Companies today are re-evaluating how they manage supplier relationships, for a number of reasons. Many organizations have experienced unexpected interruptions in their supply chains over the past few years, whether due to natural disasters or political unrest, because the global financial crisis forced key suppliers to close their doors, or because tight liquidity prevented suppliers from scaling to meet the company’s new levels of demand.
At the same time, businesses have become increasingly aware of the potential impact of cyber risks on their supply chain, thanks to incidents such as the data breach at a Target supplier, which put the personal data of 70 million Target customers at risk and damaged the retailer’s long-standing reputation.
In the past, senior executives might have asked, “How likely are we to experience a supply chain disruption, and how much would it cost?” Today they’re also asking, “How quickly could we recover from such an event?” And rather than focusing the bulk of their attention on the risk that a particular disruptive event might present, senior executives are now looking broadly at the resilience of their supply chain. A growing number of companies—cognizant that no measures can fully assure them of preventing a supply chain disruption—have sharpened their view of risk management over the past 18 to 24 months to focus more on understanding their path to recovery if and when crisis does strike.
This paradigm shift requires the corporate procurement, finance, legal, manufacturing, quality assurance, and other key departments to work together as a cohesive unit. The impact of a disruption would be felt companywide, so individuals from a range of corporate functions must be involved in developing resilience strategies to address a disruption’s potential consequences. However, if these teams don’t see eye-to-eye, the process may be stymied by conflict and inefficiency.
Fractures in the Finance and Procurement Relationship
Finance and procurement managers are necessarily key contributors to a supply chain risk management initiative. Unfortunately, many businesses’ finance and procurement functions disagree over fundamental elements of supply chain risk management. Like other types of tension between departments, the finance-procurement conflict is often rooted in a lack of understanding about the value that each team has to offer.
For example, procurement may criticize finance for being too numbers-driven in assessing suppliers, for using only financial metrics to benchmark supplier viability. By contrast, finance may criticize procurement leaders for not focusing enough on the numbers and for overemphasizing relationships.
It’s true that placing too much emphasis on relationship history or instincts about a supplier can cause challenges, as decision-makers might miss warning signs of potential issues. On the other hand, factors other than the cut-and-dried financial figures may provide context that’s crucial for effectively managing supply chain risks. Product quality, timeliness of delivery, and other metrics must play a role in supplier decisions, alongside cost. Holding suppliers to performance expectations around these “softer” metrics helps ensure that the company will be able to deliver products that effectively meet its own customers’ needs.
When procurement and finance groups both take firm stances that discount the value of the other group’s preferred metrics, their differing mind-sets can lead not only to misunderstandings between the teams, but also to disagreements about how the company should engage with specific suppliers. Suppliers need clarity around their customers’ expectations in order to meet performance requirements, and this type of internal conflict can create unnecessary confusion around these metrics that can lead to customer/supplier misalignment and a declining relationship.
If these disagreements are allowed to fester, or if they need to be escalated to the CEO for mediation, they can drive a deep and lasting rift between the two teams. Conflicts lead to further conflicts in a manner that is ultimately cyclical.
In order to most meaningfully contribute to both supply chain decisions and a company’s overall goals, treasury and finance professionals need to understand and be plugged into the idiosyncrasies of the procurement office. Procurement and finance teams must work collaboratively so that both groups contribute fully to helping the company as a whole achieve the best possible results.
Can’t We All Just Get Along?
The first step in resolving interdepartmental tensions is to build into each function a healthy respect for the other group. Developing this sense of respect may begin when the company’s CFO and its chief procurement officer (CPO) cultivate a solid relationship. The CFO can lay the groundwork for such a relationship by making an effort to understand how much an effective procurement team, and the CPO who is that team’s leader, can impact the company’s bottom line.
Thirty years ago, the CPO was generally viewed as a back-office manager with little influence on executive management. Today, the CPO is becoming more influential, and research is confirming the wisdom of that approach. A 2013 study conducted by IBM found that high-performing procurement departments drive higher profits: “Top-performing procurement organizations reported average enterprise profit margins of 7.12 percent, compared to 6.19 percent for all respondents and just 5.83 percent for low-performing organizations.”
A successful procurement function builds strong supplier relationships, which encourages individual suppliers to cut costs, deliver on time, and provide higher-quality goods and services. This means that the CPO can impact profitability not only by reducing the costs of components to the company’s products, but also by improving customer satisfaction through timely delivery of a high-quality end product. In fact, in IBM’s 2014 survey of more than 1,000 procurement leaders, 42 percent of respondents chose revenue growth and increased competitive advantage when asked to select their top three priorities.
Despite this power to impact corporate profitability, the CPO still takes a backseat in many companies. The 2013 IBM study found that only 33 percent of CPOs believe they have significant or very significant influence in their companies, when “influence” was defined as having a voice in strategic organizational imperatives, such as delivering customer service, driving efficiency, and creating meaningful brands.
For a procurement manager who feels underappreciated, the best way to start building a productive dialogue with the CFO may be to quantify the impact of procurement’s preferred metrics on the organization overall, showing how improved relationships with suppliers can translate to an improved bottom line. As an example, during very challenging times in the automotive industry, executives at a leading automotive original equipment manufacturer (OEM) could not understand why their suppliers weren’t cooperating with their cost reduction initiatives. Upon surveying their suppliers, they realized that the suppliers had no interest in working on cost reductions. They felt there was no real incentive to do so, as the OEM was a company they felt forced to work with rather than one they particularly wanted to work with. The OEM committed to modifying the culture of how it managed supplier relationships, and over time it saw a drastic change in the level of cooperation from its suppliers, who now actually wanted to work with the organization. The resulting cost reductions enabled the OEM to better compete in its market, which boosted the bottom line and benefited initiatives of both the CPO and the CFO.
