Over the last 25 years, procurement has changed dramatically. It used to be simply buying goods and services. But now procurement involves overseeing an integrated set of management functions -- managing supplier relations, contracts and payments, and strategy. Procurement officials have to pay more attention not just to what they spend on goods and services, but to the broader costs of operating, maintaining and replacing the items and resources they purchase over time.
Procurement has grown in importance, but it doesn’t get recognized as important. Why is this? Often because it’s difficult to document procurement’s specific contributions: Were the cost savings the result of skillful negotiations with vendors or a lucky shift in the market? In addition, the financial benefits of a favorable procurement deal often extend beyond the initial purchase price to other areas of performance. The result is that procurement often shares its successes with other groups, but when it fails, it gets all the blame.
Globalization only makes the need to place procurement in a broader strategic context more urgent. Senior executives often face “make or buy” decisions -- whether to move production offshore to their own subsidiaries or to outsource it to outside producers or subcontractors. But procurement professionals make decisions directly related to these strategies, such as where to buy, from whom and under what conditions.
Therefore, the choices procurement makes are no longer simply about understanding direct purchase costs or observable transaction costs, such as transport expenses or import duties. Now they involve more complex issues that relate to cultural, institutional and political differences.
In evaluating procurement costs in today’s globalized market, organizations should have a framework to identify and manage different sources of transactional costs -- even in areas in which they have varying degrees of control or influence. Therefore, it’s helpful to consider transaction costs along two dimensions: first, in terms of objective and subjective issues; and second, in terms of internal and external influences.
Objective issues are of a technical or professional nature. They are measurable, and usually linked to financial issues such as direct costs, improved quality, on-time delivery, transportation costs and life-cycle costs. Subjective costs, by contrast, are related to emotional or intuitive world views and how an organization connects to them. These issues can include unethical business behavior, diminished brand confidence or adversarial labor relations -- and while not overtly related to finance, they can still have major financial implications.
Internal factors relate to the specific business -- its market position and its reputation and brand. External factors are tied to developments outside the company -- issues such as regulations, labor costs and currencies.
Combined, these factors can affect not only a company’s financial health, but its overall existence. There is a logical extension to considering all these factors. The decisions procurement makes will affect a company’s strategic decisions. And this, in turn, means two essential things: Procurement must become more closely connected with those making strategic decisions, and various management groups must become more involved in procurement’s decisions. In other words, procurement and strategy must be more closely intertwined within a company’s day-to-day operations.
In considering how procurement should be more active in a company’s strategy, organizations must think about what issues procurement professionals need to be prepared to address. This involves, in essence, thinking about decisions in a holistic sense, as well as thinking about their long-term effects. So first, procurement professionals need to be accountable not only for purchasing, but for managing complete transactions. Although procurement specialists are often familiar with transaction costs, they lack a full appreciation for the effects some costs have on overall economics.
And second, once procurement professionals figure out transactional costs, they must decide how to optimize them. This means knowing where costs can be minimized and where they are necessary. Transaction costs may be acceptable when procuring innovative or key strategic goods, for instance -- when these goods or services are of high value to the company. But if the goods or services are routine or commoditized, then cost is the primary factor to consider.
This article is adapted from “Rethinking Procurement in the Globalization Era,” by Frank A.G. den Butter and Kees A. Linse, which appeared in the Fall 2008 issue of MIT Sloan Management Review. The complete article is available at http://sloanreview.mit.edu/smr/.