Actions for CPOs to overcome challenges in 2023: Mckinsey
Mckinsey recently released a report putting forward 10 actions that Chief Procurement Officers can take to overcome the toughest procurement challenges in 2023.
According to the article, procurement leaders are already disappointed as the volatility and inflation of the previous year showed no signs of abating. The procurement function itself continues to face major changes that have made its traditional operating models obsolete. Front-running procurement organisations are increasingly distancing themselves from the rest of the pack, deploying their talent, capabilities, technology, and insights into the world’s complexity in ways that propel them far ahead of the rest of the pack.
Mckinsey says that in 2023, there is no space for one-size-fits-all procurement models, and that a category-level response is essential. Some categories continue to experience rising prices and supply constraints, requiring a cross-disciplinary approach to improve the total cost of ownership. Other categories are seeing downward price pressures, creating an imperative for procurement leaders to rapidly capture price improvements.
Procurement functions, as we are all painfully aware, are facing overwhelming challenges, but we also know that procurement can play a critical role in solving today’s most pressing business problems. Mckinsey says that it cannot do so on its own however, stating that success now requires an entirely new level of resilience improvement and value creation built through a coordinated enterprise-wide effort.
It says that in order to protect margins, contain cost escalation and dynamically capture opportunities, procurement functions require an expanded mission, advising that CEOs should consider positioning their procurement leaders at the centre of the company’s response to the current context, tasked with a clear mandate to protect margins. CPOs can then mobilise executives for cross-functional impact and escalate investments in the talent and systems required to achieve and sustain outperformance.
Mckinsey’s proposed ten core actions: ‘A resilience toolbox’
To combat volatility, inflation, and shortages and build resilience, procurement leaders can take ten core actions. The first step is to gain transparency into the pressures they face. With this visibility, they can create value across the supply base. To achieve this, they should mobilise other parts of the business, including the supply chain, operations, and commercial capabilities. Supporting these efforts, a central nerve centre or control tower, and new capabilities are necessary.
To succeed, procurement leaders need to build an agile procurement function with stronger links to both internal and external partners.
Create transparency to enable action:
To enable action, transparency is crucial, and it should include a 360-degree view of vulnerabilities and real-time information delivered to a "resilience cockpit."
Action one: Conduct a 360-degree risk assessment
The first step, identified as "Action one," is to conduct a 360-degree risk assessment to identify vulnerabilities accurately. To decide on the right actions, Chief Procurement Officers (CPOs) need transparency about three types of risks:
How are events affecting the end-to-end value chain? Which categories may be hard to secure in the foreseeable future?
What vulnerabilities—including financial, fulfilment, reputational, and environmental—do suppliers face?
How are suppliers’ costs of goods sold (COGS) trending? Can we quantify the inflation or deflation they face? What do the results mean for our company’s P&L?
Companies must understand their upstream value chain to manage risks effectively. To provide insights required for scenario planning, a digital twin can be implemented.
An example, says Mckinsey, of a successful implementation is a European utility that continuously identifies and updates risks related to critical materials, key suppliers, and exposure to inflation. This solution is linked to external data sources and models inflation exposure to notify decision-makers of any new risks.
Action two: Gain real-time visibility
"Action two" is to gain real-time visibility. Leading companies have set up a resilience cockpit that provides real-time insights into customer demand, inventory, market pricing, and supply disruptions. The cockpit automatically enriches internal data with market data, making it accessible to CPOs and other company leaders.
The report gives the example of an automotive Original Equipment Manufacturer (OEM) that implemented a digital twin of its value chain by automating data flows using third-party databases, transport declarations, and news sites. The implementation resulted in a cockpit that monitored over 1,000 components and 100 raw materials. The cockpit integrated 60 data feeds across regions and specifications, enabling sensitivity analyses of different sources of volatility, such as foreign-exchange risk and individual site operations.
Partner across the supply chain:
Action three: Refresh category strategies
"Action three" is to refresh category strategies actively to manage costs and risks relating to labour and logistics. Procurement needs to apply market feedback quickly to capture emerging opportunities and work differently with suppliers. New relationships should focus on developing innovative specifications, improving sustainability, reducing emissions and waste, and building capabilities.
An example of a successful partnership is a specialty chemicals manufacturer that partnered with top suppliers of inflating commodities to radically improve the total cost of ownership and reduce risk. Procurement convened this program, including team members from R&D, operations, and finance. The internal participants worked with the supplier to rapidly qualify a lower-cost, lower-emission set of specifications that allowed the manufacturer to mitigate a double-digit cost increase.
Action 4: Enhance the risk operating model
"Action four" is to enhance the risk operating model to thrive in the current context. Companies must fundamentally upgrade their risk operating models, and priority enhancements can include the following systems:
- Sales-at-risk dashboards. These dashboards present data from weekly monitoring of risks that affect sales and profits.
- Supplier transparency. This analysis identifies suppliers and maps dependencies to assess network resilience and vulnerabilities (Exhibit 2).
- Supply and demand prediction. Advanced solutions can predict future capacity shortages and situations requiring excessive lead time, so the company can pre stock inventory.
