Geraint John (GJ): What are the main operational, financial and strategic risks that you are actively seeking to manage in your companies at the moment?
David Lawrence (DLa): I think ours would be around supplier continuity, commodity price risk management and the corporate citizenship element. Supplier continuity includes the element of financial instability and potential risk of suppliers failing on us, but also making sure that third-party goods and services are available to make and sell our brands when we want them.
The financial element is obviously a high priority at the moment but it’s not the only element. Commodity price risk management is an element; we do a degree of hedging around some of the corn and other commodities that we buy.
Corporate citizenship is the third area; the sustainability element seems to have gone down slightly recently, in terms of its profile, but we think the ethical and human rights elements of the agenda of what we are buying from our various suppliers is actually more important these days because of the temptation to cut corners.
Richard Alderton (RA): Cost is getting an even higher focus than before and that is driving us out to China. But then you expose yourself to potentially unstable currencies; if the RMB floats free from the dollar, what happens then? What if there’s a change in political leadership?
At the same time, some countries are taking a more protectionist view to the recession, for example where we are having to set up a local supply base in order to be able to trade within that country. This diverts us from our strategy of developing a global supply base.
Andy Haworth (AH): Although it has still to manifest itself, there is a clear concern about supplier continuity and how best to support suppliers who do get into a distress situation. We are having to deal with greater currency risk, which is changing our approach in some areas. There is also more pressure on cost, which brings greater emphasis towards low-cost country sourcing.
GJ: If you had to pick one of those risks, which would say was the most significant at the moment?
AH: I think there would be two. First, the potential of suppliers getting into distress and ensuring that we respond appropriately to early warning indicators. Second, making sure we capture cost benefits and flow the value through to clients in order that they will continue to invest.
Steven Pink (SP): It’s very tempting when money is tight and pressure is on margin to tighten your belt. What we’re finding when we talk to our corporate customers, but also our personal customers, is the need for us to do things to improve their experience and enable better standards of clinical care.
The risk for us organisationally is to not to go after those kind of improvements as keenly as we have been. It would be very easy for us to give up for a while and just focus on cost management.
John Needell (JN): One of the things we are trying to push is actually some of the basics: getting contractual coverage in place, getting engineers who are doing the project management to look at the procurement risks and educating the business. It’s much more about procurement as an educator and as a leader of the whole business on risk.
GJ: What are the major risks BOC is facing?
JN: Feedstock costs, electricity and gas costs are key to our cost base. Demand in lots of businesses is dropping, so how do you cope with the need to cut your cost base, both from a staffing and input costs perspective, while managing the risks? Sales and marketing, a while ago, really wanted the gold star standard; now they are much more interested in cheaper products. But the risks are the same.
Colin Davies (CD): We’re under tremendous pressure to manage the risk of costs getting out of kilter with what we need to operate successfully as a business. One of our challenges is not to have 100 per cent focus on that cost risk management, but to stay very close to the different parts of the business in terms of what they need. Like a lot of companies, we are putting in predictive models around suppliers’ financial health and putting in mitigation measures to manage that.
We seem, ironically, to have an increasing number of compliance risks. I’m talking about things like Sarbanes-Oxley and the Foreign Corrupt Practices Act. Also, over the years we’ve outsourced a lot more services and used a lot more contractors to become more flexible in our cost base, but we haven’t kept up with it in terms of the way we put contracts in place with those people and manage the risks that come out of that.
David Loseby (DLo): I think some of the biggest risks are more around continuity of supply. It’s about supplier due diligence but to a level you’ve never seen before. There’s more of an open door than there was before about being receptive to some of the things that procurement can bring to the table. This is then allowing us to open up the debate with some of the commercial and sales and marketing people.
There’s a greater awareness and a greater propensity to listen by senior management than there has before. But we shouldn’t forget that we still have the day job to do, which is that we still want cost savings. The worry I have, though, is that there is a shortage of skilled procurement professionals that have the capability and the bandwidth to take on board all of these elements.
DLa: The business environment for procurement now is far better than it’s ever been, by turning the risk scenario into an opportunity. I’ll give you two examples: one is brand value engineering, which we’ve always talked about. Now the business wants to do it, because it will significantly change the security and the cost base. The second is the cost of capital; we are getting an opportunity now to look at the make-or-buy decision much more than we ever were before.
