, and one that looks beyond the short term. If strategy is merely a top down instruction, the organization can only respond, so strategy needs to be informed. We are familiar with marketing teams informing strategy, after all they are the ones connected to the needs and desires of the end customer. But what can procurement possibly add? Procurement can shape corporate strategy. An effective procurement function understands and is connected to supply base possibilities, the same possibilities that can build brand value. If we can connect these possibilities with end customer needs and aspirations, then we can lead the field. To deliver corporate strategy and shareholder value without procurement’s contribution is incomplete.
You can read more in Jonathan O’Brien’s book, Category Management in Purchasing. The new edition is out October 2015. The book provides a step-by-step guide to the tools, techniques and applications of category management. It allows readers to quickly analyse complex sourcing situations, and develop innovative proposals for sourcing. It includes case studies of IKEA, The Body Shop, NHS, Heinz, Cardiff Council, and GlaxoSmithKline.