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Lars Kuch Pedersen
January 24, 2023

Procurement Strategy - The Number One Mistake Most Companies Make

A mistake among companies' management leaders

The number one mistake that most companies make in procurement is that they do NOT manage their suppliers.

Now, what do I mean by that?

First, you need to understand that a company is not just an isolated entity that can work completely independently and be competitive in the market without external partners and suppliers. A company is part of a larger supply and value chain. A supplier is an extended ‘team’ that is part of the company’s value chain. A supplier contributes to the value chain, like an internal team/department does, to the overall aim of serving the end customer. A supplier just happens to be a team that works in a different legal entity outside the company, but the supplier can still have a significant influence on the company’s overall performance and competitiveness – as can an internal team.

Or in other words: A company can have two types of suppliers:

  1. External suppliers – what we normally call ‘suppliers’.
  2. Internal suppliers – what we normally call ‘employees’.

With this understanding, we can now look at how companies normally manage these two types of suppliers. As both the external suppliers and the internal supplier (employees) are part of the company’s value chain they both need to be managed to maximise the value output from the company and to reduce costs.

Management by Objectives (MBO) for ‘internal suppliers’ (employees)

Management by objectives (MBO) or Management by results (MBR) as the recognised Harvard Professor Peter Drucker named it, is widely recognised as the best practice within management. According to George Odiome, MBO can be defined as:

A process whereby superior and subordinate managers of an organisation jointly define its common goals, define each individual's major areas of responsibility in terms of results expected of him and use these measures as guides for operating the unit and assessing the contribution of each of its members.

MBO can be illustrated as below 5-step process:

It is widely recognised among top leaders and business thinkers that MBO is the best way to manage organisations, internal business units, teams and people, or the internal supplier as I call them.

Management of external suppliers

However, when we look at management of external suppliers’ companies do NOT practice MBO. Many would object to this claim by saying something like:

Objection 1: ‘We manage our suppliers very closely on cost.’
Objection 2: ‘We manage our suppliers closely on delivery performance.’
Objection 3: ‘It’s not relevant to use MBO on suppliers as they are not that important’.

My short response to all three objections is: They are not right (in nearly all larger companies).

I feel comfortable claiming this because I have worked for +14 years in procurement and I have helped hundreds of large companies within the supplier management space across +10 countries and I know what the real practices used within supplier management are within larger companies in the Western World. And it is NOT MBO.

Regarding Objection 1

When many companies would say that they manage suppliers closely on cost, they actually mean they manage on price! The big difference here is that the price is just one element into the ‘total cost of ownership’ calculation that would make sense to do on suppliers as there are many other costs associated with having a supplier. And only very few companies actually try to calculate and manage the total cost of owning a supplier. I have only seen very few real examples.

Regarding Objection 2

When many companies say they manage suppliers on delivery performance, they actually mean that they have a solution where they can internally measure the delivery performance. But they only share the performance data with suppliers when performance is low (when there are problems). That is not MBO. In MBO thinking, specific objectives for delivery performance should be set up front and agreed with suppliers, and then the delivery performance data should be continuously (and not just once a year) shared with suppliers – also when performance is high.

Regarding Objection 3

When many companies say that it is not relevant to use MBO on suppliers they completely ignore the cost structure of the company. Over the past decades, there has been an increase in outsourcing, which has meant that the external spend (supplier costs) now represents a larger share of revenue, typically 40-70% of revenue in a manufacturing company, where labour costs typically represent 10-40% of revenue. Furthermore, there is good reason to believe that suppliers to a greater or lesser extent influence the level of internal labour costs, as a 'good supplier' helps a customer reduce labour costs, while a 'poor supplier' increases labour costs. That is why MBO is also highly relevant in most larger companies in relation to suppliers because suppliers are the majority of the total costs within the company.

Supplier management by objectives (SMBO)

This is why a new concept or practice is highly needed to stimulate greater value creation via suppliers. A concept I would call ‘Supplier Management By Objectives’ (SMBO), which can be defined this way:

A process whereby managers of suppliers and their suppliers jointly define common goals, define each supplier's major areas of responsibility in terms of results expected of the supplier and use these measures as guides for operating the cooperation and assessing the contribution of each supplier.

SMBO can be illustrated as below 5-step process:

Benefits of SMBO

The benefits of implementing SMBO are many:

SMBO develops a result-oriented fact-based focus

The SMBO process is all about the delivery of results (outcome) as opposed to management by crisis or feelings. The SMBO process is done in a way that makes objectives measurable and verifiable, whilst making sure that each and every one can be attained. The idea is that problem areas are highlighted, with goals put in place to iron out those issues, thus making everyone more effective in the job that they do.

SMBO facilitates effective control and progress

One of the main features of SMBO is the continual monitoring of progress. This allows everyone to measure their performance against the standards that have been put in place. It is those clear standards that allow everyone to work towards a very identifiable set of goals, all allowing for better control.

SMBO facilitates effective planning

SMBO makes planning in the supply chain much more effective. Everyone is forced to look at results as opposed to feelings or crises management. When effective planning is put in place, fewer of those problems tend to arise, allowing the company and supplier to focus on what is important.

SMBO acts as a motivational force

Since everyone is on the same page when it comes to reaching goals, there is a higher level of imagination and creativity that comes with that. With everyone working together for a common goal, there is a much higher level of motivation to reach them.

SMBO facilitates personal leadership

SMBO gives supplier managers and suppliers the opportunity to display their skills and performance. Keeping all suppliers focused will paint a supplier manager in a very positive light and make them more likely to advance within the company.

I hope this inspired.

Lars Kuch Pedersen
Founder of LeanLinking SRM and Negotiation Solutions - Procurement Advisor to Global Top 100 brands - Mission to empower procurement.
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