When time is short, a radical new approach helps procurement leaders find savings fast.
Faced with slow revenue growth, intensified competition and greater investor focus on cash flow, companies in several sectors have adopted turnaround-like programs to improve bottom-line performance. These programs, such as corporate turnarounds and restructuring programs, seek to deliver maximum cash impact in a minimum period of time. They typically focus strongly on addressing external spend as the fastest, surest, and least painful way to rapidly improve cash flow. Because a focus on external spending produces substantial benefits early in a turnaround program, companies gain strong momentum and time to pursue far more nuanced efforts later on. Procurement is therefore an important focal point for many transformations.
Companies can capture significant value as external spend can typically run from 30 to 70 percent of a company’s total expenditure, depending on the industry. In our experience, bottom-line savings of 15 percent are achievable, resulting in a 5 to 10 percent reduction in the overall cost base. Up to half of these savings can be delivered within six months. This impact can be realized without the disruption of FTE reductions or incurring market risks associated with price increases. A rapid external-spend restructuring program provides the additional benefit of building a more commercially aggressive organization for the longer term.
Although many companies have experience with programs to improve procurement performance, companies under cash pressure require a more fit-for-purpose approach to meet their need for rapid cash generation. The aggressive cost reductions needed in turnaround situations require very different measures than traditional procurement improvement program (Exhibit 1).
To succeed, companies must go beyond the usual central procurement-led annual sourcing exercise by making external-spend reduction an overall business a priority for the entire management team. Additionally, executives and staff at all levels of the organization must adopt an owner’s mindset, placing a relentless focus on identifying all opportunities for improving operating costs. Companies also require disciplined execution and performance management to ensure value is delivered to the bottom line.
- The distinctiveness of a rapid transformation approach can be expressed through five guiding principles:
- Adopt an owner’s mind-set towards external spend
- Ensure active involvement by the CEO and the board
- Identify fit-for-purpose levers that generate cash rapidly
- Use line-led, granular initiatives to drive value
- Establish an unrelenting performance infrastructure to ensure value accretion.
This approach can be deployed in any situation that requires a significant and rapid cost improvement. While the genesis of this approach is in restructuring or turnaround situations, we have found that similar principles can be applied effectively to other, non-turnaround situations where CEOs are looking to pursue significant improvements in the cost base, and are willing to make tough decisions.
1. Adopt an owner’s mind-set towards external spend
Employees throughout the organization must adopt an owner’s mindset toward controlling spend and generating immediate cash impact. This mindset entails constantly evaluating the full potential behind each spend category, refusing to settle for anything less than this, and continually asking, “What would I do if I owned this business?” Executives and key stakeholders should agree on targets and be incentivized to deliver on these targets as well as related initiatives. Each contract should be assessed through the lens of an investor-owner. The focus should be on the company’s sustainability, rather than fairness to suppliers.
To instill an owner’s mindset, companies must rapidly reset spending behavior throughout the organization, so that there is no appetite for non-critical spend. Deployment of top-down mechanisms—such as demand rationalization, travel restrictions, challenging open purchase orders and opening all contracts for negotiation—should be implemented to prevent any non-critical spend from occurring.
A “spend-control tower” is an effective way to manage indirect spend, as well as contractor and FTE costs and other discretionary spend. The implementation of a control tower typically yields savings of 15 to 30 percent on indirect spend within the first month (see sidebar, “What a spend-control tower can do”). It also sets the stage for zero-based budgeting, which requires a mindset that challenges every dollar in the budget before it is spent. Mindsets must transition from “I will spend every dollar in my budget” to “I have no budget and will only spend where critical.”
2. Ensure active involvement by the CEO and the executive team
Traditionally, procurement programs have been led by the procurement organization, working in tandem with business units to elicit buy-in and shared commitment to savings targets. In turnarounds, it is critical that the CEO and the top team commit to the importance of external-spend reductions early on and rally the organization around the program. Given that, as noted above, external spend typically accounts for 30 to 70 percent of a company’s total expenditure, this topic should be a priority for the CEO.
CEOs should be seen as their company’s change leader, responsible for triggering a radical rethinking of the operating model and the company’s conventional wisdom (see sidebar, “How one CEO became a change leader”). They must be a role model, leading with actions as well as words – and they can carry out a variety of symbolic actions that demonstrate their commitment to the transformation to the entire organization. Examples include:
- Role modeling cost reduction programs, such as traveling in economy class instead of business class,
- Participating in team review sessions on cost reduction and helping to accelerate decision making,
- Rewarding individuals who have helped the organization achieve significant cost reduction,
- Communicating the transformation’s progress and reiterating a personal commitment to the program to the organization on a frequent basis.
