‘Corporate virtualization’ has taken hold across all large businesses today – the on-going phenomenon of replacing internal functions and labor with suppliers has changed the very fabric of the modern company. It has not been a planned or even conscious decision – but over the last 20 years is has been an unstoppable force.
Research into the trend of corporate virtualization has found that today, labor costs account for a mere 12.5% of the average company’s revenues. Non-labor (supplier) costs are up to 70%. Surprised? You’re not alone.
We asked 44 senior executives from finance and operations functions what percentage of their revenue they thought was attributable to third-party costs. Only one respondent estimated the number to be greater than 40%.
This highlights that the people who most need to be aware of the statistic, and would most benefit from doing so… simply aren’t.
So if the people responsible aren’t aware of this major disparity between internal and external costs – the chances are they aren’t thinking about how best to manage the new reality.
Most businesses that have large core costs invest in managing them – and are doing so effectively. Of course they are. It’s the core business. However, the story is very different in non-core costs. And yet it’s in non-core costs that large financial gains can be achieved, and operational improvements and productivity gains delivered.
So why are senior executives not giving this more attention? Perhaps it’s because the function responsible for managing non-core costs, ‘procurement’, is under achieving. My favorite quote I heard from one of these executives was “if I believed all the savings that procurement reported to me, we would have a negative cost base!”.
These executives have slowly being switching off to procurement’s increasingly redundant message and turning their attentions elsewhere to areas they can see a real difference.
Managing suppliers as assets and levers for business growth
While business has changed, management practice has not changed with it. Since the 1970’s, management teams have worked tirelessly to link staff performance with the strategic goals of the business – resulting in labor being viewed as a key asset for any business.
Understandably attention remains focused on employees. Yet, with our research showing that supplier costs now account for 70% of revenue expenditure, and non-core costs typically being between 15-25% of revenues, it is clear that very few know how to make suppliers an asset in the same way.
So here are 5 tips for getting to grips with your now ‘extended enterprise’:
- Recognize that the areas that make up non-core costs are very broad and numerous – over 300 hundred different areas in fact. Each demands in depth knowledge and insights to manage effectively. You need to have access to all this knowledge – and it needs to be kept constantly up-to-date.
- Recognize that the management of non-core costs requires a diverse range of skill-sets, such as negotiators, contract managers, analysts, process mappers, change managers, business partners, researchers, category experts (in over 300 areas!)… and so the list goes on. Have you got all these skillsets? If not – you need to get them.
- Audit what technology you have and review what best-in-class procurement functions have. Technology makes procurement functions more effective, informed, knowledgeable, and so on. Make sure you’ve got the right technology. And keep on top of it – there’s a lot of innovation going on in this area.
- Consider what the principle activities are of your procurement function. How much time is spent on the sourcing exercise? How much is on engagement with functional managers and change management? And how much is spent on commercially managing your supplier relationships on an on-going basis? If the majority of time is spent on sourcing, then focus is going in the wrong areas. The real lasting commercial benefits from effective procurement comes from focusing inwardly on the other functions in your business, and on commercially managing your suppliers.
- Consider how you are measuring procurement’s performance. Is it largely around savings? Now think about what you really want procurement to deliver. Is it to deliver savings, or actually is it to help your functional managers achieve their objectives. Do you want your CIO, or CMO to achieve savings and reduce their budgets? Or do you want them to improve productivity, and drive growth? You get what you measure – so think deeply about what you want to achieve.
Replacing labor with suppliers has moved many business operations away from the center of businesses. They augment missing skills, knowledge and expertize and extend your internal capabilities. However, there remains a gap between your business goals and your suppliers.
This has serious implications if left unmanaged. But can return great results if you get it right – as this short animation shows: