Successful supplier relationships are crucial for executing a company’s overall business strategy. How does the pharmaceutical industry rank comparative to other industries and what best practices may facilitate better overall management? DCAT Value Chain Insights (VCI) examines what it takes to bring supplier relationship management to the next level.
Implementing a robust supplier relationship management (SRM) system can be a challenge from both organizational and operational perspectives. What are optimal approaches and how does the pharmaceutical industry stand with respect to other industries? DCAT Value Chain Insights (VCI) takes an inside look
SRM's role in overall procurement performance
To consider the importance of SRM, it is important to evaluate it in the context of the overall performance of a procurement organization. A.T. Kearney’s Assessment of Excellence in Procurement (AEP) study, released in October 2014, is one cross-industry analysis that provides such an evaluation. The 2014 AEP study, the eighth in the series since 1992 and first since 2011, had three main goals: (1) evaluate how procurement has progressed since 2011; (2) determine how ready procurement is for the future; and (3) identify lessons learned from leading procurement organizations. The study included input from procurement and supply chain executives at more than 185 companies in the manufacturing (33%), process industries (41%), and services (26%) sectors, with average annual revenues of approximately $15 billion with participants from Europe, the Middle East, and Africa (43%), the Americas (41%), and Asia Pacific (16%). SRM was one of eight dimensions of purchasing and supply management evaluated in the study. The others were: human resource management, performance management, information and knowledge management, sourcing and category management, operating process management, organizational alignment, and supply management strategy. The 2014 AEP study found that companies designated as overall AEP leaders exhibit a combination of overall strong performance in the use of procurement practices across the eight dimensions, together with high financial impact as measured by return on supply management assets (ROSMA). Additionally, leaders were designated for each dimension based on those companies scoring in the top 20%.
Evaluating procurement’s overall performance among leading companies
So what did the 2014 AEP study find? Leading companies' procurement organizations achieve double the measurable cost reduction versus other companies while also driving competitive advantage through supplier-driven innovation and risk management. While procurement organizations for leading companies have continued their upward trajectory, most companies only sustained the gains they made between 2008 and 2011 as a result of more proactive measures taken with respect to the financial crisis and economic downturn.
“We were surprised that after the gains made between 2008 and 2011, many companies only sustained their improvements over the last three years,” said John Blascovich, A.T. Kearney partner and co-author of the report. “The typical company may be ‘wasting a crisis’ [referring to the 2008 financial crisis] by not continuing to enhance one of the most powerful levers to improve profitability and competitive advantage.” The reasons that many companies have not reached the next level of procurement performance include the lack of designated responsibility by procurement organizations to take the lead for all major spend categories and explore broader value-creation opportunities, weak strategic and organizational links to the rest of the business, and difficulty communicating the procurement function’s return on investment, according to the 2014 AEP study results.
The AEP study found that leading procurement organizations integrate more closely with the business units and regions to increase their relevancy, influence, and impact. These organizations generate double the ROSMA performance levels compared to the typical company and delivered benefits at a rate ten times greater than the cost of their people, technology, and external support. Leading companies have achieved this performance by: (1) building high-performance teams as a catalyst for business alignment; (2) reducing cost through category excellence; (3) creating competitive advantage through supplier capabilities; and (4) investing in the procurement team to deliver high performance.
The 2014 AEP study showed some key ways in which the procurement function's status has slightly increased since 2011, when the last AEP study was conducted. In the 2014 study, 32% of respondents said that they “fully agree” that their procurement organizations had leadership for all key expenditure areas, a similar level in the 2011 study. Fifty-five percent of participants said that procurement’s mandate was communicated and accepted, up slightly from 53% in 2011. Forty-six percent of participants said that procurement extended its mandate to include broader value-creation opportunities, up from 41% in 2011 and 19% in 2008. Twenty-five percent of participants said that procurement had extended its mandate to identify and recommend new business opportunities, up from 22% in 2011 and 13% in 2008.
Despite these advances, procurement has not seen as much progress since 2011 as might have been expected. According to the 2014 AEP study, gains from sourcing have slowed, as sourcing approaches, such as volume bundling, supplier consolidation, and competitive bidding, have led to resistance from suppliers and yielded diminishing returns. Additionally, procurement benefits as a percentage of influenced spend have returned to the historical average following the heights reached in 2009 and 2010. In 2013, procurement benefits as a percentage of influenced spend was 4.3%, down from the levels of 7.2% in 2010 and 7.9% in 2009, but more in line with historical levels pre the financial crisis of 3.9% reported in 2008.
