Lower costs and lower overhead

After banking $1.1 billion in cost savings between 1998-2000, Alcoa, the Pittsburgh-based maker of aluminum and aluminum products, has promised its investors another $1 billion worth of cost reduction by 2003. And it’s asking its procurement organization to deliver a sizeable piece of the savings through leveraged sourcing, better deals for supplied goods and services, and big internal productivity improvements.

Spearheading the procurement effort with procurement leaders from North America and around the world is Christie Breves, vice president of procurement for Alcoa Business Support Services (ABSS). Breves came to Alcoa through its 1998 acquisition of Alumax Inc., where she spent 18 years in a series of management positions spanning accounting, maintenance, strategic planning, materials management and purchasing.

Breves describes Alcoa’s purchasing organization as neither centralized nor decentralized, but rather, “center-led”. She heads up the company’s North American Lead Team for Procurement, which comprises her direct reports in abss as well as the procurement directors for each of the company’s North American business units. While the North American procurement directors report directly to their business unit leaders, Breves says they have strong, dotted-line connections to her group as well. “We are a matrixed organization,” Breves says. “The alignment is very tight and we have clear metrics, meaning that people feel very accountable for meeting company objectives.” 

Breves also leads Alcoa’s Global Procurement Lead Team, which includes her sourcing counterparts in Europe, Australia (including parts of Asia) and Latin America. She reports to company controller and vice president, Alcoa Business Support Services Tim Mock who reports to Richard Kelson, Alcoa executive vice president and CFO. She also meets monthly with Alcoa’s chairman and CEO Alain Belda. “Our top management is very interested in what Alcoa’s procurement organization is doing,” she says. “Their obvious interest and backing is a key to what we have been able to do in terms of delivering savings and reducing our costs quickly.”

A great challenge, according to Breves, is that Alcoa is asking its procurement group to deliver a very large piece of its $1 billion cost savings promise while at the same time reducing the cost of the procurement function. “By Dec. 31,” she says, “we need to cut a fairly significant amount from our procurement costs without jeopardizing our ability to deliver on the savings target. Our Procurement Lead Teams have developed a strategy which procurement is now deploying to meet this challenge.”

Go to full listing of Alcoa’s North America Lead Team (NALT) members

Procurement first
Breves says Alcoa’s management team made a decision to roll out its new information technology (IT) platform starting with the procurement and accounts payable groups. “This is a significant investment for Alcoa,” Breves says, “and we needed to make sure we would earn a return quickly.” 

Alcoa’s Enterprise Business Solution Team figured that a common information platform would enable the procurement group to leverage the company’s purchases worldwide and cut overhead costs very quickly. “It had been difficult getting the information needed to do strategic sourcing and was virtually impossible to develop one common process with 40 different procurement systems in North America alone,” Breves says. “No matter how well our commodity managers understood the supply chain, we knew we could not hit our efficiency goals without a common platform. There was a joint decision by IT, procurement, and Financial Shared Services (including accounts payable) to accelerate deployment of the ERP system for the requisition-to-pay process in North America.” 

What the common platform inspired procurement to do, according to Betsy Harrington, director of procurement solutions, was develop a menu of eighteen “optimized process flow paths” for various types of buys (see box. ). 

“The original intent,” notes Harrington, “was to implement the ERP system ‘out of the box.’ But we had gone through a major cost benchmarking effort and we realized that simply implementing out of the box was not going to get us to the level of internal cost efficiency that we wanted to achieve.”

At that point, Harrington says, Alcoa’s North American procurement, IT and Financial Shared Services leaders made a decision to delay their implementation for three months (from October to January) so they could design new requisition, procurement, receiving, and payment processes that could be implemented with the lowest possible number of transactions or human interventions. “Between October and December we created detailed designs where we documented standard operating procedures, contract terms, audit controls and metrics that were important for each flow,” Harrington says. Example: The optimized process flow path for an item Alcoa classifies as a “non-inventory consumable” goes basically as follows:

• Commercial contract is established with supplier.
• Supplier sends EDI invoice with payment and accounting information. 
• Invoice is routed automatically to accounts payable for approval, electronic payment and automatic account distribution.
• Statistical controls and variance reports monitor the process.
• Physical infrastructure for the flow path has a milk run (predefined frequency and route) that retrieves the item from the supplier and moves it into a plant delivery point where the user can pick it up. (Each plant devises its own physical system, Harrington notes. Some may create pickup points while others deliver items to the end users.)

