Mulani on Excellence: Reduce supply chain risk by increasing procurement expertise
Narendra Mulani -- Logistics Management, 6/1/2009
Most companies have some risk management expertise within their finance organizations. However, most companies have minimal risk-management expertise within their supply chain organizations.
Take the procurement function: Despite tenuous business conditions, increasingly wild commodity-cost fluctuations, and emerging/converging material sources, few buyers have all information and tools they need to do their jobs effectively. The reality is that supply chain risk has increased significantly, but companies' ability to support procurement with improved risk-management capabilities hasn't kept pace.
And what are companies missing as a result? Accenture experience has shown that applying innovative risk management practices to procurement could reduce raw material and commodity-based product costs by up to 3 percent. Cost drops of this magnitude rarely happen quickly. For most companies, in fact, an escalating series of new and enhanced capabilities are needed with each stage adding new resources, competencies, and tools. One basic level of improvement might be a more astute "corporate risk culture"—an organization-wide effort to increase risk awareness.
From there, companies could incorporate specialized tools for identifying and managing risk scenarios; develop more standardized approaches to forward pricing (passing on price changes to the customer); or smooth their ability to substitute different commodities or commodity-based products as conditions necessitate.
Further up the ladder might be more advanced risk management capabilities such as:
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A formal risk management policy that articulates the organization's risk appetite, risk limits, and risk-taking policies.
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Additional tools focused on making holistic decisions across the product portfolio.
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More sophisticated demand planning expertise. Highly accurate demand forecasts are key to defining optimal procurement batches, thus avoiding "panic purchases" and emergency transportation costs.
At the very top, "superior risk management capabilities" might complement the previous attributes with:
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A formal trading strategy that specifies the organization's risk appetite, risk limits, and performance measures.
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A commodity trading desk staffed by professionals who are specially trained according to the above trading strategy.
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Additional specialized technology to support market modeling, simulation, and efficient trading based on established rules.
Key Success Factors
As shown in the graphic, it may not be necessary for each company to achieve "superior risk-management capabilities." The key is recognizing (and subsequently attaining) a balance between the company's commodity dependency and the impact of commodity price volatility on the company's portfolio. Still, Accenture experience has shown that four success factors are generally required to significantly reduce procurement risk.
The first of these is to align procurement and finance. Given that a typical company's strongest risk-management capabilities (and responsibilities) reside within the treasury function, it is vital that procurement and finance tighten their bond. One such link might be a corporate risk policy that aligns the company's overall risk appetite with the comfort zone of each individual buyer or trader. Clearly defined and shared responsibilities are also needed to ensure that finance and procurement work together to pool risks and hedge the company's total position accordingly. This also helps individual buyers see the effect that their purchasing decisions have on the company.
Tighter linkages are also needed to optimize commodity supply and price. Again, the key is bringing two disciplines together. On the one hand, procurement personnel execute a sourcing strategy that considers price and availability of raw materials, and ensures a reasonable level of inventory to meet demand. On the other, experts in corporate trading support procurement by pooling purchases and contracting with market participants on future purchase volumes and prices. This may include setting firm prices or negotiating on options to protect against sudden price increases.
A third success factor is to maximize demand visibility across the supply chain. To mitigate risk—from product development to production to sales—information must be drawn from every point and fully integrated into procurement planning. One good example is an international stainless steel company that is building a business intelligence and integrated planning tool to pull commodities information from multiple databases. In addition to maximizing data transparency, the new application should improve spend analysis, report generation, and demand/supply alignment.
The final success factor is to instill effective performance measures. In a highly volatile market, savings on purchases over the previous year cannot be the sole measure for commodity purchase performance. This lone metric won't reflect successful negotiations when prices are high and is generally misleading when prices are low. A more effective approach is to link the actual purchase price of a commodity to its market price and assess the effect of raw material price fluctuations on the business. These metrics provide the insight a company needs to continually adjust and improve risk models.
Bringing risk management to bear on procurement is the concept that ties together the four risk management capabilities and the four success factors noted above. Key benefits include lower raw material costs and enhanced company-wide competitiveness; but risk-reduction opportunities relating to currency, availability and market penetration may also figure prominently.
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