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1、Industrials&Electronics PracticeHow medium-size enterprises can better manage sourcing Small and medium-size enterprises often struggle to find procurement cost savings.Yet there are ways to do it while still pursuing growth and providing a superior customer experience.September 2023by Deepanshu Cha
2、wla,Ryan Fletcher,and Stijn Tollens CHUNYIP WONGHow medium-size enterprises can better manage sourcingIt is an age-old question that has confounded companies big and small:how can we reduce external spending without harming supply chains or sacrificing the quality of our products and services?The qu
3、estion becomes more relevant in times of economic uncertainty and high inflation as large companies take drastic cost-cutting measures such as reducing office space or scaling back on investments.1 While large companies can usually drive procurement cost savings with relative ease,small and medium-s
4、ize enterprises(SMEs)typically lack the necessary scale despite being the backbone of many economies around the world(see sidebar“The critical role of SMEs”).When it comes to procurement,SMEs often do not have the same purchasing power with suppliers that larger companies do because SMEs lack scale
5、and often have a single source of supply,rendering them unable to seek pricing that is more competitive.Moreover,SMEs sometimes lack focus or the wherewithal required to rein in spendingand when they do,value capture is often slow,prone to stagnation,and mostly ad hoc,resulting in incomplete,subopti
6、mal,or even unintended outcomes.So what factors prevent SMEs from undertaking a procurement transformation that goes beyond spending cutsone that helps simplify,realign,and strengthen the organization to help it grow and provide a better customer experience?Is there an approach or framework that SME
7、s can use to regain control of their budgets and external spending in a way that doesnt harm productivity or diminish morale?There isas long as CFOs,chief procurement officers(CPOs),and COOs are willing to be innovative,make hard and timely decisions,and take necessary steps to transform their busin
8、esses.What stops companies from reining in external spending?In the United States and Canada,according to McKinsey analysis of data from S&P Global,companies with less than$3 billion in revenue represent 86 percent of total enterprises and 26 percent of total revenue(Exhibit 1).Perhaps unsurprisingl
9、y,the largest corporations(those with annual revenues of more than$5 billion)contribute the biggest chunk of revenues,while those with 21 Mark Maurer and Jennifer Williams-Alvarez,“Companies weigh fresh cuts as operating costs go up,”Wall Street Journal,August 3,2022.The critical role of SMEsSmall a
10、nd medium-size enterprises(SMEs)include a broad range of businesses that have revenues,assets,or a number of employees below defined thresholds.Each country has its own definition of what constitutes an SME.In the United States,the Small Business Administration(SBA)classifies small businesses accord
11、ing to their ownership structure,number of employees,earnings,and industry.For example,in manufacturing,an SME is a firm with 500 or fewer employees.SMEs generally exclude large multinationals,state-owned enterprises,and conglomerates.Despite their size,SMEs play an important role in the economy,emp
12、loying large numbers of people and helping to shape innovation.According to the SBA,SMEs contributed 43.5 percent of US GDP in 2023,paid 39.4 percent of the countrys private payroll,and created seven million more new jobs than large businesses did from 1995 to 2020.1 Governments regularly offer SMEs
13、 incentives,including favorable tax treatment and better access to loans,to help keep them in business.1 “Frequently asked questions about small business,”US SBA,March 2023.How medium-size enterprises can better manage sourcingannual revenues of less than$1 billion make up the largest group of compa
14、nies.But while SMEs account for a significant slice of total revenue,a broad range of factors are limiting their ability to implement meaningful procurement cost savings in a way that not only boosts profits but also transforms companies along functional lines and prepares them for future shocks and
15、 economic downturns.Overcoming these limiting factors would be prudent,given the precedent set from 2017 to 2022,when smaller companies struggled most to maintain margins(Exhibit 2).The COVID-19 pandemic and the subsequent inflationary period have created challenges for companies of all sizes,but in
16、 aggregate,the biggest companies saw a much less dramatic drop in net income in comparison and have fully recovered or even exceeded prepandemic margin levels.With the benefit of hindsight,it would have been optimal for SMEs to have had cost-cutting and procurement strategies in place before the pan