“The optimized processes balance controls with risks,” Breves explains. Where risk is thought to be high, Alcoa maintains some manual controls or human interventions in its ordering, receiving, document matching, and payment processes. Where the risks are deemed low, lower, or lowest, Alcoa has developed plans for automating traditional financial control activities, creating dramatic reductions in its overhead cost structure. 

All of the decisions, Harrington adds, have been coordinated closely with Alcoa’s internal audit and accounts payable functions. “We established a Lead Team that met once per week to look at issues that crossed over functions and made sure we were all synchronized. Now we are revising our internal audit protocols to accommodate the new process flows. As our business units are audited, the auditors will be looking to see if they are using the flows designed for specific types of purchases.”

Common features of the optimized processes include:

• No paper purchase orders and, in many cases, no purchase orders at all.
• Extensive use of the Alcoa Mall, which simplifies the requisition-to-pay process.
• Limited receiving.
• No paper invoices and, in many cases, no invoices at all.
• Significant use of Kanban signals.

To push use of the new optimized flow paths throughout Alcoa’s sprawling organization, Harrington’s group conducted extensive training and also implemented a Web-based e-learning tool, which is basically an Internet site containing detailed content about how to apply and implement the optimized process flows. 

“The idea,” according to Harrington, “is to push detailed information on the flows out to hundreds of purchasing people, especially those who either missed the training or were trained, but need a refresher. A person can access an entire flow module or they can zoom in on specific pieces such as the required audit controls.”

The Mall experience
Another piece of Alcoa’s ambitious cost reduction plan is a major acceleration of its Alcoa Mall roll out. The Mall, which is basically an e-procurement implementation, currently uses Ariba software but will switch over to the common ERP platform.

To increase use of the Alcoa Mall and other low-cost automated ordering and payment processes among its North American locations, Harrington says Alcoa has begun regularly documenting the purchasing transaction types executed by each of its North American business units. What’s more, it is now burdening its purchasing and accounts payable overhead according to these metrics. For example, a business unit that relies most heavily on low cost transaction types such as the Mall or “pay from receipt” pays a lower percentage of the total overhead bill than a business unit relying more on expensive PO-invoice or non-PO-invoice transaction types.

The result: Mall transactions rose 138% between Dec. 2001 and March of this year. In the same time period the number of suppliers represented in the Mall rose from 34 to more than 275. 

Breves notes that more Alcoa business units have been requesting support to implement the optimized pull-pay processes with suppliers. All new contracts, she says, include automated clearinghouse payment mechanisms and 365 suppliers have been converted since Jan. 1 of this year.

Comprehensive leveraging
While technology and optimized processes are taking a big bite out of overhead, Alcoa’s procurement organization is also focusing on leveraging to the greatest logical extent its 40 or so major spend categories using a disciplined, strategic sourcing process, according to Breves.

At present, she says, roughly 35% of Alcoa’s North American purchases are done at the individual plant level. The goal is to drive that figure down to just 10-15%. To do this, Alcoa has formed no fewer than 44 sourcing teams to assist in meeting the objective of leveraging 90% of the North American spend (see box). It should be noted that approximately one half of this spend is unique to one business unit and will be leveraged by the business unit.

Alcoa has built a disciplined strategic sourcing process which covers detailed market profiling, strategy development, creation of supplier selection factors, a “go-to-market” plan, a contract development component, and ongoing contract management. 

To support its strategic sourcing teams, Wilbert Long, director of leveraged procurement, says Alcoa provides extensive training as well as a detailed system—the Project Management Office (PMO)—for tracking the progress of its sourcing initiatives. 

While Alcoa started with a Wave I/Wave II plan for its comprehensive leveraging rollout, Breves says Belda and Kelson decided they didn’t want to wait for Wave II. As a result, with one or two exceptions, all 40-plus strategic sourcing projects were accelerated to Wave I status. “I was very concerned about having more than 40 teams working at one time,” Breves says. This is where the Project Management Office comes in. Based on techniques commonly deployed in major IT rollouts, Alcoa’s PMO is a software and management approach that tracks savings forecasts, important milestones, and reporting due dates that each strategic sourcing team must meet. The milestones link directly to the strategic sourcing process.

