A next-generation operating model for source-to-pay

A next-generation procurement operating model that capitalizes on advances in digital, data, and analytics delivers new levels of performance across the value-creation lifecycle.

Samir Khushalani and Edward Woodcock

DECEMBER 2018 • OPERATIONS

Effective procurement has long been recognized navigate new markets and new sources of supply. It as a source of a competitive advantage (Exhibit must balance the benefits of global sourcing and 1). But achieving excellence requires a concerted standardization against the risks associated with effort to align a variety of capabilities, insights, and complex logistics, and the need to tailor products activities in an integrated manner across the whole and supply chains to suit the requirements of local organization. markets. It must develop the agility to manage price volatility, shortages, and supply interruptions. Achieving the level of performance and cross- GES 2018 Increasingly, it must cope with political uncertainty functional integration required for procurement and global trade tensions. A next generation operating model for source to pay excellence has never been easy. And the big trends Exhibit 1 of 2 that are reshaping so many aspects of modern Then there is the proliferation of data and the rise business are only adding to the complexity of the of the Internet of Things, coupled with advances challenge. Today’s procurement function must in automation, analytics, and digital technologies.

Exhibit 1 Procurement pays: Procurement health shows a strong correlation to corporate performance.

Better procurement practices … … result in higher performance

Average survey scores Annual procure- Annual reduction Average EBITDA2 across all drivers ment savings of COGS1 margin Scale 1-5 Percent Percent Percent

Procurement 3.5 4.9 0.4 20.2 leaders

Middle of 2.7 3.8 0.1 17.0 the pack

Procurement 1.9 2.3 -0.1 10.9 followers

Confidence level of correlation > 99%

1 Cost of goods sold 2 Earnings before interest, taxes, depreciation, and amortization

A next-generation operating model for source-to-pay 2 These developments create many new opportunities This end-to-end remit is shown as in the honeycomb at for procurement, such as allowing companies to the center of Exhibit 2. At the heart of the honeycomb learn more about supplier capabilities and customer is the procurement strategy. Given the strategic requirements, and helping accelerate, streamline, nature of procurement—and its impact on the bottom and improve the effectiveness of internal processes. line—the design of the operating model must start with an understanding of the overall business strategy Together, these factors create a business imperative and how to align specific procurement practices with for the C-suite to reexamine, rethink, and desired outcomes. For example, if a company is in reimagine the procurement function. Capturing growth mode, its procurement strategy may emphasize the opportunities offered by this fast-changing supplier management, development, and innovation. If, technological and commercial landscape will call for however, the company is focused on profitability, more deeper and more interconnected capabilities. attention will be directed towards traditional sourcing activities aimed at reducing the cost of supply. Reimagining procurement To maximize the impact and potential of the The six elements surrounding the procurement procurement function, companies need to strategy represent a comprehensive set of activities develop and coordinate a comprehensive set of needed to capture and to sustain value. The capabilities that encapsulate recent advances in difference is important. To deliver value, the technology, analytics, and management practice. We procurement function must do more than develop describe these requirements in a next-generation appropriate sources of supply. It must ensure procurement operating model that restructures the transactional and compliance-driven activities are function’s relationship with its internal customers performed correctly, to sustain performance and avoid and supply base. Our model reframes the remit of potential value leakage—which can be substantial. the procurement function (the comprehensive set of interconnected activities it should either lead or The seamless execution of these components requires participate in) as well as the enabling elements (the close coordination and synchronization between critical elements needed for efficient and effective procurement and its stakeholders, both internal execution of these activities). (business operations as well as corporate functions such as finance, IT, internal audit, HR, and legal) and We define the remit of the procurement function external (the supplier community). expansively, recognizing the interconnections between different activities needed to drive value To enable the efficient and effective execution across the end-to-end source-to-pay lifecycle. of these six elements, companies must achieve For example, insights gained through business excellence in six enabling components of the operating partnering will influence specification definition, model—processes, digital, organization, capabilities demand management, and sourcing decisions; and culture, governance, and data and analytics— decisions made during the contracting will have represented by the outer ring of Exhibit 2. implications for payment-optimization strategies; the efficacy of the vendor-onboarding process Value capturing will influence the quality of data obtained for To generate new value for the business, next- subsequent vendor performance management and generation procurement functions must become spend analytics. adept at three primary activities: business partnering, category management, and sourcing and contracting.

3 Digital procurement: For lasting value, go broad and deep GES 2018 A next generation operating model for source to pay Exhibit 2 of 2

Exhibit 2 A successful procurement operating model coordinates multiple capabilities to enable, capture, and sustain value.

