As laid out in my June 29 column, chief purchasing officers (CPOs) often find themselves constrained in their jobs by short-term financial goals they had no real input into. In such companies, the purchasing function is considered tactical, and the purchasing officer not, in practice, a full-fledged member of the executive group.
Below, I’ll lay out an example of how this works and then offer my perspective on how a top purchasing executive could take action to transform their supply management group into a more strategic function.
Some may say that the above description of purchasing’s position within a company is false. After all, don’t CPOs set supply management’s annual material cost reduction goal independent of a company’s other executive staff.? And similarly, isn’t there very little interaction needed with those other areas to obtain supplier price reductions? And if so, isn’t it entirely appropriate that purchasing should operate in a “silo” relative to overall organization?
Hmmm. The example below shows this is not the case.
I once worked for a division whose organizational structure was such that purchasing reported to product engineering, while product engineering reported to manufacturing. In other words, purchasing was represented on the divisional president’s staff by manufacturing based on input from the vice president of product engineering.
Again, hmmm. If this hierarchy doesn’t make the case to you that—at least in this division—purchasing was a tactical function, I’m not sure what will.
Anyway, one year, the president’ staff set a purchasing material cost reduction goal of 3.5%. The story I heard was that this goal was proposed by the financial arm of the division, and manufacturing—of course—agreed to it. The goal was then sent down through product engineering and given to purchasing as the department’s primary performance metric. (It should be noted that failure to hit this goal would not affect manufacturing’s annual performance metrics.)
At the time, corporate purchasing had set an annual year-to-year cost reduction goal of 5%. I asked my boss how this goal was to be regarded relative to the divisional 3.5% reduction goal and was told as far as our people were concerned, they would be told that their performance would be measured against the 5% corporate goal. In fact, the 3.5% divisional goal was not to be communicated to divisional purchasing personnel.
I assigned myself the task of putting together a business case to both influence my boss to set our material price target at 3.5% and to help him understand how difficult it would be to even hit that target.
Below, I lay out a few of the points I made:
1. Close to 50% of our annual purchasing spend was on two primary components needed in the manufacture of our product. Pricing for each had already been established in long-term contracts—agreed to well above my labor grade—with the average yearly price reduction expectation set just short of 2%. This basically limited the scope of my department relative to impact of our cost-reduction work, meaning that we could only work on purchasing material cost reduction with about half of the annual spend. This would, in effect, mean that they would need to deliver price-reduction of either 5% or 6.5%, depending on whether the goal was based on the divisional or corporate annual target, with the suppliers we had price-setting responsibility for. I pointed out that basing purchasing employee performance based on what I considered unobtainable goals wasn’t fair, either to the individual or the department.
2. Setting a 5% goal across all divisions didn’t make sense since there were drastically different levels of competition in the markets each participated in. In our division—which faced the most competitive pressure—we had to push hard for lower initial part pricing just to make our product competitive. Not so much in the other divisions which had, for some of their products, market shares of over 50%. Our products were lucky to have a market share in the high single digits.
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To support the above position I had, in fact, heard from suppliers that sold both to our division as well as others across the company that the other divisions tended to leave “more meat on the bone” in up-front pricing than we did.
3. How could we justify either target when our internal operational cost reduction goal was under 2%?
Regardless of the overall goal, I didn’t think it fair to our employees to think that all suppliers should have the same material cost reduction goal target(s). Why? For a couple of reasons. First, cost reduction opportunities vary significantly between the different commodities and engineered products. Second, there is also a difference in cost reduction opportunity between lean and non-lean suppliers. Because of this, depending on the product types a particular buyer was responsible for, they might have an easier or more difficult time in meeting their personal performance goal.
The response I got was that our “public” material price reduction goal would be 5% and be treated as a “stretch” goal and the division’s “internal” 3.5% would be our “minimum acceptable” goals.
My factory reduced our overall spend by between 1 % and 2% that year and I felt pretty good about that result. But our manufacturing VP was not.
What would my expectation be of the top purchasing executive in the situation described above?
First, bring a strong, detailed analysis of purchased material cost reduction opportunity into the annual fiscal planning meeting and based on that, propose a practical purchased part cost reduction goal.
Second, compare this number to cost reduction goals of the other functional areas which, by the way, were all less than the one given to purchasing. In particular, I would compare this to manufacturing’s goal—since this would represent the closest parallel to supplier operations—and point out that lean strategic suppliers should be regarded in the same light as our internal operations.
As a matter of fact, the division’s manufacturing cost reduction goal was set below 2% and remember, it was manufacturing that had agreed to a 3.5% goal for purchasing! It is interesting to point out that I had done a “quick scan” analysis of the realistic potential for cost reduction of purchased material and it came close to matching manufacturing’s goal.
Finally, based on the first point above, I would propose an aggressive but realistic material cost reduction goal for the for the purchasing function. And if the function’s goal was still set at the 3.5% level, I would make sure the inconsistency of this relative to the manufacturing goal was well-documented.
Anyway, no pushback was given on either the 3.5% and 5% goals, and they remained the measures of our performance for that year.
I believe that most purchasing departments accept material reduction goals given by executives from other functional areas that have no real understanding either of purchasing or the current operational status of current suppliers. And that most purchasing executives accept these goals as gospel, regardless of supply chain realities. And because of this, purchasing is considered a tactical, second-tier function within many corporations.
Paul Ericksen’s recently published book, “Better Business: Breaking Down the Walls of the Purchasing Silo,” is now available: https://store.IndustryWeek.com.
Paul Ericksen’s book is Better Business: Breaking Down the Walls of the Purchasing Silo. Ericksen has 40 years of experience in industry, primarily in supply management at two large original equipment manufacturers.
