Written by Patrick Boëdec, February 8th, 2023.
For a long time, the central purchasing office was considered as a cost center whose role was to negotiate framework contracts so that the entities and subsidiaries could benefit from better conditions thanks to the massification of the group's volumes.
The central purchasing offices quickly sought to become profit centers, by negotiating not only better net prices with suppliers, but also "back" rebates on annual transactional volume.
The temptation was quickly to generalize the negotiation of cooperation budgets, which were increasingly important, and whose diversity and sophistication of wording demonstrated that the amount negotiated had become both an objective and a performance criterion for the center.
It is at this point that we must ask ourselves the fundamental question about the purpose of a central purchasing office and its economic model:
Should it be a cost center that negotiates conditions for operational staff or a profit center that collects the suppliers' tithes from Corporate?
What degree of autonomy should be left to the central office in the management of its activity and the development of its skills.?
How should buyers be evaluated? Should there be indicators relating to the amount of "Blood money" (budget and/or back-payments made by suppliers at the end of the year), perhaps the "Delta rebates" (improvement in net purchasing conditions), or should the reduction in the purchasing mass from one year to the next be monitored?
These questions seem simple to answer but, in reality, they reveal conflicting interests.
1. Should it be a cost center negotiating conditions for the operational staff or a profit center collecting tithes from the suppliers to the Corporate?
a) Some central offices have no other vocation than to negotiate prices at the lowest possible cost for the benefit of operational staff. Buyers are regularly challenged on their skills by entity managers, adherents, etc., who consider that prices are never satisfactory. In this type of organization, the purchasing director has very limited autonomy in his or her investments.
It is not always easy to justify spending on professionalization or the implementation of new tools because they do not generate short-term results. The purchasing director often has difficulty getting the operational staff to finance them. I have already seen several purchasing directors in this situation, having to go back to the drawing board three or four times before being able to set up an Purchasing IS or new recruitments...
In this model, the buyers are only functional, and over time, the central offices are subjected to successive cutbacks to reduce costs and improve productivity. In the end, the best people resign, the loss of skills increases proportionally to the rate of turnover, and the plant ends up being functionalized most of the time.
b) On the other hand, the central offices, beyond the search for net prices, look for "back" discounts that directly enrich the company's bottom line. The central office claims its status as a profit center and becomes the armed wing of the "Corporate" in a short-term financial logic.
In my experience, no one really endorses this negotiation strategy focused on budgets; the action of buyers is part of a kind of unspoken commitment. The managers, on the other hand, are delighted with these revenues, which increase every year and are always at the right time during the closing period. This appetite for budgets helps to perpetuate what is gradually becoming an institutionalized practice.
The danger of this strategy is to see the central offices "get rich" at the expense of the subsidiaries. It is easy to understand that the "blood money" is attractive for a management team, it is visible and tangible, while the improvement of the net prices negotiated on behalf of the operational staff is dissolved in commercial attractiveness. It is also obvious that from the point of view of a top management, it does not have the same impact and for the buyers, the Delta-rebates do not generate the same level of recognition...
The buyer's activity can very quickly come down to collecting cheques at the end of the year, which suppliers will be quick to pass on in their prices. We must not be naïve; companies determine their nets and raise prices according to the conditions that will be demanded, whether in "back" discounts or budgets.
In this model, the subsidiary runs the risk of losing competitiveness, especially during calls for tender, because it will not benefit from the best purchasing conditions vis-à-vis the competition.
This business model can quickly become pernicious and disconnect buyers from the reality on the field of operations. In the end, everyone loses, except the suppliers, whose rate increase will always be more profitable than the budget amount claimed by the buyers.
c) Finally, there may be an exception to this model, when it is a question of tax optimization; in this case, the central office raises the conditions of the suppliers in a fiscally non-attractive country and establishes internal transfer prices which vary between subsidiaries according to the level of taxation in the countries, the aim being to modulate the accounting result before taxes.
In this case, the head office is the armed wing of the holding company, its action is supranational, and the subsidiaries must resign themselves, on the altar of the general interest, to accepting a form of "corporate" tax at the expense of their financial performance. The general interest then takes precedence over the local interest.
2. What degree of autonomy should be left to the plant in the management of its activity and the development of its skills?
First of all, autonomy depends directly on the hierarchical attachment, which reflects the importance that shareholders attach to the purchasing function, i.e. its contribution to the company's financial results. The fact that the Purchasing Director reports to a CFO shows that this function is not considered strategic, otherwise it would report directly to the CEO.
The level of autonomy reflects the ability to arbitrate between stakeholders, but also defines the capacity of commitment of the central office on behalf of its internal customers, whether in terms of referencing, technological choices, negotiated service levels, etc.
The same is true for investments, the central office must implement new tools (Purchasing IS, collaborative platforms, Sourcing databases, but also introduce new technologies such as blockchain, engage engineering consulting, value analysis missions but also components cost breakdown investigations or technical, organizational, financial audits.)
The centrale must also ensure presence of buyers in the field (visits to industrial sites, trade shows, symposiums ...) without forgetting the imperative of the central office to guarantee quality of its services) without forgetting the imperative need to organize the buyers' skills development, this list is not exhaustive…
The central office must therefore have a sufficient operating budget to act with complete financial autonomy, enabling it to build the future, as long as these expenses contribute to a long-term competitive advantage, without necessarily having an immediate financial impact, but it is also necessary to prepare the future.
