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Companies doubled down during the pandemic on securing the supply of goods and materials that would allow them to continue to operate during the most extraordinary of times. However, as we continue to accelerate away from COVID-19, inflationary pressures have sent input costs skyward and the reliability of supply chains has remained fragile due to further macroeconomic disruption.
Against this backdrop, how should Sourcing and Procurement (S&P) teams respond to develop greater flexibility and agility to navigate these headwinds?
Structure S&P to make a strategic difference
Extreme scarcity of supply continues to be a challenge, with sharp focus required in sourcing carefully considered substitutes when preferred goods remain unavailable, compounded by the additional challenge of rapidly rising costs.
Over the past 18 months we have seen organizations stray from the path of driving continuous improvement and value creation, to the point where many procurement functions have become price takers in many situations, accepting or absorbing a lot of these increased input costs. In many industries – for example, restaurants, hospitality, and leisure – companies also have adjusted prices two or three times since March 2020 to mitigate the bottom-line impact of cost increases. However, in today’s climate there is a limit to that. Consumers are being squeezed by high inflation across the board, and discretionary spending patterns are changing.
Increasing strategic impact in S&P through enhanced agility is easier said than done. A strategic contribution means being first – not last – to the conversation, exerting a proportionate level of influence upon supplier negotiations and decision-making. Having a “seat at the table” and being part of the end-to-end decision process – from R&D and new product development through to supply chain and operations – is vital in truly executing a cross-functional approach. A mature procurement function will have the opportunity and bandwidth to discuss strategic supplier partnerships and find solutions that can endure for the long term too.
Much relies on the foundations of how procurement functions are structured, and the role that they play in the organization. Despite the decades-old mantra of strategic procurement needing to be elevated to a strategic function, there are still many organizations that lack maturity in that respect. By this we mean individuals with the critical category expertise that will bring success in negotiating with suppliers – for example, proteins or beverages in the restaurant industry.
The function also must have a baseline visibility of spend, but again we see that there are still significant challenges in achieving that. They may know who their main suppliers are and have good relationships with these vendors; however, they may lack transparency on elements such as pricing and visibility into patterns of total spend.
Getting those basic procurement principles and capabilities in this environment is more important than it has ever been. For example, spend analysis should be a continual exercise. For many companies it is undertaken once a quarter or even just twice a year, with procurement organizations lacking the capability or tools to implement this on a rolling basis.
The pursuit of enduring, mutually beneficial solutions
In many instances there will be a limited supply base for certain goods, all of whom are facing similar challenges. Suppliers also will be looking at their own customer bases and trying to rationalize the customers that are less valuable to them. These conversations require senior cross-functional team attention to secure the right, mutually beneficial contractual terms (length, transparency, performance metrics etc.), plus a level of mutual support agreed between the business and the supplier. Proportionality will apply to this kind of conversation, as it won’t be possible or realistic for every supplier, but it is vital for the larger strategic suppliers and categories of high spend, where being a price taker should be avoided at all costs. Key contractual agreements, fit for the new market environment, should include features such as:
- Committed or dedicated supply: Define quantity requirements (weekly, monthly etc.) and timeliness of delivery to cover you from market shortages. This may require a supplier becoming the exclusive provider of the specific category need to lock in the optimal agreement. While this is not normally desirable (with the preference to have secondary suppliers in place as well), it could help achieve better outcomes.
- Price mechanism: Agree to a pricing formula that is constructed to accept the right amount of market volatility, depending on the category, the nature of the spend to the company, and the expected volatility. A good pricing structure will allow buyers to have visibility and transparency into how their price will change, guarding against suppliers hiding margin in pricing and potentially gaining from market fluctuations.
- SLAs: include Service Level Agreements with penalties to incentivise supplier compliance and performance (surety of supply, on time deliver) to avoid business disruption.
- Also consider establishing Preferred Supplier Lists (PSLs), where pricing has been negotiated with secondary suppliers across multiple categories to have alternatives ready to call upon in case of supply disruptions or failures.
The benefits of an inflation war room
Inflationary pressures are not going away anytime soon, and companies need to act rapidly to rebuild their inflation management muscle. We have seen significant benefits in deploying an “inflation war room” approach to mobilize margin protection activity across an organization. The approach brings dedicated focus to this critical business issue and allows a business to:
- Triage and prioritize: Through the mobilization of cross-functional teams from procurement, operations, finance, and sales – among other functions – the team can consolidate an entire universe of recent and future price increases from suppliers and with customers. Missing data can be populated, and a holistic assessment of risk areas can take place, building a better understanding of the impact of each price increase on overall profitability, forming a related priority list to be acted upon.
- Capture context: Assumptions around cost exposure can be validated and forecasts adjusted accordingly. Competitive pricing intelligence can be gathered to inform pricing adjustments and mitigation targets can be assigned to procurement, product design, operations and sales.
- Plan and conduct negotiations: Here, procurement power is consolidated, and contracts, cover, and supplier bases are optimized. Winning supplier negotiation strategies can be planned, alongside identifying those materials with stretch, target and minimum price increase thresholds.
- Build response strategies: Initial proposals are delivered, including detailed, targeted asks. The impact of customer responses is assessed, and decisions adapted dynamically as negotiations progress. New terms are aligned to commodity indices where possible, enabling a company to achieve their desired risk profile.
- Measure and monitor: It’s vital to develop dashboards to segment cost and price increases and track overall status. Monthly financial bridges can be maintained to manage gross margin and EBITDA impact in an enduring way, by taking a forecast-led, forward-looking approach that is continuously updated.