Laurent Guerry (LG): To be a little bit provocative, don’t you think that also this is a challenge for the purchasing function? With the clients I’m working with, all the work on risk management is very difficult for the procurement department to prove and demonstrate results. For instance, in terms of hedging, the results are not always there. Every day you have new suppliers in financial troubles or going bankrupt, and basically there is little that can be done when you reach such a situation. And when a supplier goes bankrupt, there is really no solution.
DLo: But that’s where your supplier relationship management comes in, so your suppliers come back to you and say ‘I need to make you aware of this situation, or we need to do this before we get to this point’. The bringing back of that proactivity and opportunity to do something different, to avoid a potential issue in terms of supply or cost or an opportunity to hedge or change the way in which you construct or deliver something, is where that next raft of food for the table is going to come.
Also, if we move to this arrangement with a supplier, they will put buffer stocks in place of XYZ, which means that if – like in our business – suddenly a supermarket turns round and says ‘Oh, by the way, we’ve just increased the forecast fourfold for the next two weeks and we expect it to be delivered’, you have the robustness within your supply chain to handle that.
GJ: But you’re not suggesting that suppliers will come to you and say ‘By the way, we’re in financial trouble, what can you do to help us?
DLo: No, not exactly. I think if you push and tease hard enough, people are more likely to be open and honest with you in current times, whereas in the past they would not have dared stray into those areas. But as someone in the procurement profession you still have to find ways of teasing that information out. It’s about having access to the right people and being able to ask the right questions to get that information.
GJ: A number of you have mentioned supplier financial health. This seems to be the number one risk issue for CPOs at the moment. Do you feel you are on top of this?
JN: I don’t think it’s just about companies that are getting into financial difficulties; there are a lot of companies that are changing their business models. So products they used to supply are getting cut out of the range. If you focus on the fact that it’s a company as a whole that goes, you might miss a trick.
GJ: Andy, you mentioned earlier that you hadn’t had a problem in this area yet. Do you feel you have a good sensing mechanism in place?
AH: The world has certainly changed and we are monitoring a range of risk indicators, including strategic, financial and operational performance of suppliers. A single issue in isolation would not necessarily flash up a red flag, but it may flash up a concern, and then we rely on our relationships with suppliers to have open dialogue and ask those very honest, straightforward questions.
RA: We have identified some suppliers through some fairly rough techniques like who’s starting to pay late and who’s asking for early payment. We are identifying those suppliers that are in trouble and to whom we have not given orders, because our order book is down.
But of course the recession will end and we want to keep the supply base warm for when that happens. We are now planning to work with our sales organisations where they will run campaigns to proactively push the products that those suppliers in trouble need the business for.
GJ: When times are hard there is a danger of retreating inside your own four walls. At Diageo, David, how collaborative are you trying to be with your suppliers in an effort to manage some of the current risks?
DLa: We’ve tried to put more rigour into looking at which suppliers are really critical. We start with where our most profitable SKUs [stock-keeping units] are, which brands are going to drive the most profit for our organisation, and then ask which suppliers are critical to those. Conventionally, you start with your biggest spends and work down; actually it will be the little guys that supply the small things that are going to stop our brands being produced and sold globally.
GJ: Are you taking a collaborative approach at Pfizer, Colin?
CD: I think selectively. We’ve got three main parts to our business: research and development, manufacturing, and sales and marketing, and each of those areas has different needs. In the manufacturing area, they are quite mature at managing the category and understanding who the critical suppliers are in that supply chain and working collaboratively with them, and the others on a more routine-type relationship. The issue is to get that manufacturing procurement thinking in other parts of our business where we also have critical supply chains but they may not be so obvious.
SP: If you make the working assumption that most businesses are run by intelligent people, then I think part of our job is to really be a facilitator close to what the end customer is saying and doing. Often businesses fail or get into trouble because they are too slow to react, and I think there are some organisations where a procurement function should be less of a gatekeeper and more of an enabler.
GJ: Stephen, are there any insights you can share on this issue from the CPO interviews you did recently?
