Centralize!
What it takes to centralize procurement in a decentralized corporate culture.
By Gene Richter -- Purchasing, 2/6/2003 2:00:00 AM
Most procurement experts believe 15-20% of purchased materials and services can be saved (billions of dollars in a large company) by centralizing procurement and leveraging a far-flung corporation's buying power. Despite this expert opinion, backed by numerous examples, many medium and large companies maintain decentralized, splintered, uncoordinated procurement operations. This story examines the reasons for this seeming incongruity and the factors necessary to centralize procurement within a decentralized corporate culture.
In his new book, Who Says Elephants Can't Dance, Lou Gerstner, former CEO of IBM, comments on page 244:
"Too often managers begin to express the view that they lost their manhood or womanhood if they didn't control everything that touched on their business."
And further on page 245, he says:
"Shared activities usually fall into three categories. The first and easiest category involves leveraging the size of the enterprise. Included here would be unifying functions like data processing, data and voice networks, purchasing, basic HR systems, and real estate management."
And further on page 249:
"If a CEO thinks he or she is redirecting or reintegrating an enterprise but doesn't distribute the basic levels of power (in effect, redefining who "calls the shots"), the CEO is trying to push a string uphill."
Two factors are needed to effect the centralization of procurement successfully:
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First, it requires that top management believe fully that centralized procurement is the best way to optimize procurement effectiveness. They need firm resolve and an iron will to overcome many objections (and requests for exception) particularly from general managers of divisions and geographies.
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Second, a highly skilled and team-playing procurement leader (chief procurement officer, or CPO) must be put in place. This person may come from inside or outside the company, but must be an experienced procurement professional, not just a skilled leader. They must keep their department lean and responsive to the needs of the business.
Many companies have correctly chosen a decentralized structure as the best way to manage diverse and geographically spread operations. In this system, general mangers are given primary P&L responsibility. This has proven the most effective way to manage many functions, including sales, manufacturing, and product engineering. However, procurement is an exception to the norm, because leverage and maintaining a consistent interface with major suppliers are of overriding importance.
In most situations, purchased materials and services equal 50% or more of a division's total revenues and can have a major effect on quality and on manufacturing continuity. This often leads general managers to demand authority over key procurement responsibilities, especially source selection and supplier performance. However, most companies with centralized procurement are able to significantly reduce a division's purchase costs and still be responsive to a division's need to have world-class sources. And, because of their greater leverage and effective relationships with a supplier's top management, they are able to effect superior supplier quality and delivery performance.
Although a diversified corporation may be able to maintain a relatively consistent level of revenue and profit growth, it is not uncommon for several divisions to concurrently be contracting or expanding. If a division is experiencing a downturn, it is mandatory that a central procurement department be responsive, by reducing staff enough to assure the troubled division receives a lower expense allocation. Also, the central procurement group should be giving top priority to lowering that division's purchased cost.
One proven alternative to full centralization of all procurement people involves having the heads of division or national procurement operations report directly (solid line) to the centralized procurement leader (CPO). However, in this alternative, all the people that report to these several division or national procurement heads remain on the division or national payroll (not the central procurement payroll). Thus, the decentralized general managers remain in total control of headcount, by far the largest element of the administrative cost of procurement. Yet, by having all heads of procurement as direct reports, the CPO can control procurement policy, procurement strategy, supplier selection, and supplier relationships. This is essentially the organization concept employed successfully by IBM.
One failed alternative to centralized procurement that is often tried, is to appoint a titular head of procurement, but give he/her no real power to enforce procurement policies or sourcing decisions and an inadequate staff. Some decentralized companies view this as a compromise decision, but it results in the worst of all worlds. The attempts to curb maverick buying and enforce global contracts on local divisions, alienate procurement people, local management, and suppliers alike.
The role of the board of directors
When and if a corporation decides to centralize procurement authority it is important that the decision be endorsed by the Board of Directors (BOD), making it the clear, fundamental policy of the company. Generally two resolutions are required:
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The BOD should delegate to the CPO the authority to effect all expenditures to acquire materials, facilities, and services from any party outside the company. The CPO may then redelegate, usually for a renewable one-year period, authority to acquire some items, if they lack the necessary expertise. These items might include advertising, legal services, employee benefits, real estate, investment banking services, etc.
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The BOD should resolve that the company not engage in reciprocity, i.e., buying from a customer when that customer is not competitive in price, quality, delivery, and/or technology. The CPO and his/her people must select and manage sources with the sole intent of optimizing price, quality, delivery, and technology. A corporate practice that ignores competition and favors a customer unwarrantly, will demoralize all concerned and send a hopelessly mixed message to other current and potential suppliers.
One advantage of having these Board resolutions to back up the CPO's authority is the internal audit team is alerted to look for maverick buying by nonprocurement people and/or reciprocal purchases. It also assures some measure of continuity in the event of CPO, CEO and/or CFO management changes. No one takes issues to the Board of Directors without firm resolve and management consensus. This built-in inertia helps to keep an effective, centralized procurement function in place once it has been established. Unfortunately, it sometimes prevents bold, sweeping change to ineffective, decentralized procurement functions. It's the CEO's job to assure this latter type inertia is not having a negative impact on his/her enterprise's profitability and competitiveness.
In summary, centralizing procurement is far from easy to do effectively despite the big rewards to stockholders and to a company's competitiveness.
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