Procurement 2022. The new world of inflation and risk

The CPO as inflation mitigator and risk manager

The world just changed.

In the two decades preceding the 2020s, the themes of procurement were driven by cost reduction, low-cost country sourcing, lean supply-chains, and an over-riding fundamental concept of year-on-year savings. Procurement professionals had become used to a fundamental supply-market stability, with a reliance on single-sourced suppliers, with limited risk management, hyper-efficient global supply chains and a focus on strategic sourcing to incrementally improve profitability by lowering costs.

In 2022, economies are rapidly resetting after multiple pandemic lockdowns, global supply chain disruptions and, just when stability seemed like it might be returning, war in Europe.

The recovery perspective

When Covid hit in Q2 2020, we knew that procurement would need to be agile, flexible and smart and, in order to help their organisation survive.

At the time, we looked ahead and made some operational recommendations: Covid-19; How procurement can help businesses thrive and survive.

We called out a need for procurement functions to rapidly adapt to a new world and to be able to transition through several phases from “Keeping the lights on”, through “Managing the Rebound” to “Repositioning supply chains” and “Risk management”. For functions that had become used to a stable frame of reference this was never going to be easy with new skillsets required to be immediately deployed.

What wasn’t foreseen was such a long period of stagnation followed by an economic rebound which has triggered a tsunami of inflation, as pent-up demand (particularly in China) far outstrips supply for key commodities, materials, and transportation.

The recovery tick gets a refresh:

Supply Chain risk chart

The forward perspective

Procurement, supply-chain and operations leaders are now facing two seismic global impacts; the first is inflation and the second is supply chain risk.

Impact 1: Procurement in an inflationary world – the end of “easy” savings

We are in for a sustained period of inflation.

The economic balance of supply and demand has shifted for many commodities, materials and transportation, tipping economies into a period of escalating prices.

US inflation is running at 7.9% and expected to hit 8.5%.  Eurozone inflation has hit 5.9% already and the UK is running at 5.5% the highest in 30 years and expected to jump again as soon as new figures are announced.

It is the fundamental cost drivers that give even more cause for concern. A deeper analysis of the cost drivers quickly shows how the cost of energy is driving the issue, with energy inflation running at over 30%. The war in Ukraine and the consequential impact on global energy supply has made a significant and potentially long-term impact.

 

Euro area annual inflation and its main components,

 

Whereas procurement has been used to driving year-on-year cost reduction, supported by a theme of continuous improvement, driven efficiencies, over supply of container shipping capacity and cheap labour and, therefore, low-cost manufacturing in Asia.

In the future, procurement will not have these “easy” savings. Whilst there may be an argument that cost increases have been slowed, the CFO will look at the absolute cost increase and only see his or her profitability eroded. Without any intervention, the baseline will trend upwards, and buyers will not be able to use simple market levers, such as competitive tendering, auctions and leveraged negotiation to make savings.

However, this doesn’t mean that buyers simply roll-over and accept price increases (and organisations must therefore attempt to maintain their profit margin by raising their process and passing on to customers). What is does mean is that procurement must pull a different set of levers to make an impact.

A strategic approach to procurement is now needed, requiring the use of more complex, and more internally focused levers, such as specification change, process optimisation, value engineering, demand management and supply chain reconfiguration.

Savings will no longer come from competitive leverage techniques that only impact price. In the new world savings are going to be driven by reworking specifications to lower cost, changing processes to give suppliers more benefit to share (such as order quantities, transportation and packaging), re-engineering lifetime costs and completely reworking supply chains to buy from different regions. We have just helped leading framed photo company, Mixtiles, make savings and reduce risk by near-shoring the supply of frames from China to the US domestic supply-market. A higher like-for-like unit price but a lower end-to-end cost and shorter lead times.

Case study: How Mixtiles shortened supply chains and lowered risk by near-shoring to US and EU suppliers

And CFOs will need to be more sophisticated in their measurement. Old price minus new price times annual volume isn’t going to be pretty. Decision-making needs to be based on, firstly an end-to-end supply chain and secondly, a whole life total cost of ownership whilst we accept that investment will be required and apportion over time.

The downside is that cost optimisation is harder and will take longer to implement. The upside is that the impact will be step-change rather than incremental. The prize is bigger savings, but they are harder to get.

Of course, this was happening before. More mature procurement organisations were effectively exhausting the market levers and were already deep into cost optimisation. We have been working with organisations for the last twenty years to embed Category Management and Strategic Sourcing. But most procurement functions do not have the knowledge, skills, techniques, and expertise. For the less mature procurement functions .. it’s time to grow up quick!

So, we must consider two aspects to be able to mitigate inflation.

Strategically, we must reorientate Procurement so that the function is set-up and focused on the right areas, and with the right processes. There are six areas which will mitigate inflation and drive value

Read: Procurement Strategy 2022; Reorientating Procurement to mitigate inflation and drive value

Tactically, we must switch our focus, shifting away from competitive levers such as tendering and going deep into the more internal levers of demand management, specification change, value engineering, process improvement and supply chain optimisation.

Read: How procurement can still make savings in a world of inflation

 

Impact 2: Supply chain reconfiguration and supply base management to mitigate risk

Nearly all executives are now fully aware of the consequences of supply chain disruption. There is nothing like a production shutdown or an inability to service customers to bring a new focus on to supply chain risk. Covid lockdowns, lack of container capacity and now, war in Ukraine have changed the way we think about long and lean supply chains.

A fundamental shift to active mitigation of supply risk is needed. Procurement leaders need to equip themselves with three risk mitigation playbooks;

  • Strategic sourcing to mitigate risk
    Using strategic sourcing to dual-source or multi-source supply. Reversing the trend towards consolidation to leverage volume but accepting overall higher aggregate pricing in order to mitigate risk.
  • Repositioning supply chains to mitigate risk
    Reposition the supply base and shorten supply chains. Reversing the trend for low-cost country sourcing based on low shipping costs but accepting higher unit costs for an end-to-end saving, shorter lead times and lower risk.
  • Supply base management to mitigate risk
    Pro-actively managing suppliers and contracts. Reversing the trend to rely on suppliers with minimal oversight and moving to active, ongoing and robust management of suppliers and contracts in order to identify risks and eliminate before they can manifest.

A change to procurement strategy and a new role for the CPO

The CPO has a new role. It is chief inflation and risk mitigator.

To successfully fulfil this role, procurement functions must redesign their strategies.

  • Inflation must be defended against and mitigated. This can be achieved through a strategic approach to procurement, requiring upgraded approaches, skills and expertise.
  • Savings can still be driven, and profit margins improved but the focus shifts to using more complex, internal levers rather than purely commercial levers. Buyers need to become internal consultants.
  • Supply chain risk must be mitigated and managed. This can be achieved through strategic sourcing, repositioning supply chains and active supply base management.

Six points to consider

  1. We are in for a sustained period of cost inflation which will erode profitability if it is not addressed,
  2. The days of “easy” savings are gone BUT….
  3. Procurement can still (and must) make savings (and restore profit margin) but through strategic procurement, using more sophisticated levers,
  4. We are in for a period of geo-political instability so must expect more supply chain disruption,
  5. Supply base management is now essential to manage and mitigate risk,
  6. Procurement must upgrade itself in order to achieve this. The new world requires new skills, knowledge, techniques and expertise. Buyers must become internal consultants

 

For further information or to discuss how Procura could help your organisation – please get in touch:

Email us: info@procuraconsulting.com

Call us: +44 (0)203 693 7275

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