3. Identify fit-for-purpose levers that generate cash rapidly
To maximize the value realized, companies must implement a suite of tools, levers, and capabilities to ensure (see Exhibit 2). Teams should apply technical tools, such as clean-sheet costing and teardowns, to define the maximum potential available. Team members should be encouraged to chase value as if their own money were at stake.
However, depending on the company’s context or the urgency of their requirement for cash, it may be prudent to prioritize speed over maximum value for certain spend categories.
Although it takes 12 to 18 months to realize the full impact of most benefits of such a program, there are a few initiatives that can deliver cash early on (for an example, see sidebar, “Fleet-size rationalization for immediate cash impact”). This short-term impact is invaluable to the bottom line and helps the organization gain confidence in its ability to deliver the turnaround. Short-term wins include:
- Demand rationalization, which can help manage the scope of activities and is effective immediately
- Reopening all contracts for negotiation and creating a deal calendar for upcoming negotiations as a starting point for the team
- Estimating and managing off-contract spend through a spend-control tower. By challenging all purchase requisitions relative to demand, substitution, scope and price levers, a control tower rapidly instills a cost-conscious culture throughout the business.
Teams should also examine the full suite of procurement levers available and evaluate each lever to determine its applicability and suitability.
4. Use line-led, granular initiatives to drive value
To maximize the value delivered by procurement in a turnaround situation, it is critical to create a granular set of initiatives that have stretch targets and well-defined owners. This consolidated list of initiatives, consisting of hundreds of initiatives with improvement value and delivery timelines developed by the procurement and business stakeholders, forms the bankable plan against which the entire organization is accountable. The upfront development of this bankable plan must promote four critical success factors:
- A granular set of initiatives, all expected to entail strategic supplier negotiations that correspond to individual contracts ideally
- Stretch targets for all initiatives, requiring procurement leaders to tell bold stories and challenge targets
- Ownership of initiatives by contract owners, not category managers. Contract owners deliver the value, while receiving guidance from category managers
- Setting granular, trackable milestones to ensure feedback on the progress of delivering the pipeline of initiatives. It is also crucial to involve business units at this stage of the planning process, to ensure they are part of the journey from the beginning and support the eventual delivery of cash.
These line-led initiatives deliver best value when they are grounded in facts, based on solid analyses, and executed through strong collaboration between procurement and business units.
To rapidly capture commercial savings from procurement, companies can establish a “Negotiation Factory”—a systematic and repeatable process for supplier engagement. A negotiation factory empowers negotiation teams with standardized best practice tools such as detailed RFQ pricing templates, best of benchmarking, negotiation scripts, and role plays. By deploying the best procurement resources in the negotiation, businesses can ensure that they maximize the value from all negotiations, instead of just the ones conducted by highly skilled contract owners (see sidebar, “How a negotiation factory enables cross-functional collaboration between procurement and business stakeholders”).
5. Establish an unrelenting performance infrastructure to ensure value accretion
In rapid transformations, close-to-flawless execution is required to ensure success. Disciplined execution requires unrelenting performance tracking. Companies need to develop granular implementation plans and then relentlessly monitor progress against the plan to track bottom-line impact. Each cost reduction initiative should have detailed activities, milestones, owners, and a clear link to value drivers and cash.
Procurement initiatives should be tracked on three levels:
- Implementation milestones. Tracking actions and milestones on a weekly basis helps to ensure that initiatives are advancing in accordance with the plan and enables the company to immediately identify and address any roadblocks. Tracking implementation can also reveal opportunities for accelerating delivery.
- Impact targets. Tracking changes in the value drivers and KPIs that each initiative is intended to target ensures that initiatives deliver real impact. It also enables rapid intervention in cases where the expected impact is not achieved.
- Bottom-line results. Tracking actual bottom-line results ensures that cash is being delivered. Under normal conditions, the company should track bottom-line results monthly; however, if the company is experiencing a severe cash crunch, it may need to conduct this tracking on a weekly basis through a “cash war room.”
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Reducing external spend to deliver rapid cost improvements should not be regarded as a one-time event. To sustain the impact, a company must fundamentally change how executives and staff at all levels of the organization think about procurement. By adopting these five principles discussed above, companies will begin the process of instilling an owner’s mindset across the organization, breaking down cross-functional barriers, and elevating procurement’s importance as a vital value lever. The first companies to accomplish this transformation will achieve a major competitive advantage through superior bottom-line performance.
About the authors: Tarandeep S Ahuja is a partner in McKinsey’s Melbourne office, where Shijith Prathapan is a specialist, and Sukrut Kharia is an associate partner in the Sydney office, where Yen Ngai is an expert.