Keep in mind that supplier collaboration can result in other benefits as well. One is that if a particular supplier sees a change coming—whether it anticipates financial challenges, it foresees a significant management or ownership change in its future, or perhaps it even worries about potential issues in its own supply chain—then a procurement team with close ties to that supplier may have better insight into those possible challenges and may be better equipped to respond to them. Likewise, if a company expects to ramp up its production in the near future, a procurement team with close supplier relationships may have a better sense of whether the company’s current suppliers are capable of scaling as needed, and may be more likely to make the expansion seamless.
Once procurement and finance executives are seeing eye-to-eye, they’re ready to ask their teams to embark on a joint supplier risk management initiative. Finance should bring to the table a firm grasp of the numbers indicating suppliers’ financial contribution to the company, and team members should be prepared to demonstrate their analytic talents. Procurement should come to the table armed with information about all the risks it sees in the company’s key suppliers. When both teams are prepared, and are ready to work closely together (and with the rest of the cross-functional team), then the company is ready to embark on a comprehensive supply chain risk management initiative.
Making It Happen
It’s not an initiative to undertake lightly; assessing risk and developing a resilient supply chain can be daunting. The project team is going to need to define, in-depth, what the company’s supplier risk management strategy should look like in three to five years. All too often, companies become concerned about supplier risk and implement a risk initiative, only to lose focus and abandon the project after a year. This process is a journey, and it takes time, patience, and long-term coordination to be successful.
To bring the strategy to life, a company should ensure that it has the appropriate individuals in place. To that end, a number of the Fortune 500 organizations we work with have added a new position that reports to the CPO and focuses on identifying, assessing, and mitigating supplier risk. This person typically has both a strong procurement background and a strong understanding of risk management. The role ends up being critical to the company’s view and management of supplier risk. The individual works in tandem with suppliers and with key stakeholders inside the organization, such as finance, legal, and operations, to ensure that the company’s overarching risk management objectives are met, as are the risk management goals of individual departments.
We encourage our clients to have detailed discussions with suppliers about risk and their financial health. These discussions improve communication, provide better insight into what’s happening behind the scenes in the relationship, and ease tensions from any misunderstandings. In order for the discussions to be productive, however, procurement staff may require training—an easy step to overlook in a risk management initiative.
Understanding the financial strengths and weaknesses of existing and prospective suppliers is crucial to meeting the objectives of everyone involved in the project. But although most procurement professionals understand the basics of risk assessments, many are uncomfortable with financial assessments. The finance function may need to help educate procurement staff about how to understand suppliers’ financial health and how best to employ the tools the company uses to measure organizational strengths and weaknesses in other areas, such as customer credit decisions.
Because understanding, managing, and developing risk and resilience strategies are complex undertakings, they generally involve a great deal of data and require fairly sophisticated data analysis. Most companies we work with seek third-party assistance with the collection, assessment, and management of this information. They use external providers for financial analysis, business continuity plans, and to track certification requirements and compliance status. Many organizations are now using the PESTEL model (political, economic, social, technology, environmental, and legal risks) as a framework for the information they track and analyze. Having the right tools in place is paramount to understanding risks, spotting red flags, communicating consistently across departments, and identifying opportunities for efficient and scalable growth in business with specific suppliers.
Changing a Culture
As the evolution of supplier risk management continues to play out, a company’s decisions about strategic initiatives related to the supply chain will increasingly require a multidimensional view of the impact on the corporate balance sheet. That makes a strong finance-procurement relationship crucial. The functions must work together to ensure not only that the company’s supply chain is healthy, but also that the organization is on track to meet its risk management and revenue objectives.
Finance must think of procurement as a strategic partner in order for the collaboration to have a meaningful impact on the organization’s bottom line. The functions may always clash to some degree, simply by virtue of the distinct personality types involved. Like every other relationship, the finance-procurement partnership can be improved through frequent, open communication.
Some companies have implemented monthly meetings between the CFO and CPO to discuss opportunities and concerns. These meetings, like financial training for procurement professionals, should become standard practice. Open communication ensures that teams are on the same page; should an issue arise in the future, everyone will already be in agreement about what factors to consider and how to determine the best path forward to ensure minimal impact on long-term operations.
Building this relationship is worth the investment. If a company can simultaneously capitalize on finance’s and procurement’s strengths, it can gain better insight into the risks and opportunities in its supplier relationships, which can minimize the impact of a disruption, help ensure that suppliers deliver on time and within budget, and contain costs. I’m hopeful for the future and feel confident that the culture shift toward a more prominent and engaged CPO will leave companies more prepared when the next crisis strikes.
Rose Kelly-Falls is the senior vice president and head of supplier risk at Rapid Ratings International Inc., a firm that assesses the financial health of its clients’ suppliers, corporate customers, and other counterparties. She works with supply chain clients to develop, implement, and grow their risk management initiatives, sharing best practices and collaborating on process improvement. A former procurement practitioner at Ford Motor Company and Rolls-Royce North America, Rose is seen as a thought leader in supply chain risk and writes and speaks extensively on the topic.