Value Flow Management: Value-Driven Category Management & Strategic Sourcing

value-redOur previous discussions about how to resolve the problem of a Lack of Effective Cross-Functional Involvement & Buy-In focused on the standard internal conflict management techniques that are necessary when adopting a Tactical approach to category management and sourcing.

Our conclusion was that, while this type of approach can deliver significant price and cost down benefits (and especially if the company is facing a strategic cost challenge), in the end it is always likely to be sub-optimal (see our blog on Tactical Solutions to the Lack of Cross-Functional Involvement & Buy-In). This is because Procurement-led category management strategies necessarily generate significant internal conflict.

This occurs because the Procurement Function is normally attempting to ‘do’ category management as a ‘cost-down project’ to the rest of the organisation, rather than understanding that what should be occurring is the embedding of a cross-functional end-to-end process that manages the flow of value within the company, and between suppliers and end customers.

The over-riding problem with Tactical approaches is that they always generate internal dissonance and conflict, because the Procurement Function only sees category management as a mechanism to help deliver its KPIs, rather than as a strategic process (in which the Function may only play a supporting role) to assist with the delivery of the strategic goals of the organisation as a whole.

In what follows some case examples will be used to assist understanding of the difference between a Strategic (Value Driven) as opposed to a Tactical (Price/Cost Down) approach to category management and sourcing.

Understanding Value: The Supply v Spend Dilemma

In our earlier discussion of Tactical Solutions to the Lack of Buy-in and Early Involvement) we focused on 3 cases, in which the judicious use of internal power & leverage analysis, linked with effective change management, provided opportunities for significant reductions in costs.

While these are excellent examples of what a Procurement-led, Tactical approach can achieve they fall somewhat short of the value-based improvements that can be delivered (and without the need for internal conflict resolution) if a more Strategic (Value Driven) approach is adopted.

To understand this difference one must first recognise that there is a fundamental short-sightedness in the way in which most Procurement professionals think about category management.  This is revealed most starkly in the standard explanation of what is to be managed, namely: ‘categories of spend’.

More than anything else this ‘nomenclature’ demonstrates why Procurement professionals fail to understand what is the ‘strategic purpose’ of their organisations, and why categories need to be managed.

It may come as a shock to some, but organisations do not exist strategically in order to reduce the costs of ‘categories of spend’; on the contrary organisations exist in order to generate profits from the delivery of ‘categories of supply’ to end customers.

For end customers there is then always a Value for Money (VFM) trade-off to be considered, when they purchase any goods/services. This trade-off refers to the value of what is supplied technically (in terms of quality and delivery service levels) relative to what is its total cost of ownership.

The reason so much category management work is ‘non-strategic’ arises from this VFM trade-off issue, as between understanding categories as ‘valued supply items’, or seeing them merely as ‘spend items’.

What appears to have happened recently is that, because Procurement is only ever managed against cost down targets, and because it has adopted category management as the best tool available for it to reduce costs through standardisation and consolidation techniques, category management has become a ‘one-legged stool’.

By this we mean that Procurement often sees category management merely as a project-based process that is to be imposed on the organisation as way of reducing costs, rather than as a ‘three-legged stool’ in which Quality, Cost and Delivery have to be analysed and managed as trade-offs with the business strategically.

The consequence of this dominant Tactical way of thinking is the inevitable internal conflict that arises in the business when the Procurement Function tries to ‘do’ this to other Functions, in pursuit of their own (rather than other Functions’) performance targets. The result is normally a lack of buy-in and resort by Line managers to post-contractual opportunism once contracts have been awarded, as we outlined previously (see the blog on the Problem with Cross-Functional Involvement & Buy-In).

Despite this, as we show below, by adopting a Strategic (Value Driven) approach to category management, and by working collaboratively with the relevant Line managers and Procurement staff, it is possible to radically transform these unfortunate post-contractual outcomes and generate cross-functional buy-in and early involvement.

