a quantitative way to determine psm best practices - · pdf filea quantitative way to...

GlobalProcurementExcellence


EIPM Annual ConferenceGeneva, Dezember 8, 2006

A Quantitative Way toDetermine PSM BestPractices


1

This is what youwill feel like …

This is what you will hear …

Starting point for our research

Source: McKinsey

Data transparence is key: Businessdata warehouse, SAP, Oracle …

Imagine you are …

… a general manager promoted to a CPO role

… a CPO changing industries

… a purchasing professional asked torevamp a local procurement organization

… a CEO wanting to give guidance to hisprocurement organization

Global sourcingis a must!

Training, coaching apprenticeship!Supplier developmenthas high impact

Tools create results –e-Procurement the solution

Benchmarking is the key togood prices

2

Main questions we wanted to answer (quantitatively!!)

Source: PSM Best Practice Team of McKinsey and SMI

• How much differentiating is good procurementreally?

• And what makes up good procurement? What reallymakes the difference?

• What is the payback from the managementinvestment?

Expect somesurprising answers…

3

General conclusions and insights

Contents

Survey approach

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More than 200 participating companies, fromall geographies and major industry sectors;70% with > 5 USD billions in revenue�

�Comprehensive survey, based on experi-ence from 1000+ McKinsey procurementengagements over the last 5 years

�Conducted in collaboration with SupplyManagement Institute (SMI) of EuropeanBusiness School

� Results statistically correlated andvalidated confidence level >95%

Our insights are based on a large-scale, empirical study focused oncorrelating PSM* practices with performance

Source: PSM Best Practice Team of McKinsey and SMI* Purchasing and Supply Management


5

The empirical survey is based on the "Health to Performance"framework of McKinsey's Global PSM Practice

PSM health PSM performance

"Contribution to companysuccess relative to cost,revenues, quality andexecution speed"

Business strategy alignmentand contribution“PSM alignment and support ofbusiness strategy”

Source: McKinsey

Categorymanagementand execution"What PSMstrategies andprocesses thecompany followsto create value"

Capabilities &Culture"The way PSMprofessionals think,feel, and conductthemselves in theworkplace,individually andcollectively"

��

Structure &Systems"How the resourcesof the PSM functionare managedthrough formalstructures and howthe function interactswith other companyfunctions"


6

The “Health to Performance" framework differentiates 11 drivers


Drivers Description

• Business strategyalignment andcontribution

• Strategies and practices tocontribute to larger strategicgoals of the company

• Strategic sourcing • Category strategies and internal category managementprocesses

• Supply base strategy • Supplier segmentation strategies and supply base mgmt.• Value chain management • Strategies to optimize value creation from existing suppliers

• Performancemanagement

• Translation of PSM aspirations into a measurable targethierarchy and tracking of performance against it

• PSM roles andresponsibilities

• Global coordination of strategic and transactionalPSM activities

• Cross-functionalcollaboration

• Organizational setup of cross-functional collaborationand PSM's role in it

• Knowledge and infor-mation management

• Systems supporting data evaluation, e-PSM andknowledge sharing

• Influence and reach • Tools and activities to track, manage and influencedemand and compliance

• Mindsets andaspirations

• View of PSM’s role and aspirations across internalstakeholders

• Capabilities of PSMprofessionals

• Practices of recruiting, training, and developing PSMprofessionals

��

Each driver isexplored through 3-4detailed questions

7

The empirical survey follows a structured process to collect andanalyze data and to feedback results to participants


Structured interview

Neither formal norprofessional RFxprocesses in place

Standardized RFxprocesses usually resultin competitive offers

RFx* processesHow are effectivenessand efficiency of RFxprocesses ensured?• Are there category-

specific strategy guide-lines on RFx processes?

• How often are importantcategories RFQ’ed?

• Are there standardized/automated processes tominimize work load forstandard categories?

Yourrating3 51

• No category-specificguidelines on how to doRFx

• RFx done veryirregularly

• High individual workload due to a lack oftools, templates, anddata sources

• Content issuescommonly resulting infollow-up questions bythe suppliers

• 2 to 3 quotes obtainedas a standard practice

• RFx processes basedon formal rules withcategory-specificexceptions

• Regular RFx mostlyamong existingsuppliers

• Relatively highindividual work loaddespite standardizedprocesses/tools

• Necessary dataavailable but distributedin different systems

• Normally high contentquality results in goodreturn rates

RFx processes highlystandardized, stream-lined, modular to fullyexploit supply marketopportunities

• Category-specificstrategic differentiationof RFx approach

• Regular RFx for allimportant categories,also involving newpotential suppliers

• Largely automatedprocesses for standardcategories based oncomprehensive datasystem