Stephen Finch (SF): What came out of our survey, which was slightly shocking, was when we asked people what the typical KPIs for the procurement function were, whether cost, risk or growth, it came down a lot to an emphasis on cost. One of the things I’m nervous about with this conversation is while it sounds very good to get this integrated thinking, how embedded is that in the way the business works? If the pressure goes off, does it just revert to the way it was before?
RA: I had that same concern in our company, but the reason I don’t have that concern any more is because we’ve structurally changed the organisation. We set up a supply chain board and manufacturing, purchasing and logistics sit on that, but so too do the two most senior marketing executives, the most senior sales guy and it’s headed by the CEO. For me, that was a huge change in direction.
AH: : I’d reinforce that. I think supply chain is much more on the radar screen of senior management now than it’s ever been. They, and others, take an active interest in how the risks are managed and how we are creating value and opportunities.
SF: The other reaction I had is that departments are very stretched. On the one hand there is extra work looking at the bankruptcy problem and doing extra due diligence rather than ticking the boxes. That takes time and resources and a different set of capabilities, asking a different set of questions. Then on the other side if you are trying to do value engineering, that’s equally resource-consuming, so I’d be interested to know how you balance that.
DLo: It comes down to prioritisation at the end of the day. It’s also recognition that there will be things that you have to put off for tomorrow. But you can only put them off for so long before you’ve got to deal with that particular issue. For procurement people who are genuinely doing the right thing and doing it with a passion, we are having to do more with less. That’s a reality and I don’t think that’s going to change for some time, so we might as well just get used to it.
JN: I’m finding that more and more of the business is coming to me and saying ‘Look, I spend £70,000 on this and I need to take money out’. I’m having to say ‘Frankly, even if I save you 10 per cent, I’m not going to do it’. I’d love to do it, but we just don’t have the resources to do that. It’s a painful decision, it’s how you tell someone ‘Yeah, I’d love to help you, but we’ll save more money by doing other things’.
SP: It’s about doing things in a different way. The point was made about putting governance structures in place to ensure that happens; if you are going to be a procurement or supply chain leader, you’ve got to be a business leader too. If that’s not where the organisation has come from, sometimes that’s created by putting a mechanism in place. If that works and delivers business objectives in a rounded way, then there’s no reason to take that governance structure away when the macroeconomic environment changes.
GJ: How are you looking at the supply risks in low-cost country sourcing and extended global supply chains?
DLo: In more cases than not we’ve looked at trying to bring things more local than push them further away. That’s probably because in my industry – food manufacturing – the need to ensure continuity of supply and the cost of transport, stockholding and therefore tying up working capital goes against trying to produce things locally or have shorter-haul shipping distances.
It’s about looking at what is the right thing to do in a particular case, rather than taking a blanket approach. It’s understanding the total cost and the overriding driving parameter. Is it continuity of supply? Is it quality? Is it service? Is it cost? That’s then tied up with – particularly on the direct side of procurement – world supplies, foreign exchange rates, and availabilities of different commodities and sources, bearing in mind that for grown products there is no guarantee that from one year to the next the same volume is going to come out of the same area or country.
GJ: Is this a live debate for you at Diageo, David?
DLa: It is and it’s a mixed model as well. In certain regions – for example, our operations in Africa – we are looking to increase the amount of in-country sourcing to enable them to continue to get products on shelves when they need them, but where we have more global commodities – glass, card, paper – we’re looking to use the current climate to get our business to do more of this sort of thing.
AH: Until recently we were operating in markets of great scarcity and supply risk which had the capacity to delay projects and therefore did not easily lend itself to low-cost country sourcing. The easing of demand coupled with pressure for capital cost reduction mean that we are now much more active in, for instance, China, particularly for components rather than systems or services.
RA: I would echo that. The two key success factors we’ve had are that we have a team on the ground in Shanghai and we have been selective about our products. The major reason you go to China is the low labour cost. Our marketing people are very nervous about the finished good being made at a supplier in China. So we are doing a halfway house, where two-thirds of the cost of goods is in the components but the final assembly is done in our own factory in Shanghai. That means we are the last people to touch that product, so we can be assured of the quality.
GJ: Let’s turn to the issue of commodity pricing. Some analysts are predicting upward pressure again in the next 12-24 months. How much is this on your risk radar at the moment?