Examples of Strategic Value Flow Management
‘From Day Rates to Project Effectiveness & Efficiency’

In a previous blog we described a situation in which, despite the best efforts of the Procurement Function to end single source supply with the most expensive supplier in the market, Line managers post-contractually ignored the framework agreements put in place with two other lower cost suppliers, and continued to award 100% of the volumes to the highest priced supplier on a bundled equipment/staff day rate basis.

Obviously, Procurement saw this strategy as a failure for their desire to reduce costs.  We were asked to help, and we immediately brought the relevant Line managers and Procurement staff together into one of our two-day QV® Challenge Workshops (see blog The QV Way) to analyse the issues.

QVWorkshop

The reason for doing this is that it was obvious that Procurement had not engaged sufficiently with Line managers to understand either the reasons why they preferred the technical performance of the higher priced supplier, or why they would continue to work with them, even if the cost was considerably higher than the lower cost suppliers.

The upshot of the Challenge Workshop was an understanding of the following key VFM drivers for this category of supply:

  1. Quality of technical equipment performance was critical to project delivery
  2. Availability of the right level of technical competence/know-how was key to project delivery
  3. Costs were relatively insignificant when compared with the impact on revenue flow of having the right technical staff and equipment on site

Given this VFM trade-off it is hardly surprising that Line managers would choose to work with suppliers who delivered their primary targets (i.e. project technical efficiency and effectiveness in generating revenue flow and profitability) rather than the targets established by Procurement (i.e. reduce day rate costs irrespective of the impact on technical performance).

Interestingly enough, once we had convinced Line managers that we were not solely interested in cost reduction targets, and that we had a genuine interest in their VFM trade-off concerns, it was then possible to work with them on many other aspects of their sub-optimal management of this category of supply.

We quickly established that there was no clear performance data that actually supported the view amongst Line Managers that the most expensive supplier was technically superior. Eventually, Line managers were forced to concede that their preference for the most expensive supplier was not based on fact, but merely on their ‘subjective preferences’, without the use of objective selection criteria.

Once we had established that the category was not being professionally managed technically, we were then able to shame the Line managers into establishing objective KPIs for technical and commercial performance. This allowed us then to identify the baseline performance of the incumbent (and most expensive) supplier, and also convince Line managers of the desirability of allowing other suppliers the opportunity to demonstrate their technical (NOT commercial) prowess.

Over a number of small pilot projects Line managers gradually began to compare the performance of suppliers they had never used before, and they (not Procurement staff) decided that the technical performance of the new suppliers was as good (if not better) than the incumbent supplier. Given that the cost was significantly lower (sometimes by over 40%), eventually Line managers completely replaced the previous incumbent with 3 commercially hungry and technically able suppliers.

In this example, we can see what can happen when a Strategic (Value-Driven) as opposed to Tactical (Price/Cost Down) approach is taken to category management.

While there was some tension at the beginning of the process as the current approach by Line managers to category management was discussed and challenged, by focusing on the KPIs of Line managers rather than on those driving Procurement, it was possible to have Line managers understand that it was they that needed to manage things differently. This was because they were making serious errors in delivering against their own technical KPIs.

The technical benefits that flowed from this exercise were substantial, and these simply could not have been delivered if the conversation had only been about price and cost.  Significant cost savings were also made, but without us ever really focusing on these as the primary driver of the strategy.

In the end a cross-functional team (primarily led by Line managers) saw that a professional approach to category management was able to deliver significant improvement in value. This included improvements in project efficiency and effectiveness that impacted on revenue flow, profitability and technical performance, as well as reducing the total costs of ownership.

Improving value in this way is the goal of all Category Vale Flow Management exercises, as an additional short case below explain.

From Widget Costs to Fundamental Marketing & Manufacturing Strategy Realignment

In another VFM exercise we were involved with, a company asked us to assist with a problem they had with the excessive costs and poor availability of a small tactical widget for one of their major products.

