Scaling up a procurement department is challenging but you already know that!
And you also know that a well-designed procurement organization can significantly increase the value it delivers for the organization, i.e increase in EBITDA (Earnings Before Interest, Tax, Depreciation, and Amortization).
But how do you go about setting up your self for success while scaling up the procurement organization?
That is a question you might not have an answer to. So we asked around our customers and prospective customers and we have attempted to summarize the findings in this blog post.
In this post, we will cover a step by step process to help you scale your procurement organization.
Whether you are seasoned professional or just starting with procurement, we hope that you will find actionable information.
Challenges with scaling up a procurement organization
Before we talk about scaling up a procurement function or increasing the strategic value of procurement, let’s look at some common challenges a procurement team faces while scaling up a procurement function.
We are assuming that you have some sort of procurement function and you are trying to scale up the team to meet the demands of the business. If you are just starting the function, please read our complete guide on how to build a procurement team first
Lack of clear goals/objectives
When you look at scaling up a function, it is important to clearly identify clear goals you want to achieve. Needless to say that your goals should be SMART (Specific, Measurable, Achievable, Realistic, Time-bound)
The simple fact is that if you don’t have clearly defined goals then you don’t know what are you scaling up for.
It is like you are optimizing the function to run faster, but you don’t know why you are doing that.
The most common objective for procurement teams is to save company money!
That is not a clear objective, if saving money is your only goal, you are setting the department for failure. Cost savings are a by-product of better engagement with the stakeholders.
Better stakeholder engagement comes from understanding the “Why the department exists” and how it can be better aligned with corporate goals.
If your organization culture is to run fast, then slowing down things with more procurement policies is not going to sit well with the organization.
Lack of executive support
This is one of the common challenges for many procurement leaders. Let’s take a hypothetical scenario to describe this challenge.
Acme Inc provides a platform for helping companies pay their suppliers faster. The company is 5 years old and has raised $X million in funding.
Since the focus is on revenue growth, each team is running as fast they can without much compliance oversight.
Now you “the procurement leader” is brought in to scale the existing procurement function which currently reports into the chief legal counsel. Procurement is currently transactional – creating purchase orders and sending PO to vendors.
So the challenges you need to solve for are
- Where should the procurement function report? – Finance, Legal or operations
- How to get buy-in from all executives to support the function. For example, the head of marketing, engineering, etc.
Cost savings are still the main Key Performance Indicator (KPI) for procurement but for building the executive support, the conversation has to move from just cost saving to being an enabled and trusted advisor to the organization.
Lack of skilled resources
The procurement function has changed a lot in the last 5 years. As organizations are realizing that just cost savings in not enough – more CPO’s (Chief Procurement Officers) are realizing that they have a lack of skilled talent
Deloitte recently conducted a Chief Procurement Officers Survey. Among many other things, they ask the CPO’s to rate their current team skillsets on how well they are aligned to deliver procurement value for the organization.
As you can see above that 51% of CPOs think that they don’t have the right skill set in the team or in other words there is a skill gap.
As you look at scaling up the procurement function, it is critical that you spend time on identifying the type of skillset required to scale up the function.
There is definitely a lack of skilled talent in the market. There are many reasons for it, primarily
- The skills required in today’s world is very different from what was required a decade ago and the existing workforce is not always able to acquire new skills as required.
- Procurement is not a sexy function and there are not many educational institutes who are continuously producing awesome procurement talent.
- If you ask procurement professionals on how they joined procurement? We can bet that most people would say that they somehow got into procurement but never intended to build a career in procurement.
This is a real challenged for procurement leaders – finding great talent. So how do you overcome that? By selling the vision of procurement. We will clear this more in a later section on how to build your procurement team.
Objectives for scaling up the procurement department?
We looked at some of the challenges with the scaling up procurement organizations, now let’s look at how to get started with scaling up your procurement department.
The first step in scaling up the organization is to define a clear set of objectives for scaling up. You should clearly define what you want to achieve, why you want to achieve that in and what time frame.