AH: It’s an interesting one for us. We mainly buy services, but commodity costs, which may be at tier three or four in our supply chain, can still represent 50 or 60 per cent of the value. Last year, for instance, we saw the price of steel drop by 50 per cent and we are now seeing commodity prices come back off the floor. If we didn’t have that knowledge, it would certainly disadvantage us.
CD: I think where I can influence the business going forward is putting a lot more focus on what constitutes the prices that we pay, in terms of suppliers’ costs of production. One of the things we have been looking at over the past couple of months is potentially using some external companies that would monitor key markets for us, both in terms of generally what’s happening in the market but also in terms of what the changes to the input prices – the raw material prices – are in those markets. We’ve tended to do that internally but I think there’s a growing recognition that we only have so many resources.
GJ: Is the threat of inflation in some of your spend categories something you are thinking about now?
CD: It’s really a normal discussion point. Like most of the companies around this table we are organised on a category management basis and it’s really up to the category manager to determine how they manage their category and the priorities they put around it. It’s critical, but it’s not the most critical part of our business.
GJ: Steven, is inflation on the radar at Bupa?
SP: Absolutely. If you look at utilities and food costs, in particular, they are significant cost drivers for any private hospital group. One of the reasons that we’ve been given in some of the more taxing negotiations we’ve been having recently is that there’s been upward pressure on those cost-driving elements.
We’re just about to look at an initiative, not focusing on the larger suppliers but on the smaller ones in the UK to see if there is a way that we can consolidate our buying expertise and
provide some help to some of those smaller organisations through our group purchasing function, in terms of their utilities and food procurement.
LG: I would be interested to know to what extent commodity hedging is the responsibility of the purchasing department versus finance. When you look at how purchasing performance is measured, very often it’s not considering commodity price increases. And, from an organisational perspective, very often hedging is managed by the finance department. That’s why sometimes there is confusion.
DLo: We certainly manage hedging for all the commodities. Some of the changes over weeks or even days can be huge in terms of percentage changes. We’ve had to understand those commodities that are linked to the cost of oil and those that are not linked and are therefore related to supply markets. Different things have different drivers, so for us it’s understanding the cause of effect on commodity prices, including those markets that are attractive to traders and investors who see an opportunity to buy when there’s a low point in the market and then sell back again once they’ve made their gain. I would always argue that that’s not a finance function’s job.
GJ: Have recent events helped to bring procurement and finance together more to address these issues?
AH: I think there is more collaboration and discussion now, particularly around the financial stability of suppliers, payment terms and identification of some of the early risk indicators. We have regular dialogue on hedging of currency and forecasting requirements.
CD: I think this is a good example where procurement and finance do need to work more closely together. On commodities, we should be experts in the market and finance should not be, but they may just do the execution, whereas in the currency markets maybe they are more the experts.
GJ: I’d like to turn to your functional ability to manage these risks, and whether you have the people and the skills to really do this effectively. Stephen, what insights are there in your research on maturity levels?
SF: We put together a five-point scale to describe the different ways in which people were managing risk. It ranged from “unstructured”, which was the very basic ‘we’ll do it when it hits us in the face’ approach, to “reactive”, which is ‘we know these risks exist but we’ll get to it when we need to’, then a more “proactive” approach, which was about anticipating what might happen and creating contingencies and early-warning systems.
People who are proactive recognise the need to collaborate internally as well as externally, but I think we’re really starting that process rather than already having it as a full approach. Then, at stages four and five, the mindset changed very much so that risk and cost became central business issues. Stage four was “cross-functional” and five was what we term “value-creating”; looking for the upside as well as protecting the downside. In our research, we didn’t really interview anybody who was fully adopting the five on our scale.
GJ: Where would you put yourselves on this five-point scale?
AH: We are certainly towards the upper end of the scale, scoring a four in many areas. For instance, supply chain is represented on the group risk committee, so we can demonstrate a proactive, cross-functional approach and appropriate processes and systems.
DLa: I’ve self-assessed myself as a four. The fact that my role exists with a team of half a dozen people speaks quite strongly, and we’re now getting to a point of maturity in that cycle where I’m talking to my team about how we can step back out having increased capability around the procurement function, and letting people manage it themselves by having key performance indicators in there, assessing certain risks. It’s how that then gets codified into category management. Do people, as part of the sourcing exercise, look at what the contingency around that is? How do they assess the qualification criteria?
