Did you know that efficient procurement practices can add to your organization’s competitive advantage? Before I explain how, I want to start out by talking about Porter’s Five Forces of Competitive Position Analysis. Harvard Business School’s Michael E. Porter developed them as a framework for assessing and evaluating the competitive strength and position of an organization.
This theory is based on the concept that there are five forces — barriers to entry, threat of substitutes, rivalry, supplier power, buyer power — that determine the competitive intensity and attractiveness of a market. Porter’s Five Forces help to identify where power lies in a business situation. This concept is useful both in understanding the strength of an organization’s current competitive position, and in determining if the organization should be open to entering new markets.
Five Forces analysis helps organizations measure competition intensity, attractiveness and profitability in a specific industry, and can help executives make informed decisions relating to:
- Whether to enter a specific industry
- Whether to increase capacity in a specific industry
- Developing competitive strategies
It is not surprising that two of the Five Forces — bargaining power of suppliers and bargaining power of buyers — are directly related to an organization’s procurement function
Supplier power is an assessment of how easy it is for a supplier to increase prices. It is driven by:
- The number of suppliers available for each essential product or service the organization needs
- The distinctiveness of their product or service
- The relative size and strength of the supplier
- The cost of switching from one supplier to another
Buyer power is an assessment of how easy it is for buyers to lower prices. It is driven by:
- The number of buyers in the market
- The importance of each individual buyer to the organization
- The cost to the buyer of switching from one supplier to another
The fundamental purpose of all sourcing and procurement activity is to utilize the external market and suppliers in an optimal manner in order to gain a competitive advantage. Every item or service being sourced should contribute, directly or indirectly, towards competitive positioning.
The major point here, according to Reginald Peterson, Corcentric’s director of indirect supply programs, is that in order to improve your organization’s competitive advantage through procurement, every procurement department’s goals should be to simply buy everything the organization needs better than their competitors.
According to Peterson, your procurement department should take the following steps to increase your organization’s competitive advantage
- Embrace innovation: Procurement professionals are increasingly being required to not only possess the necessary skills to deliver cost savings, satisfy social responsibility targets, manage supplier relationships, and manage risk, but now are expected to be innovative in order to gain a competitive advantage. Procurement’s contribution to innovation can occur in the product development phase, because 70 to 80 percent of the cost of a product or service is determined during the design or specification phase, which has a direct impact on the organization’s competitive advantage in the marketplace. In addition, innovation within the procurement department can improve the communication of complex data, support the negotiation phase through online auctions and bidding systems, or through online catalogues which allow you to check product availability, place and track orders, and make payments. These tools have become more vital to efficiently procuring goods and services than ever before, thereby removing cost from the process.
- Procurement optimization: Installing an efficient, effective procurement process can deliver quick but tangible P&L improvements and enhance the agility of the procurement process.
- Increase supplier participation and loyalty: Suppliers are critical to the success of an organization, but the lack of trust between buyer and seller is more common than we (procurement professionals) care to admit. Furthermore, you cannot increase supplier participation and loyalty without incorporating supplier optimization practices. Since most businesses purchase 80 percent of their goods and services from 20 percent of their suppliers, it is critical to every procurement department to find time to foster real relationships with your top suppliers to reap sustainable financial benefits.
- Minimize dark purchasing practices: Having spend visibility for all purchasing activity gives you the ability to reduce procurement costs, improve relationships with stakeholders, and track purchasing patterns to make financial improvements in the long run.
- Recognize Procurement as an influencer throughout the organization: Procurement cannot be efficient if it manages costs in a highly decentralized environment. This management style reduces the organization’s competitive advantage and increases operational costs. Therefore, more and more often, procurement leaders are being invited to the C-level table because executives understand that procurement is evolving from a back-office function to a respected business operation that is key to an organization’s competitive advantage. In fact, a recent IBM Institute of Business Value (IBV) studybrought into the spotlight the impact that chief procurement officers can have on a company’s profitability. The study showed that organizations that employ high-performing procurement departments report 7.12 percent profit margins, as opposed to 5.83 percent for those with low-performing procurement organizations.
Following these steps will turn your procurement processes into a competitive advantage for the entire organization.