Having said that, here are some of the common objectives for scaling up the procurement organization
Better stakeholder engagement
This is one of the most important objectives of any procurement transformation journey.
Procurement stakeholder engagement is key to procurement involvement in the organization.
What do we mean by procurement stakeholder engagement?
Procurement stakeholder engagement is defined as the process where procurement engages with different department owners/stakeholders to help them enable the purchase of products and services required to effectively run the business.
Let’s break it down
Procurement stakeholders, in this case, are your internal departments whom you support in various sourcing activities. We are only referring to internal stakeholders at this time and not external stakeholders like suppliers.
What do we mean by enabling your stakeholders?
By enabling stakeholders, you are helping them achieve their department goals which of course are aligned with the organization’s goals.
Notice we said their department goals.
One thing to note here is that the department goals are not always directly aligned with procurement goals. Procurement is generally measured by savings delivered, not many departments are setting up their goals like cost savings!
Almost most of them would have a goal, for example, improve customer experience or increase the NPS score. They would have identified certain initiatives that would help them get there.
So enabling stakeholders means helping them achieve the goal of improving customer experience by supporting the sourcing decisions for various initiatives.
So now depending upon the budget assigned to the department, there might or might not be any procurement cost savings.
So when you are setting engagement as an objective, you also have to think about the skillsets you would need to acquire or hire to better support the team objectives.
Increase spend under management
Spend under management is defined as the total spend the procurement department can influence in an organization.
In other words, it is the pie of the total spend which is negotiated by the procurement team.
As you manage more spend, you deliver better cost-saving and hence increasing spend under management is important for many organizations.
In our experience, procurement teams who are looking to increase spend under management are already delivering savings in other areas of business.
In other words, the management understands the value delivered by Procurement and now they are looking for ways to extend the value to other departments within the organization.
How do you increase spend under management?
Increasing spend under management is an important objective but how you go about increasing spend under management.
The universal answer is – “It depends” on the following factors
- If increasing spend under management needs more resources because the current resources are unable to handle the workload then that is an easy problem to solve for. In that case, the answer is – higher more resources.
- If you are struggling with engagement with stakeholders, then increasing spend under management requires selling the procurement value within the organization.
- If you need deep category expertise to engage with stakeholders, then you should look at acquiring that expertise or hire someone who already has that expertise.
Increase in purchasing compliance
In certain cases, procurement is already engaged with stakeholders, they are helping them negotiate cost down but still unable to reach the savings goals.
It is not uncommon to have decentralized procurement departments or even if the procurement department is decentralized, different locations keep on purchasing from their own set of problems.
In that case, you have a purchasing compliance issue.
So while you are looking at scaling up the procurement organization, you should also look at increasing the purchasing compliance
What is purchasing compliance?
Purchasing compliance can be defined as compliance to pre-defined procurement policies or procedures.
- Compliance could be purchasing products/services from the preferred vendors.
- Purchasing compliance includes purchasing products/services through preferred purchasing channels. For example, purchase order vs P-card.
- Purchasing compliance means getting purchase authorized at the right level of management before making the purchase.
Here is a summary of potential objectives for scaling up your procurement department
Getting executive buy-in
Scaling up procurement needs investments, whether that is an investment is in resources, technology, etc.
So while scaling up a procurement organization is a noble goal, the investment in resources needs to be justified like any other investment.
Especially when the investment is all Opex except some portion of the technology investment could be capitalized, the investment in resources impact the EBITDA both from SG&A expenses and impact through reduced cost.
Getting buy-in for investment in resources
The first step is, of course, quantify the investments in some form of ROI calculation and then get the executive buy-in from finance or your reporting manager for the investment.
Most of the procurement professionals report up to finance, so that means getting the approval from Chief Financial Officer.
If the mandate is coming from the CFO office to scale up the organization then of-course the selling part becomes easier.
Here are some suggestions on how you should present the business case for approval
Better experience for employees
If you are hiring more resources to support your organization, then you should already have a quantified view of how it will make the experience better for your employees.