ICS LYT PR NA O A C Value capture: & ES S Identification and TA E A S execution of commercial D 2. Category management and demand levers to capture value (traditional E offering) C 1. Business 3. Source

D N partnering to contract I A G

N

I

T

R A

E

L V

O STRATEGY

G 6. Supplier 4. Procure

C management to invoice A P N A 5. Invoice IO Value sustainment: B T IL to pay A Implementation IT IZ I N of a structured ES A supplier-management & RG CU O program, and buying LTURE Value enablement: channels to help Design and deployment prevent value leakage of a holistic best-in- class procurement operating model

ƒƒ Excellence in business partnering starts with ƒƒ Best-practice category management goes procurement developing a clear understanding beyond squeezing suppliers for the lowest of the business’s strategies, goals, and plans, possible price. High-performing procurement and the business developing an appreciation of functions capture other sources of value procurement’s role in delivering its objectives. by proactively and continuously managing A major energy company achieves these twin categories of spend. These tactics can be objectives by closely coordinating interactions externally oriented (creating competition in between engineering and procurement, with the the supply base, negotiating more favorable two functions collaborating in the development commercial terms, or investing in joint and review of purchase specifications. Vendor innovation with suppliers, for example) bidding processes are designed to ensure they or internally oriented (such as by better meet design-to-value criteria while remaining managing demand, or optimizing product broad enough to ensure that multiple vendors specifications to minimize excess costs due to can compete. unnecessary functionality).

A next-generation operating model for source-to-pay 4 ƒƒ Procure-to-invoice covers the span of Next-generation category management will activities from needs identification through make use of advanced-analytics techniques to approvals, purchase-order generation (and to identify emerging opportunities in supply expediting), advanced shipping notification, markets. For example, consumer-goods and finally to the receipt of goods or services. companies are starting to use tools that combine The procure-to-invoice process can often be machine-learning based agronomic models with highly manual, poorly documented (if, say, local crop, weather, and related data to improve an end user places an order by phone directly price forecasts and help food buyers make better from the suppler), inconsistent, and opaque. purchasing decisions. Furthermore, if the requisite controls are not in place, purchases may be subject to long ƒƒ Typical source-to-contract processes are cycle times, value leakage, and fraud potential. plagued by repetitive manual activities and Next-generation solutions embed governance inconsistency across the organization, resulting into how goods and services are ordered, such in long cycle times, lack of transparency, and as by enforcing well-defined buying channels suboptimal outcomes—thus exacerbating that prescribe how purchases are made—often friction between procurement and the business. digitizing the buying process. A chemicals By contrast, a well-managed source-to-contract company has adopted this approach, creating process doesn’t just create value by identifying highly automated channels in which robotics and selecting the best source of supply. It also expedites simple orders while consolidating deepens supplier relationships. For example, more-complex requests in several global a major telecommunications company has centers of excellence, thereby ensuring standardized a set of highly institutionalized compliance across the end-to-end purchase processes, built around a design-to-value process. approach. By evaluating bids against clean-sheet cost models, the company finds ways to optimize ƒƒ A well-managed invoice-to-pay process both supplier prices and product specifications. should not just be a strong business control that ensures the right supplier is payed the Value sustaining right amount at the right time. It should also While significant value can be generated through create incremental value for the business. superior business partnering, category management, For example, a global financial institution and sourcing and contracting, these activities captured over $10 million in savings in less alone are not sufficient to ensure this value flows than three months simply by identifying and to the bottom line. Once the contracts have been enforcing expedited payment where early- negotiated, mechanisms are needed to drive payment discounts could be captured. Another compliance with these agreements so that the chemicals company found that it could replace savings are fully realized. To ensure the credibility 60 percent of the labor required for invoice- of procurement’s claims to savings, its staff must pay processing activities by deploying bots to scan equal attention to the more transactional, but vital, and code invoices directly into its core ERP value-sustaining activities of procure-to-invoice, system. Costs for the automated tasks fell by invoice-to-pay, and supplier management. 80 percent, even though the manual work that

