Procurement Talk

An Enduring Advantage Professor Martin Christopher makes the case for value-based procurement

For many years, procurement has been primarily cost-based with a focus on reducing expenditure through more efficient buying processes such as category management. Cost reduction will always be a critical priority in business – particularly when margins are under pressure. However, in recent times there has been a growing recognition that enduring competitive advantage rarely comes from cost reduction alone. The focus must instead shift to understanding the ways in which procurement can enable the business to deliver more value in the marketplace.

Previously, the marketing and procurement functions within the organisation have not always worked closely together and often there has been no strategic alignment between the two. Now, because of a fundamental change in the market from product-based to service-based offers, there needs to be a re-evaluation of the procurement/marketing relationship. The main driver for this transition in the market is the increasing tendency amongst customers to buy performance or experience rather than a physical product. Many years ago, Professor Theodore Levitt, then Professor of Marketing at Harvard Business School, observed: ‘people don’t buy products, they seek benefits.’ 

This idea has now become widely accepted and has been developed further by academics such as Robert Lusch and Stephen Vargo who created the concept of the Service Dominant Logic (SDL). The essence underpinning the philosophy of SDL is that products are merely vehicles for delivering a service. Other commentators have picked up this idea and have introduced the notion of servitisation – a focus on how products can be transformed into services, with an emphasis on using rather than owning.

“As we move away from the ‘one-size-fits-all’ approach to marketing, so the challenges facing the procurement function will increase”

As companies seek to embrace the principles of servitisation by augmenting and enhancing the product/service offer, new partnerships will inevitably need to be forged with vendors who have the necessary skills and capabilities to complement those that exist within the business. This trend will be further reinforced by the growing customer demand for tailored solutions. As we move away from the ‘one-size-fits-all’ approach to marketing, so the challenges facing the procurement function will increase.

It can be argued that the focus of procurement will need to switch from sourcing products and services to sourcing outcomes. Outcomes are measured in terms of performance, particularly through adding value to the organisation’s customers. This idea is at the heart of what might be termed value-based procurement, the objective of which is the identification of those sources of supply that can fulfil a need, whilst encountering the lowest cost of ownership, i.e. to maximise the ratio.

Outcome/Total Cost of Ownership

As organisations make the transition from cost-based to value-based procurement, relationship management with suppliers will take on a new emphasis. In many cases, the business will become more dependent on its network of suppliers to provide the innovation and knowledge necessary to enable the delivery of a wider range of solutions to its customers. Hence, the focus of supplier relationship must be on establishing and maintaining a culture that will encourage and sustain this transfer of knowledge.

Previously, organisations were predominantly structured and managed with the objective of optimising their own operations, with little regard for the way in which they interacted with suppliers. The business model was essentially ‘transactional’, meaning that products and services were bought at an arm’s length and there was little enthusiasm for developing longer-term, mutually dependent relationships.

The new competitive paradigm is in stark contrast to the conventional model. It suggests that, in today’s challenging market place, the route to sustainable advantage lies in managing the complex web of relationships throughout the supply chain in a cost-effective, value-creating network.

The key to success in this new competitive framework, it can be argued, is the way in which this network of alliances, suppliers, intermediaries – and sometimes competitors – are welded together in partnership to achieve mutually beneficial goals. Orchestrating the supply network is at the heart of value-based procurement, and it reflects the fundamental principle that the network is the competitive vehicle today – not the individual company. When competing as a network, it becomes apparent that the aim should be to maximise collaborative advantage rather than competitive advantage in its traditional, single, firm meaning. To achieve collaborative advantage and to leverage the collective competencies and skills across the network means that knowledge must be shared and harnessed. It is this realisation – that the organisation no longer stands alone – that is prompting organisations to re-examine their approach to supplier relationship management. In this new world, the role of procurement is to seek out opportunities for the co-creation of value across the network of which the organisation is a part.