For example – You currently have a department based approach for resource allocation, i.e a procurement resource could be supporting one or more than one department at the same time.
If your current resources are overloaded with work, that might be causing a slow response time for queries from your stakeholders.
If your current resources are a generalist (handle all spend categories) and your stakeholders need a specialist (category managers who are experts in one or more categories), then that is an opportunity for improving customer experience.
If you currently using a manual purchasing process and planning to automate using a purchase order tool, then that will improve the experience for stakeholders.
These are some of the examples of how investment in resources can lead to a better experience for the employees of the company or in other words procurement stakeholders.
Procurement cost savings are the main KPI for procurement and of-course it is the most quantifiable KPI which can be used to build the case for scaling up the procurement team.
Most finance professionals are interested in cost savings and not cost avoidance. We have already covered different types of procurement cost savings but at a very high level.
Cost-saving is the reduction in the cost of an allocated budget line item. For example, you have a budget of $1M for raw materials and you were able to reduce the material cost by 10%. So $100,000 in cost savings.
Cost avoidance, on the other hand, is the avoidance of cost. For example, negotiating out of a price increase from a vendor.
As you can see that cost savings vary from industry to industry and it also depends upon the maturity of the procurement organization.
Since you are scaling up the procurement organization, it is safe to assume that you are probably not achieving the same % of procurement savings as best in class companies.
So what savings % you should use to build the case for increased cost savings?
Industry-standard cost savings benchmark is close to 8% of spend under management. For example, if you managing $50M in spend than as per industry best practice, that is $4M in annual savings.
You can go with the benchmark but we recommend that you take a more conservative approach for the following reasons.
- It takes time to hire resources, build strong engagement with stakeholders. So you should plan for cost savings to increase over a period of time. We recommend that you use 3-4 year’s time span to get to the 8% number.
- Start with a conservative number. We recommend 2-3% cost savings for the spend under managed.
- You can present an increase in spend under management over time, which would increase the savings delivered. You could probably show a quarter over quarter increase in savings delivered.
Reduced compliance risk
Compliance risk may or may not be a driver for a company based on the size of the company.
For example, if you are a public company (traded on the stock exchange) then there are certain regulatory requirements you have to meet.
As per the SOX (Sarbanes Oxley) act of 2002, companies need to have financial controls in place to ensure the financial viability of the company.
Section 404 specifically talks about vendor and cost controls. It is, of course, a priority for the CFO to ensure proper controls are in place and they are being tested for their effectiveness,
If you need more help on how Section 404 controls and how procurement automation can help achieve that, read Procurement compliance for CFO’s and Controllers.
Now, what if you are not a public company?
Procurement compliance is the basic financial hygiene a company must-have. It is not just about reporting that you have controls but strong compliance helps you get better visibility into your spend and make better decisions.
Basic purchasing controls for compliance are
- Purchase compliance – all purchases are authorized before they are sent to the supplier.
- Vendors are properly vetted and there is no conflict of interest.
- Invoices are matched against the purchase orders to ensure the accuracy of the invoice.
Top-down message or bottom-up approach
The other consideration in getting buy-in is to get buy-in from others in the company.
For example, if you are a Software company – then other executives include the head of engineering, marketing, dev-ops, etc.
Getting approval from finance is more for investment into resources, however, to increase the value of procurement in the organization, you have to have buy-in from the stakeholders.
The question is whether you increase engagement with the individual team members or work directly with the leadership to garner support?
We recommend you do both and here is why
If you already have good engagement with certain team members in a group, then you can build on it and have them help you to increase the influence of procurement.
In the long term, that is a good model because the adoption organically grows without a strong push from the top.
Having said that, that is not always the case, so you need to make sure that you have to buy-in from the top and then can help you drive the message.
North star metrics for the procurement department
When it comes to measuring the performance of the procurement team, procurement cost savings are still a dominant KPI ( Key Performance Indicator). However, procurement cost savings are an outcome of various steps that a team takes before it gets to those savings numbers.
With that in mind, for scaling up your procurement organization, you should define some leading indicators which help you gauge the progress you are making on your journey to scaling up your organization.