5 Digital procurement: For lasting value, go broad and deep the bots replaced had been conducted in a low- a particular channel and category. This shift cost, offshore shared-service center. can be expedited by recent innovations in process-data mining, so that organizations ƒƒ Supplier management is the discipline of can use the data that flow through their purposefully managing interactions with purchasing and payment systems to identify external providers of goods and services to and address the process variances that lead maximize value for both parties. Too often, this to suboptimal purchase outcomes (such as area is reduced to being compliance-oriented or an order being placed with a nonpreferred exception-based in reaction to emerging issues. supplier) and rework (such as a purchase This tactical interaction ignores the opportunity order being generated retroactively). to develop strong, collaborative relationships with key suppliers that can unlock new sources ƒƒ Governance. Governance mechanisms of economic value. Through joint innovation, must evolve beyond static steering mature supplier-management organizations committees and manual compliance checks. can deliver year-on-year sourcing-cost Next-generation procurement governance reduction, service-quality improvement, and will use digital tools to institutionalize revenue growth. Our research shows that decision rights through automated companies that score higher in supplier- workflows that enforce policies in real time. management capabilities see almost double These digital workflows ensure purchases the level of earnings growth when compared to are made via the right buying channel and organizations that lag their peers. with the right vendor. Continuous auditing of spend data also allows the development Enablers of a next-generation procurement of statistical models that help to identify model suspect purchases and allow corrective While the six areas of the next-generation action to be taken. procurement operating model describe what is required for procurement excellence, they do ƒƒ Organization. Procurement organizations not describe the capabilities needed to put these are starting to embrace Agile concepts elements in place. We therefore also focus on six where a small proportion of employees enablers of superior performance. oversee highly automated and repeatable processes. This frees up most staff to “flow Each of these enablers drives incremental value to where the work is” and engage in those through advanced next-generation practices: sourcing and partnering activities that add the highest business value. While a small ƒƒ Process. Leading procurement organizations number of staff may be specialists with are going beyond defining end-to-end value deep category expertise, this model allows streams and buying channels. In a next- most procurement professionals to work generation operating model, processes are not across units and categories, helping the only harmonized across business units and organization respond more effectively to geographical regions but also employ category- the most pressing procurement issues. One specific solutions that streamline approval consumer-goods manufacturer made it processes for the user journeys associated with easy for the business to access procurement

A next-generation operating model for source-to-pay 6 expertise on demand by creating a dedicated are building upon clear, correct, and consistent center of excellence of thirty staff with skills in master data, enforced through intelligent contracting, developing requests for proposals, automation: using machine-learning and drawing up robust statements of work. algorithms to match invoice data to the right spend category, or robotic process automation ƒƒ Capabilities and culture. The most mature to pull the correct vendor information from a organizations embrace a mix of adult-learning trusted data source. They are also developing and open-source eLearning modules to real-time analytics of procurement and develop both hard technical skills (such as supplier performance, linked to P&L impact. the construction of clean-sheet cost models Companies can also use third-party data or supply-market analysis), and softer skills and indexes to deliver category insights. (such as negotiating techniques and business Solutions now available use machine-learning partnering). Next-generation procurement algorithms to identify and suggest value levers functions are replacing ad-hoc legacy training for reducing total cost of ownership for specific efforts by making targeted investments in categories such as packaging or temporary digital capability building. For example, the labor. global energy company has its procurement associates complete a structured series of online and in-person training courses on topics such as negotiation. Putting the right operating model in place for procurement can be a game-changer, doubling the ƒƒ Digital. Advanced procurement organizations impact of even “successful” sourcing departments. are increasingly making use of automation This extra impact comes from a wide range of technologies to eliminate unnecessary manual sources. The next-generation procurement work from transactional processes. Digital operating model will be equipped to deliver approaches can also enhance user experiences incremental value in ways that are underexploited by making access to procurement services today, such as tail-spend management, payment- easier and more intuitive. A professional- timing optimization, supply-chain finance, and services company is piloting a smart-workflow analytics-driven insights. It will also ensure that solution that dynamically routes work between the procurement function delivers on its potential, procurement and financial systems according reducing the value leakage that plagues many to the risk-management requirements of a given organizations today. supply contract. The system then governs the assignment, onboarding, risk-assessment, and Getting started on a transition to a next-generation supplier-certification tasks, and may eventually operating model may seem daunting. But the cover supplier performance management as well. initial steps can be taken quickly. A comprehensive review of each of the six value-creating and ƒƒ Data and analytics. Advanced-analytics value-sustaining elements defined in the model techniques can create better market intelligence can highlight where an organization needs to to allow more informed decision making in focus its investments. Similarly, a review of the procurement. Next-generation organizations extent to which the six value enablers have been

7 Digital procurement: For lasting value, go broad and deep applied to each of those elements will indicate the type of investments required. From these building blocks, a company can construct a comprehensive roadmap for the transformation of its source-to-pay processes.

Samir Khushalani is a partner in McKinsey’s Houston office, and Edward Woodcock is a senior expert in the Stamford office.

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