“The PMO is how we track where each team stands. It helps us spot teams that might be in trouble and who may require additional resources to get back on track,” Long says. “We also review the quality of the work the teams are producing,” he adds. “For example, gathering market intelligence and understanding internal requirements are extremely important steps in our strategic sourcing process. We require the work to be very robust and we review it periodically.”

The PMO uses a green-yellow-red system of alerts. “If they’re green, they are right on track,” Breves says. “Yellow means they have issues. Red tells us it’s time to send in the cavalry.” 

The tracking system is important, Breves continues, because many of her organization’s cost savings objectives are “front-loaded” into the first half of 2002. “We wanted the savings on our books early in the year, so we really needed to create a tight discipline for executing these processes. We couldn’t afford to wait until the deadline to see if our teams were going to deliver on their forecasts.”

Software for the PMO was developed internally at Alcoa. Team leaders enter their progress data through a Web interface and they also have bi-weekly conversations with either Long or Diane Stanko, director of global IT and services procurement.

Training, according to Long, runs typically over two or three days and teaches, for example, best methods for conducting rigorous market analyses. “We expect our commodity managers to become experts for their respective commodities,” Long says. “We want them to know everything about the market, the technology, and suppliers’ cost structures. We also want them to thoroughly understand our spend by business unit and location.” 

Process and product standardization is a big part of any comprehensive leveraging program and much of the work, Long says, goes into breaking down internal resistance. “Working through the North American Lead Team we have resolved many of the issues that were barriers to comprehensive leveraging,” he says.

Mary Jo Smith, business unit procurement manager for Alcoa Engineered Products and member of the team agrees: “In earlier days, procurement activities of the corporate group and the business units were less connected. The corporate organization put together agreements and programs that were at the discretion of the locations to use.“ With implementation of the North American Lead Team, Smith notes that members from the field bring practical experience to decision making processes and pledge their support of the team’s goals. “We all agree on a goal and the way [to reach it] up front, so there is less time wasted on debating whether the direction is appropriate.”

Full backing from Alcoa’s top management is another key to breaking down local resistance to comprehensive leveraging initiatives, Long notes. But he also encourages commodity managers to sit down with Alcoa’s business unit leaders and sell the process on its merits. Another strategy, according to Long, has been to go after quick wins that are easy to achieve. “We start by looking at how we can leverage without having to change specifications. Before we look at developing common specifications, we’re more likely to look for commonality in our supply base. For example, a study of parent-child relationships might show that we have 10 business units using the same supplier. We’ll attack that first.”

Once they have established a strong base of market intelligence, Long says the commodity teams are ready to answer some serious questions about how they will “go to market” and what types of contracts they need to negotiate. While Alcoa encourages its commodity teams to learn everything there is to know about an industry in question, Long notes that the teams are also being asked to rethink the way business is typically done in particular industries. For example, he says the company has been redefining the roles that some distributors play in its supply operations. “If distributors are not in a position to give us significant price concessions because the margin isn’t there, our strategy might be to bid manufacturers on price, then go back to the distributors and negotiate pricing for services like warehousing and handling.” 

After strategic contracts are implemented with suppliers, savings from Alcoa’s comprehensive leveraging activities are entered into a global savings database. Savings are classified by commodity and savings type (for example, structural or cyclical) and are validated by business units—via quarterly meetings between the business units’ procurement directors and controllers—before they are entered into the database. Instances of cost avoidance are recorded in the database, but not counted toward the $1 billion dollar cost challenge, Breves notes. Alcoa’s Financial Analysis & Planning organization audits the database periodically to ensure that savings recorded there are real. Now the challenge, according to Breves, is to tighten the relationships between savings recorded in the database and business units’ budgets.

Biz on the block

The second and third steps in Alcoa’s strategic sourcing process—(two) develop strategy and (three) determine selection factors and screen suppliers are where the teams make critical decisions about how they will to “go to market” (which is step four). Will they use an RFP or an e-auction? If they choose to auction, will it be full-service including strategic sourcing support or self-serve?