As per a recent CPO survey, above are the top KPI’s for measuring procurement performance. As you can see Opex and Capex savings are on the top of the list but let’s look at some of the other metrics which drive the savings numbers.
Engagement brings more spend under management, more spend under management gets you more savings. That is the simple formula.
We have written extensively about procurement stakeholder management, so if you have not read that, we highly encourage you to do that.
So how do you track the engagement?
We suggest that you can group engagement by department or key stakeholders. For example, engagement can be measured by the department – for example IT, Finance, etc.
Or it could be based on an individual stakeholder basis. We recommend going with the department because one department might have more than one stakeholder and tracking engagement at that level is very tedious.
The engagement with stakeholders can be categorized into following buckets
- No Engagement – this is straight forward, Procurement has no influence over the spend and there is no engagement. In that case, the department is managing its own sourcing.
- Reactive – Procurement is involved last minute after the stakeholder has already vetted the solution. Procurement is then called to reduce the cost. Sometimes just to check the box that Procurement has been engaged.
- Pro-active – Procurement is involved at the start of the RFP process, ideally when a need is identified and Procurement suggestions are considered.
- Trusted partner – Your stakeholders are seeking your advice on how to reduce the cost and you are working as a team to validate new ideas and vendors.
You can assign a score to each one to get to a balanced scorecard. For example
No Engagement – 1
Reactive – 3
Pro-active – 5
Trusted partner – 7
You can then add the score from multiple departments and then take an average score across all departments.
From there on, you should set up realistic goals on increasing stakeholder engagement.
Spend under management
Spend under management is the total spend managed by procurement out of the total addressable spend.
In other words, Spend under management is a measure of procurement influence over the company’s spend.
The higher the spend under management number, the better it is.
As per Ardent partners’ research, the average spend under management is 62.1% and Best in class companies have to Spend under management as high as 90%.
The first step is establishing a baseline for spend under management and the second step is to define the goals for increasing spend under management over a period of time.
Baseline formula is straightforward
Spend under management = Total spend managed by your team/ total cash out of the door.
Obviously things like payroll, taxes, debt payments, regulatory payments, etc. should be removed from the total cash out of the door to get a true picture of total spend. This is the total addressable spend that can be managed by the Procurement team.
In terms of setting the goals for increasing spend under management – it depends upon how strong is the current engagement and how fast you are able to increase engagement with stakeholders.
A 10% increase in spend management is a realistic goal to strive for.
Procurement cost savings is one of the most important metrics for the procurement department. If you are looking to scale the organization, then increased cost savings is one of the major drivers for that.
Procurement cost savings are primarily classified into hard and soft cost savings.
Hard cost savings are a reduction in the existing cost, i.e if you are reducing an existing budget line then that is considered hard cost savings.
On the other hand, if you were able to negotiate a better cost but it doesn’t hit a budget line item then it is called soft savings or cost avoidance. For example, you were able to negotiate a cost increase from a vendor. So even though you were able to reduce an expense which the company would have incurred otherwise, the savings are counted towards the budget.
The industry average for savings delivered is 6-8%
Few things to keep in mind while setting up the goals for savings delivered,
If there is some procurement engagement, you might be already delivering some savings, for example, 5% of the spend under management.
However, don’t use that as a baseline to set up the goal for savings delivered. These are two main reasons
- If you are getting some quick wins, the savings delivered on them are usually high. For example, it is not difficult to get a 10-15% cost reduction on low ticket items like office supplies.
- Savings delivered varies by category and total spend for that category. For example, delivering 10% savings on $100,000 is feasible vs delivering 10% savings on $10M spend might not be feasible
Similarly, delivering cost savings on commodity items is relatively easy but delivering YOY cost savings on raw materials might not be feasible.
So what is the right way to set up a savings goal?
Analyze your spend at a line level to estimate potential savings. So Instead of taking an average savings percentage, use existing spend data to understand the potential.
The procurement team would have more to contribute to value add activities if the employees and enabled using a self-service model.