From the Procurement perspective the problem was that they had too low a level, and infrequency, of demand so that they had few opportunities for price leverage. They simply could not get better prices, or even ensure stock availability, and this sometimes caused delay in completing products to deliver to customers.

Having analysed the widget sourcing strategy with a cross-functional team it soon became apparent that the real issue was not the price of the widgets, but the complete misalignment of demand and supply alignment in the marketing and manufacturing strategy of the company.

The company had adopted a lean manufacturing and supply model without fully understanding that this approach could not be adopted in the absence of a standardisation strategy when offering products to customers.  In practice the company was promising customers any types of product within 10 days of order to shipment, but without the ability to deliver manufacture and/or supply against this commitment. The result was low profitability and dissatisfied customers, who rarely received goods on time because of the lack of buffer stocks in the supply chain to make good against orders.

No amount of competitive price challenges could hope to resolve these problems. In the end the company had to completely restructure its go-to-market offers and standardise its product lines around 3 standardised and 1 unique/bespoke offers. The result was aligned demand and supply, increased product sales, higher levels of customer satisfaction and, eventually, as volumes for standard parts were aggregated—lower input prices for widgets.

This example once again demonstrates the benefits for categories of supply from the adoption of a Value Flow Management approach that focuses on Strategic value for money rather than just price/cost considerations.

Key Learning from these Cases

The two cases above show that achieving buy-in and early involvement did not occur just because Procurement believes it is a ‘good’ idea.

On the contrary both cases demonstrate that when strategically important categories of supply are being analysed it is essential to persuade staff from other Functions that there is something in the process for them.

The key learning that arises from this understanding is as follows:

  1. It is easier to win buy-in and early involvement for category management implementations if the exercise focuses on the KPIs being managed by cross-functional colleagues, rather than on those of the Procurement function.
  2. Never commence a category strategy by discussing price /cost down outcomes or targets.
  3. Always focus first on the technical value for money problems (i.e. quality and service delivery etc) that cross-functional colleagues have to deliver against.
  4. It is imperative to win the hearts and minds of cross-functional colleagues by helping them to meet their targets first, rather than yours.
  5. Having a methodology to understand the relative criticality of technical and/or commercial inputs, and in relation to other sources of corporate value (i.e. Value For Money trade-offs) is a prerequisite of being able to communicate and engage with cross-functional partners, so that they buy-in to category management and strategic sourcing.
  6. You must also possess a methodology for understanding how to undertake Value Flow Management within the organisation.
  7. This will be supported if an end-to-end category management and strategic sourcing process is created to drive continuous improvement and knowledge management.
  8. In the end it is best if cross-functional colleagues rather than the Procurement function believe they invented and manage the new strategic sourcing process.
  9. The Procurement role is to act as the guardian of the process of cross-functional sourcing excellence.
  10. Ownership of the process must eventually be driven by the business, and that means by senior cross-functional colleagues if it is to be a Strategic (Value Driven) rather than Tactical (Price/Cost Down) sourcing process.

How we help organisations to achieve these Strategic (Value-Driven) rather than merely Tactical (Price/Cost) based outcomes operationally is explained in more detail in our blog: The QV Way to Improve Category Management & Strategic Sourcing.

IIAPS
IIAPS
The International Institute for Advanced Purchasing & Supply (IIAPS) is dedicated to the raising of international standards in purchasing and supply management so that real business value - improvements in the quality, cost and delivery performance of supply - is delivered to organisations.

One thought on “Value Flow Management: Value-Driven Category Management & Strategic Sourcing”

  1. Andrew, totally agree that internal conflict is generated when category management isn’t embedded as you suggest. Changing perceptions so that Procurement is seen as a strategic process is fundamental to changing this. You use some great examples here, Andrew to show what ‘best’ is in an approach to category management. Thank you for sharing. How can category management training improve to embed this in cat man managers at an early stage in their career do you think?

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