- Modelling of measures’ impact. Models can predict how well resilience measures are likely to achieve a defined set of objectives, such as those relating to volume and cost.
Partner across operations:
The report then points to the fact that procurement leaders have the ability to optimise operations and reduce energy consumption for their companies. To achieve this, Mckinsey proposed that they should take two key actions.
Action five: Optimise e2e operations
Action five involves optimising operations from end to end, which is becoming increasingly important due to the upward pressure on input prices. Procurement leaders can partner with cross-functional peers to address end-to-end levers such as reviewing specifications, challenging demand, and streamlining internal processes. These initiatives generate value regardless of market context and can provide a sustainable competitive advantage. Procurement leaders can collaborate with suppliers to reduce complexity, design to value, and update risk-reward profiles in partnership with finance and risk functions. Manufacturing and related functions can collaborate to better understand demand and response management, while sales and marketing can help track cost positions relative to competitors.
Action 6: Optimise energy consumption across terms
Action six involves optimising energy consumption in the short, mid, and long terms. Many companies are taking short-term actions to optimise energy demand in response to market disruptions, but this also presents an opportunity to optimise the future energy mix. Procurement leaders can introduce new technologies, enter into power purchase agreements, or implement self-generation capabilities. By conducting a 360-degree assessment of its energy-sourcing strategy, one global materials producer was able to analyse its energy mix under different market scenarios and establish a road map to revamp its energy sourcing over the next three years. This plan will decrease exposure to fossil fuels, reduce CO2 emissions by over 30 percent, and cut costs by 20 percent relative to base-case scenarios.
Mckinsey expresses that overall, procurement leaders have the ability to optimise operations and reduce energy consumption by collaborating with cross-functional peers and pursuing sustainable energy strategies.
Partner across commercial:
Procurement can collaborate with commercial capabilities to address integrated margin management and portfolio and product design for companies. This involves taking two actions.
Action 7: Coordinate responses for integrated margin management
Action seven involves coordinating responses for integrated margin management. This requires the tight integration of COGS and pricing, and procurement can provide real-time information on costs as well as insights about the market and competitors to help sales teams negotiate customer prices effectively. A packaged-foods manufacturer used a coordinated, cross-functional approach to offset inflation's effects on its business portfolio. This included securing alternative sources of supply, increasing internal inventory of constrained raw materials, leveraging derivatives to manage price risks, and reinvesting COGS into value-creating opportunities. By taking these steps, the company was able to create new offerings that met customer needs while controlling costs and protecting revenues, resulting in improved service and reduced lost sales compared to competitors.
Action 8: Redefine portfolio and product design
Action eight involves redefining portfolio and product design by scrutinising product designs to identify those that rely heavily on scarce materials and few suppliers. Companies can reduce dependencies wherever possible and push for rapid qualification. A consumer-packaged-goods manufacturer used advanced analytics to assess design changes in relation to consumer tolerances, equipping sourcing and R&D teams with alternative specifications and formulations that had little or no impact on consumer perception or acceptance. This allowed the company to avoid stockouts and offset price increases.
Overall, procurement can work with commercial capabilities to improve integrated margin management and portfolio and product design. This includes providing real-time cost information and market insights to sales teams and scrutinising product designs to reduce dependencies on scarce materials and suppliers. By taking these actions, companies can control costs, protect revenues, and improve service and customer satisfaction.
To counter inflationary pressure, two additional actions can be taken, which serve as enablers.
Action 9: Coordinate a holistic response
Action nine involves coordinating a holistic response through a central nerve centre or control tower. Companies should establish an agile team composed of representatives from various functions with a mandate to take action to protect margins. This team would create transparency, monitor markets, and identify risks. It would also provide additional capacity for rapidly staffing projects or supporting supplier negotiations. Some nerve centres report daily to the CEO to enable rapid decision making. For example, one global materials producer set up a process and team to track commodity markets and the implications for the company’s purchasing portfolio in anticipation of a recession. With an automated price analytics dashboard, the company could move faster than competitors to get price concessions from suppliers looking to secure their volumes amid uncertainty.
Action 10: Build new capabilities for resilience
Action ten involves building new capabilities for resilience. Procurement's chief asset is its talent. Procurement leaders need to build a team with the advanced skills required to compete in today's volatile environment, such as enhanced use of analytical tools and capabilities. Companies must also attract people for new roles, such as data scientists, data translators, and scrum masters, to win through insights. However, attracting and retaining top talent is a chronic challenge. To address this, companies are developing exciting career paths for procurement leaders and positioning procurement as a function where high performers come to sharpen their leadership skills, with executives sponsoring the trajectory of emerging talent.
Mckinsey recognises that there are real opportunities for procurement to lead
The Mckinsey report concludes by recognising that many supply chain challenges are structural and may take years to resolve, making transformative action necessary to address volatility and disruptions. However, it says that this presents an opportunity for the resulting improvements to permanently upgrade operating models.
For CPOs, the current context is a career-defining moment. Those who demonstrate value to the enterprise can become strategic partners to CEOs, CFOs, and COOs, stepping beyond the role of merely guarding a portion of enterprise costs. Procurement leaders must now step into a new horizon of value creation.
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