The 2014 AEP study also showed that overall, use of leadership practices for procurement has not increased substantially, limiting companies' ability to generate new streams of cost reduction and deliver value through SRM and that at many companies, procurement lacks the additional influence and reach needed to achieve the next level of performance. The study found that limiting progress was procurement’s lack of designated responsibility to take the lead for all major spend categories and explore broader value-creation opportunities, weak strategic and organizational links to the rest of the business, and difficulty communicating the function's return on investment, according to the AEP study.
Among, leading companies, however, procurement’s influence and ability to execute broader mandates of value creation as well as new business opportunities is much higher. According to the 2014 AEP study, leading companies are closely aligning procurement with the business at the corporate, business unit, and regional levels. Leaders focus on achieving tight coordination with both internal and external organizations through practices such as mutual goal setting with business units, regional organizations, and functional stakeholders and use reward systems that encourage cooperation among the parties. Excellence in stakeholder relationship development and management is recognized and nurtured as a critical foundation for success, both at the individual and functional level, according to the AEP 2014 study.
The AEP 2014 study found that leaders reach beyond traditional sourcing to find ways to deliver value that transcends cost savings. As part of this company-wide benefits and value discussion, procurement leaders communicate what the function delivers to the company in terms that the business can understand, typically by using the finance organization's language to measure and share performance data. They also ensure that their own organization is aligned by regularly engaging the entire procurement function around the three- to five-year vision. Also, among leading companies, procurement leaders share procurement performance data beyond their function to ensure that company-wide stakeholders are kept aware of procurement's contributions and have invested in the systems, data management, and capabilities to ensure their benefits reports and other data are accepted and trusted by finance and other leaders within the business.
The 2014 AEP study showed that besides tracking more conventional supply and demand conditions, procurement leaders closely monitor and prepare to deal with disruptive technologies and evaluate new technologies and nontraditional suppliers that might be able to increase market competition. Effective supply risk management is important. According to the 2014 AEP study, all leading companies use techniques such as continuous risk monitoring, scenario planning, value-chain modeling, disaster planning, and secondary supply sourcing while only half of typical companies do.
Generating value through SRM
Effective supplier relationship management is important in achieving value. The 2014 AEP study found that among leading companies, one-third of the value that procurement organizations create comes from SRM versus about one-quarter for the typical company. The AEP study found that leading procurement organizations have developed and continually demonstrate their SRM understanding by using a consistent, repeatable, and commonly understood SRM process and vocabulary that is used throughout their companies and among suppliers.
The importance of SRM can be seen in its role in driving performance among several key metrics. The 2014 AEP study showed that leading companies use SRM more effectively to drive both basic and more advanced measures. For example, 77% of leading companies said that SRM drives “significant” or “breakthrough” results in meeting current supply requirements compared to only 59% of typical companies. In reducing supplier unit cost, 73% of leading companies said SRM drives results while only 50% of typical companies said so.
The differential among leading companies and typical companies in applying SRM to achieve desired goals is even more striking among more advanced dimensions. The 2014 AEP study showed that 71% of leading companies use SRM to achieve “significant” or “breakthrough” results in risk mitigation compared to only 28% of typical companies. Fifty-seven percent of leading companies use SRM to improve asset or capital structures while only 13% of typical companies do.
Other key findings in how leading companies use SRM to drive “significant” or “breakthrough” results include:
- Drive end-to-end cost down (55% of leading companies versus 32% of typical companies);
- Pursue innovation development (45% of leading companies versus 14% of typical companies);
- Grow existing markets or enter new ones (44% of leading companies versus 21% of typical companies); and
- Develop or leverage differentiating supplier capabilities (40% of leading companies versus 14% of typical companies).
The 2014 AEP study showed that successful strategic SRM efforts also require selecting the right suppliers to meet a company’s goals in the long term as well as having needed capabilities. According to the study, leading companies deliver value beyond cost from SRM by integrating suppliers into the company's own processes by using methods to streamline supply chains with their strategic suppliers, including collaborative capacity management, collaborative cost reduction, integrated operations planning, and virtual inventory management. Additionally, procurement leaders integrate key suppliers into innovation and growth initiatives. All AEP 2014 study leaders have an innovation target for procurement, and nearly half have a major open-innovation effort underway to integrate suppliers into their innovation stream.