• Distinctive tool supportresulting in maximumcontent quality and easeof implementation

• Research collaboration withSupply ManagementInstitute (SMI) of EuropeanBusiness School

• Use of statistical tools likeSPSS and PLS

• Introduction of controlvariables to eliminate noise

Thorough data analysis

Bestpractice

companydatabase

Feedback to participant

0

1

2

3

4

5

PSM performance diagnostic – your companyIndustry average

Industry distribution(x companies)

Your company

Capabilitiesof PSMprofessionals

Performancemanagement

PSM roles andresponsibilities

Cross-functionalcollaboration

Knowledge and infor-mation management

Powerand reach

Business strategyalignment

Strategicsourcing

Supply basestrategy

Value chainmanagement

Mindsets andaspirations

Categorymanagement

Capabilities &culture

Structure &Systems

��

Average scores• Your company• Your industry• All companies

X.XX.XX.X

Business strategyalignment

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Conclusions and insights

Contents

Survey approach

9

Our large-scale empirical survey showed that…

• Purchasing pays: There is a strong correlation between PSM health and financial performance

• Even the best can improve: While 54% of companies score at least once a 5, no participantscores 4 or higher on all performance drivers

• Grass is not always greener: Every industry sector has its high performers, being in a low-performing sector is not an excuse

• The best see the journey: Top performers chronically underrate their performance and setstretch targets – while low performers fail to see their opportunities

• People matter most: Capabilities and culture have the strongest impact on purchasingperformance

• Increase headcount (selectively): High performers invest in 50% more strategic sourcingprofessionals per dollar of spend and realize significantly more savings

• Earn a seat at the table…: CPOs of high performers are 5 times as often part of the seniormanagement team of the company than those of low performers

• … and make the most of it: PSM involvement in corporate strategic decisions can double PSMperformance contribution

• Take charge: Center-lead to improve performance

• Take charge, the sequel: High performers are responsible for more spend than lowperformers – and they really control it


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Purchasing pays – There is a strong correlation betweenPSM health and financial performance

An improvement by 1.0 averagesurvey score … … results in higher performance

* Relative to revenues, i.e., controlling for product price decreaseSource: PSM Best Practice Team of McKinsey and SMI

Percentage points +2.2

+1.1

+4.5

Average survey scores acrossall driversScale 1 - 5

AverageEBITDAmargin

Annualreductionof COGS*

Confidencelevel of cor-relations > 99%!

+1.0

AnnualPSMsavings

Absolutevalues

Averageacrossindustries

11

69

21

33

24

6

1 0

Even the best can improve – there is room for improvement forevery purchasing organization we interviewed

* Scores range from -0.25 to +0.24, i.e., for example, from 1.75 to 2.24 for column labeled as 2.0Source: PSM Best Practice Team of McKinsey and SMI

1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0

Even the top6% of companies

score 4.0 or higheron only 5 out of 11

drivers

Average survey score*

Share of participantsPercent

12

3.25

3.21

3.16

2.95

2.71

2.65

2.45

2.42

Automotive andassemblyHigh tech andtelecoms

Packaged goods

Chemicals andpharma

Other*

Materials andconstruction

Financial institutions

Energy and utilities

Total 2.88

Grass is not always greener – every industry sector has its highperformers. Being in a low-performing sector is not an excuse.

IndustriesAverage surveyscore

* Including retail, travel and logistics, entertainmentSource: PSM Best Practice Team of McKinsey and SMI

Share of companieswith score

54

46

45

42

15

13

11

10

31

Score ofbestcompany

4.3

4.1

4.2

3.7

3.6

3.9

4.0

3.5

4.3

>3.25 >3.75

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11

14

0

0

3

4

0

7

13

High

Medium

Low

HighMediumLow

Survey scores

Self-assessment

The best see the journey – while high performers recognize they are ona journey low performers fail to see their opportunities


Survey scores

Low performers areoverly optimistic and donot see the potential

Overestimationby 0.5

Underestimationby 0.5

High performersare very criticalin their self-assessment

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People matter most – capabilities and culture have the strongestimpact on purchasing performance

* Overall performance calculated as average of standardized PSM savings, reduction of COGS, and EBITDA margin; + 1.0 in survey score per driverallows to realize X% of performance improvement achieved by + 1.0 in overall survey score, e.g., 37% of overall performance improvement can berealized by + 1.0 in mindsets and aspirations only


0.37Mindsets andaspirations

0.20

0.08Power and reach

0.07Supply basestrategy

……

Capabilities of PSMprofessionals

0.18Business strategy align-ment and contribution

Capabilities & cultureand business strategyalignment make thedifference between lowand high performance …