3. How should buyers be evaluated, should indicators be deployed relating to the amount of "Blood money", "Delta rebates", or should the reduction of spending be monitored from one year to the next?
If we consider that the way the central office remuneration system induces the behavior of buyers, it is essential to specify how it builds its income.
I have often seen buyers boast about their performance in terms of the value of cheques collected from suppliers, while these same buyers deplore the increases in their suppliers' prices from one year to the next, without making the correlation between the two events... Everything and its opposite in the same sentence...
It would be illusory to think that the negotiation of budgets can be obtained on the back of the supplier, who will try to recover the budgets paid in one way or another, either by overpricing or by justifying additional work invoiced at full price. In any case, this will be to the detriment of the operational staff.
It is in the interest of suppliers to keep their pricing high, even if it means giving back budgets, rather than taking the risk of conceding discounts and having them reflected in the price, which would pull the market down. High prices also make it possible to avoid a price war between players, which would have the effect of making the sector less profitable. Such a prospect would not fail to alert financial analysts who would de facto downgrade the rating of companies.
I know some manufacturers who adapt to the inflation of budget requests by regularly increasing their pricing to better pay back the checks at the end of the year. The key account managers then negotiate fiercely, and for as long as possible to wear out the buyers, by progressively conceding budgets according to an envelope that has been already allocated for each customer at the beginning of the negotiation. This gives the buyer the feeling of having fought heroically to get his check.
The real skill of a negotiator is not measured by the ability to ask for budgets but consists in understanding the breakdown of a supplier's costs, when possible, its TCO (cost of ownership), but also in defining the units of work of the services to be negotiated. The added value of the central office is to provide alternative sourcing, to exercise a counter-power with the design offices by positively challenging the engineers' design options and to guarantee the competitiveness of the Business Units.
Under these conditions, the amount of "back-end" budgets can certainly not be a performance indicator. The same is true of the variation in the volume of purchases, which is directly dependent on the flow of activity, supply and demand and is therefore too volatile to be reliable.
The best KPI for a purchasing function is, without a doubt, the monitoring of the variation of the multi-net price of a panel of references from suppliers, the Delta rebate. In my opinion, this is the only indicator that can be used to monitor the individual performance of a buyer in his categories. The current tools, thanks to their functionality and power, make it easy to manage this volume and complexity.
Conclusion
There is no ideal model, it is all a question of measurement and dosage. Apart from international purchasing centers whose purpose is extraterritorial, a purchasing center must not be either a cost center or a profit center.
The distribution between Blood Money and Delta rebates is the eternal debate in our business, and it is also a question of balance; in the same way as for certain families, it is advisable to open up the supplier panel, for example when it becomes difficult to negotiate, generally when there is an agreement, in which case it is advisable to introduce young, hungry sharks to "eat" the old ones... in other cases, when there is a plethora of suppliers, it is advisable to concentrate orders on a more limited number of players in order to obtain better conditions.
The articulation between Blood Money and Delta rebates works in a similar way, when you reach the end of what is possible to negotiate in terms of conditions, of price, then, it is the sign for the next round, it will be necessary to focus on the budget, on the contrary, when the amount of the budgets becomes institutionalized by the suppliers, the objective will be to take them in the opposite direction, to leave the logic of the budget to make it enter the logic of net prices.
As far as the financing of the central office is concerned, the purchasing manager must detail as precisely as possible all the budgetary resources required to deliver the short, medium, and long-term objectives. In addition to salary costs, he or she must calculate capital expenditure as well as all the costs that the center will have to absorb as part of its professionalization in terms of training, travel, studies, benchmarks, IT, etc...
Once the operating and investment costs are covered, and Blood Money is undoubtedly a good way to finance the central office, the action of the buyers must focus on optimizing the purchasing conditions, the associated services, the technical support... and pass on the negotiated purchasing gains (expressed in Delta rebates) to the operational staff in order to create a competitive advantage during the tenders, to generate growth and operating margin.
In this respect, buyers must work closely with Bid Managers, key account managers or costing units to establish the net price level to be achieved to approach tenders under the best conditions, i.e., "Price to Win".
Apart from the classic indicators, Delta rebate seems to me to best reflect of the buyer performance, his contribution to negotiate the best multi-net price conditions.
In an operational way, the coverage of the plant must be done both Top-Down and Bottom-Up.
Top-Down, when the objectives and financing needs of the Purchasing department are broken down by management between the different commodities, MROs, and Capex
Bottom-Up, when the buyers set their objectives for optimizing conditions between suppliers, divided between requested checks for some, net conditions for others, and, why not, a mix between the two sources of revenue.
A reconciliation is then performed to assess the coverage rate of the plant and set the level of savings in terms of net prices to the entities in the field.
In addition to traditional indicators, a third way would be to evaluate the Central on its contribution to the company's unit gross margin, why not? This type of indicator would have the advantage of giving an end-to-end view of the buyers' contribution to the business, whose two activities are undoubtedly interdependent.
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