While the teams are certainly encouraged to base their decisions on deep market analysis, Alcoa clearly wants to see more business going to auction. The company’s goal is to submit $1.4 billion worth of business to electronic auctions in 2002. What’s more, each Alcoa business unit has defined goals for online bidding and Harrington’s group publishes monthly scorecards that track their progress. 

Breves says, “The company is on track to meet the goal because of an enormous effort from the Alcoa organization around the world.” Examples of commodities Alcoa has put to auction include: capital and construction, chemicals, energy, fabrications, financial services, hotel rooms, leasing, machine parts, MRO, packaging, plastic components, printing, raw materials, and many types of services. FreeMarkets is Alcoa’s auction technology provider. Even when it uses the FreeMarkets self-serve auction tool (QuickSource), Breves says Alcoa prefers to have FreeMarkets monitor its bidding events in order to reassure participating suppliers that “every bid is on the up and up.” 

Training for online bidding is intensive, according to Harrington. “We’ve trained over 600 people around the world and we have 50 ‘black belts’, people we consider to be online bidding experts. We have at least one expert for every business unit and most, but not all, of these people are from the business units’ procurement functions.”

That training is paying off and Alcoa is finding increasingly creative ways to build online bidding into its daily purchasing processes. For example, Diane Stanko, director of global information technology (IT) and services procurement, says her group is just launching a pilot in which it will conduct weekly bids for contract IT personnel. How the process will work: Instead of requisitioning specific people from specific service suppliers, project leaders will requisition specific skill sets. For example, the project leader might requisition a database administrator with five years of experience. Once a week, Stanko’s team will run an online bid to fill outstanding requisitions with a prequalified group of suppliers. “Rather than waste a lot of time trying to predict our requirements or trying to figure out what a database administrator should cost, we will use weekly bidding events to obtain true market pricing as the requirements arise,” Stanko says.

Specific ground rules determine whether or not prequalified suppliers will remain in the bidding pool, she adds. “For example, if a supplier fails to provide the correct resources more than once or twice, they will be disqualified from the bid pool for a period of up to 18 months.” Other reasons for being disqualified may include failing to bid or bidding repeatedly without ever winning a job. “If they’re never competitive, then we don’t want to be giving them access to market price feedback week after week,” Stanko says. “That would not be fair to the suppliers who are bidding competitively.”

If the pilot works out, Stanko says it will serve as a prototype for other types of leveraged services buys including engineering, design, and maintenance as well as services relating to environmental, health and safety work. Stanko’s group is also working on a similar online bidding format for printed forms such as brochures and flyers. “The strategy makes great sense for any situation where it’s difficult to get a handle on the company’s aggregated buy or where it’s nearly impossible to forecast requirements,” Stanko says. “If you ask people to predict their printing requirements, you will get very little response. So our strategy is to capture each requirement as it comes up and get true market pricing as we go along.”

So far, return on investment for Alcoa’s online bidding initiative is tremendous, according to Breves. However, Long does not believe these types of results will be repeatable for the same business over the long term. “We’re using e-auctions to drive to competitive market pricing. If we win big reductions through online bidding, then we realize that we’re going to have to be very creative in looking for the next 5% savings. We’re likely to be doing more value engineering and asking our suppliers to look at reducing their own overhead costs.”

One way Long intends to do this involves extending the thinking behind the Alcoa Business System (ABS), which is modeled after Toyota’s famous lean manufacturing system, to the company’s strategic supplier partners. “ABS,” Long says, “focuses on streamlining processes and eliminating waste. The next step is to make processes consistent time after time. Ultimately, we want to make sure we are surrounding ourselves with suppliers that are moving down the same paths that we are.”

A can-do organization
Accomplishing so many changes so quickly—with fewer, rather than more, resources in procurement -- requires a great deal of discipline, according to Breves. The discipline, she notes, comes from a combination of benchmarking, metrics, organizational alignment and accountability, training, technology and optimized standard processes. “Excellent leadership provided by our procurement management team around the world has been essential. The direction to reduce our overhead costs dramatically has actually placed us in a better position today to deliver value.