Share of impact onoverall performance*

… but don’t neglect allother drivers as theycollectively stillaccount for 25% ofperformance

Total 1.00

+ 1.0 insurveyscore perdriver

15

Medium and high performersrealize USD 15 - 20 millionmore savings

Increase headcount (selectively) – high performersinvest in strategic sourcing professionals and it pays off

Example(USD 1 billionspend)

Medium and high performersinvest ~ USD 1.5 million* intomore strategic buyers

* Assuming USD 0.2 million costs per strategic buyerSource: PSM Best Practice Team of McKinsey and SMI

13

2119

-0.5

0.8

1.4

Per USD 1 billion spend Percentage points

Number of strategic buyers Annual reduction of COGS

Low performersMedium performers

High performers

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Earn a seat at the table … – reporting level of CPO mirrors thevalue creation expectation of the PSM functionPercent

6170

65

121223

93

Lowperformers

414

Mediumperformers

7

20

Highperformers

100% CPO reporting below seniormanagement team

CPO reporting to seniormanagement team member

CPO reporting to CEO

CPO is member of seniormanagement team


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* Contribution to corporate strategy development, new product development, marketing & sales strategy, M&A activities

Significant cause-and-effect relationshipPSM performance

contribution

Category purchasing processesCorporate strategic contribution*

Cross-functionalcooperation structures

Knowledge and infor-mation management

Purchasingorganization structure0.12 0.29 0.29 0.21 0.27 0.240.130.210.40

0.37 0.38 0.20 0.40 0.31

Category value creation strategies

0.140.21 0.21 0.20 0.22

0.310.26

Talent management Performance management

Mindsets and aspirations

Peopleare attheroot

0.54 0.61

… and make the most of it – PSM involvement in corporate strategicdecision making can double PSM performance contribution

18

2134

38

1011

35

2535

34

Lowperformers

30

0Mediumperformers

27

Highperformers

100%Decentralized

Mixture of centralizedand decentralized

Centralized

Lead-buyer network

Take charge – Center-lead your organization to improve performancePercent


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… and in realized influence on spendThere are differences in formalPSM spend controlled …

Percent of total spend controlled* Survey score 'power and reach'**

7177 79

1.8

2.4

3.1

* Spend figures stem from baseline survey, i.e., are self-reported by CPOs** Survey scores stem from interview, i.e., are rated by interviewers

Source: PSM Best Practice Team

Low performers

Medium performers

High performers

Take charge, the sequel – high performers are responsible for morespend than low performers. And they really control it.

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Summary


• Purchasing pays – the quantitative data on that topic isconclusive and highly correlated: on average, lowperformers in purchasing and supply management lose 5percentage points in EBITDA margin compared to highperformers

• People matter most – to improve, CPOs must move out ofthe “graveyard of the company” image (and manage thefunction accordingly). This is by far more important thansystems, methods and tools

• Centralization is good – whenever possible, take charge,both of unusual categories as well as the decision rights,and when building the organization a dominant central leadhas substantial impact



EIPM Annual ConferenceGeneva, Dezember 8, 2006



23

Contact

Dr. Nicolas ReineckePrincipalMcKinsey & Company, Inc.Hamburg, [email protected]

Chip HardtPrincipalMcKinsey & Company, Inc.Chicago, [email protected]

Prof. Dr. Christopher JahnsExecutive DirectorSupply Management InstituteWiesbaden, [email protected]

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Explanation of some basic statistical evaluations


Conceptual drawing Explanation

Cluster analysis groupingcompanies by their similarity insurvey scores, i.e., independentof performance measures. Wefind high correlation to actualperformance

Confidence level gives theprobability that there is really arelevant relationship betweenvariables, i.e., that resultshave not come by chance.Confidence level is driven by thesize of the influencing effect, thedistribution of the data sets, andthe number of data points

Statistical evaluation

Separation of low,medium, and highperformers

Confidence level ofevaluations

Perfor-mance

Surveyscores

Value

Fre-quency

Small overlap �high confidence

Med HighLow

Mean 1 Mean 2

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Definition of performance measures


Performance measure Data source

All performancemeasures represent

average 2002 - 04

Annual PSM savings Baseline survey Self-reported annual reduction of totallanded cost, in external spend controlledby the PSM function; does not covercost avoidance

Annual reduction of costof goods sold (COGS)

Company annualreports/Bloomberg

Annual change of COGS after elimi-nating effects from revenue increase/decrease; for consistency reasonsCOGS calculated as revenue – EBITDA

Company annualreports/Bloomberg

Average EBITDA margin Defined as EBITDA/total revenues (forbanks: net revenues); EBITDA calcu-lated manually to ensure consistency

Explanation

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