So what do we mean by employee self-service?
In simple terms, it is a measure of whether your employees are able to follow the defined purchasing process without the need to involve procurement all the time.
For example, if your purchasing policy requires a three bid and a buying process – then how easy it is for employees to submit a request for quote.
In some cases, it might be possible to have employees get their own quotes, thereby enabling complete self-service.
Another common example of employee self-service is implementation of approval policy.
Do they need to look up a manual to understand the guidelines of the corporate spend policy?
Or is there a purchasing system that automatically routes the user to the right approval.
These are some of the examples where enabling supplier self-service frees up time for procurement to focus on value add activities.
Another common scenario for self-service is letting stakholders know about preferred suppliers for the product they are about to purchase.
It is simple to achieve this through purchasing catalogs but what about categories like services where there is no preferred catalog?
You should think about making a list of preferred vendors and let the purchasing system guide them through the purchasing process.
We highly encourage you to run a complete audit of all the touchpoints with the different stakeholders and then use that information to enable self-service wherever possible.
How to start scaling up your procurement organization
In this final section, we will provide a roadmap you can follow to start scaling up your procurement organization.
Understand your categories
We are sure that you are not hearing for the first time that you need to understand your categories for effective spend management.
But where to get started?
The key to understanding is effective spend analysis.
We have covered this topic in detail, so if you are not familiar with spend analysis, then read the complete guide on spend analysis.
Here is a high-level summary
- Gather complete data from all different sources of spend. For example Purchase orders, Invoices, credit cards, etc.
- Categorize the data into different spend categories. There are different industry standards for classification. But for the purpose of this exercise, we recommend using broader categories. For example, Information technology, Marketing, Facilities, Raw materials, etc.
The goal is not to get detailed spend analysis at this time but to understand how much spend is in each category.
Once you have the basic category classification, You should be able to answer the following questions
- How much spend is in each category?
- What is the potential for each category – in terms of cost savings?
- Do you have the resources to support the organization?
Identify skillset gap and plan to bridge it
Once you have your category map, you should be able to identify skills you would need to support those categories. Perform a skill gap analysis and see where the procurement team stands in terms of key procurement skills.
Along with other soft skills, you should strongly assess the need for domain expertise.
If your stakeholders expect the procurement team to have strong domain expertise, then you should look at either acquiring those skills through training or through new hires.
Not every category would require domain expertise. For example, marketing and information technology.
But if you purchase, for example, specialized IT hardware, then you need someone with the domain expertise.
Train vs hire – hire and train or bring in experienced talent?
So after you have identified the skills gap, how do you go about bridging that gap?
There are primarily two ways this gap can be bridged
- Hire new talent
- Train existing talent
There are pros and cons of both, so let’s look at each one of them
|New talent brings a fresh perspective from other companies.||Depending on your hiring cycle, it might take a long time.|
|In case your only skill gap was domain expertise, then hiring new talent might be a faster solution.||Even though the new talent would have domain expertise, they need to spend time in building rapport with the different stakeholders they have to support.|
|Less expensive and faster as compared to a new hire.||Though less expensive, it depends upon the individual whether they can grasp the skill sets.|
|Training can be generally arranged for the whole group so that it increases the expertise level for the entire team.||It could be expensive to arrange for the whole team depending upon the size of the team.|
There is no one right answer here because the decision making should always be in the context of the decision you are making.
Setting up a budget and getting executive buy-in
The next step is setting up the budget required to scale up the procurement organization
The budget should include the following
- Fully loaded cost of additional headcount.
- Additional training cost
- Cost for procurement technology to enable the team.
- Any additional cost to acquire domain expertise – for example, category expertise.
The reason you need to include all these costs is that building a procurement organization is an investment.
When you are presenting the case to finance, the investment in the procurement team should be considered with the same yardstick as any other investment, i.e returns on investment.
A company might be using different methods to calculate the return on investment, so talk to your finance team to understand the preferred method.
The returns are of course the savings delivered by the procurement organization as well as benefits of increased purchasing compliance.
We recommend presenting a business case for at least 3 years because that is the minimum you would need to see the sustained impact of the procurement team.
Setting up a procurement/purchasing policy
If you already have a purchasing policy, great. If not, that should be the first step in the process of scaling up the procurement organization.
You can read more about how to set up a purchasing policy
Here is a brief of what should be covered at a very basic level
- What is the purchasing process employees need to follow for procuring products and services?
- What channels should be used for procuring the product or services? For example purchase order vs card etc.
- What should be the approval levels and who should approve the purchase. For example, a manager can approve up to $10,000 and above that, it has to be approved by the department director.
- Who has the authority to sign contracts on behalf of the company?
- How the supplier invoices should be submitted to accounts payable for payment and what information should be submitted along with the invoice.
It also would be helpful to track the current cycle time for the purchasing process so that it is easier to track the progress you are making in improving the cycle time.
Procurement technology Investments
Procurement technology can help you scale up the procurement team without investing a lot in headcount.
Here are the specific areas where you should be investing from a procurement technology perspective
Operational procurement process
Operational procurement includes the end to end purchasing.
This process includes all the steps from the time a user enters a requisition to purchase something to the time the purchase order is shipped to the vendor.
Thinking about automation from day 1 provides you with two main benefits
- Your users have a better purchasing experience and that helps you to increase the engagement with your stakeholders.
- You don’t have to invest in headcount to support the purchasing policy.
- It would be easier for you to report on past purchases and to pull data for the purpose of conducting spend analysis.
Sourcing process automation
When you get started with scaling your procurement organization, you might start with a manual process to get quotes from the suppliers.
You could also run the RFP’s manually, whereby suppliers are submitting the response of your request for proposals via email. You can then consolidate the responses and present results to your stakeholders.
However, as you scale the procurement operation, you would see that the number of RFP’s is increasing and sometimes you also might have to run eAuctions for commodity items.
That is where a sourcing process automation can help you scale up the operations without adding additional headcount to the team.
Also since the whole process is automated, it is easy to collaborate with stakeholders as well as maintain an audit trail for your sourcing process.
Sourcing process automation is something you need, but not right on day one. However, you should consider investing in these tools as you soon as you start seeing an increase in the number of RFP’s conducted by the sourcing team.
There are two main use cases where contract management can help you get better results from your procurement operations.
a) Increased savings and compliance
The procurement team’s job is not over as soon as your team has negotiated a great contract. You have to operationalize the contract and ensure that the negotiated savings are realized.
If your employees are not purchasing from negotiated contracts, then you have a savings leakage problem as well as a compliance issue.
The best way to avoid these problems is to have a contract management tool that is integrated with your procurement process so that the purchasing transactions can be tied to the contract.
The system drives the compliance to the price as well as document the realized savings.
b) Avoid unwanted contract renewals
How many times you have been in a scenario where a contract auto-renewed and you have didn’t get ample time to send the termination notice to the supplier?
It might be happening more than what you might recall.
There are many reasons for that.
If it is because of a lack of resources to look at the contracts, then before you invest in a contract management tool, it makes sense to invest in hiring the team first.
However, a very likely scenario is that you have a team but they are busy working on chasing new opportunities and no one is paying attention to renewals.
That is where good contract automation can help you track all renewals and alert users when a contract is up for renewal and it is within the notice period.
One avoided contract can easily return the investment you would make on such a tool.
Conclusion – What’s next?
Scaling up your procurement organization is an ongoing journey and you should continuously evolve across the maturity curve of the procurement engagement.
We recommend you to reassess your current state every 6 months to understand the following
- What is the procurement value add? There should be a way to quantify this in terms of cost savings or any other metrics you desire.
- What is the expectation of the organization from the procurement organization? Keep in mind that this will keep on changing as you increase the maturity of the procurement organization.
- What is the current gap between the expected value and value delivered by the procurement organization?
- How to bridge the gap.
That is a rinse and repeat cycle you would have to follow to continuously scale up your procurement organization,
Hope this helps. We look forward to your comments