17、demic,cushioning the blow from disruption in supply chains.However,the following example of a midsize company that produces residential components and fortuitously initiated a cost transformation program right before the COVID-19 3Exhibit 1Article Exhibit of 1Based on 2021 revenue,excluding identifa
18、ble subsidiaries.Source:S&P Global;McKinsey Corporate Performance Analytics North American enterprises with less than$3 billion in revenue represent 86 percent of total companies and 26 percent of total revenue.McKinsey&CompanyTotal company revenue by revenue range,1$billionNumber of companies by re
19、venue range1Revenue range,$billion5.014.03.02.01.00.50.386%7001,47814,4552,2392,21746626%8672,0951,5561,104How medium-size enterprises can better manage sourcing4Exhibit 2Article Exhibit of Net margins for US public companies by revenue size,201722,%Source:S&P GlobalThe smallest US public
20、 companies found margins hardest to maintain from 2017 to 2022.McKinsey&Company20022200222012$0.3 billion$0.5 billion$2 billion$3 billion$0.5 billion$2.0 billion$3 billion$5 billion$5 billion+outbreak illustrates how SMEs can mitigate risk by using better
21、procurement strategies.In this case,the company had long-term contracts in place for most of its business-critical external spending and reserved dedicated capacity with its top suppliers.It renegotiated better payment terms,identified and developed additional supplier sources to derisk its supply c
22、hain,and dynamically optimized sourcing decisions and logistics operations.These measures helped the company avoid some of the supply chain issues experienced by many SMEs during the pandemic.It also helped after COVID-19 containment measures were eased,when demand spiked and supplies ran short.Over
23、all,we find that five major drivers often hold SMEs back:a lack of spending transparency,a myopic focus on the short term,talent gaps,underused digital tools and automation,and exclusion of procurement and supply chain in business decisions.A lack of spending transparency Spending transparency means
24、 having full visibility into all relevant external expense information,revealed in a timely and systematic manner.While spending transparency is not new to the business sector,few SMEs adequately track and regularly reassess their spending.They often arent equipped with a dynamic spending database t
25、o How medium-size enterprises can better manage sourcingserve as the single source of truth for functions such as procurement.This is partly because small and midsize companies often underinvest in process improvement,have a plethora of legacy enterprise-resource-planning systems,or find implementat
26、ion cost prohibitive.As a result,SMEs often fail to identify basic price variances,hurting competitiveness and margins.For example,margins for a midsize industrial company that operates in North America and Europe plateaued 30 to 40 percent below peer companies;inefficient sourcing was one of the ma
27、jor contributors to the companys margin reduction.Competitive procurement has its foundation in full spending transparency.Poor spending transparency can lead to value loss and ineffective budget management.With greater spending transparency,CPOs can effectively manage external costs,exercise greate
28、r control as the situation demands,and better understand risks to supply chains.A myopic focus on the short term Unlike large companies,which employ long-term strategies for most major spending categories,SMEs often fail to strategically align their business functions with procurement categories.Buy
29、ers focus the most on transactional efforts and work with single supplier sources with limited leverage and low committed volumes.As a result,supplier relationships tend to be transactional in nature as well and not focused on long-term partnerships,making suppliers reluctant to offer contracting di
30、scounts to SMEs.Moreover,the lack of a reliable demand forecast creates challenges for establishing longer-term cost savings.However,the deeper problem is centered on inefficient sales and operations planning,which directly affects supply chain strategy.SMEs could put more effort into planning and f
31、orecasting,which can enable long-term category and supply chain risk management.Talent gapsIts not uncommon for procurement managers at SMEs to spend most of their time dealing with supply disruptions.The cause of supply chain issues can be partially ascribed to a lack of the entrepreneurial or stra
32、tegic mindset required to help derisk the supply chain.These issues can also be attributed to a lack of strategic direction at the executive levelfor example,in setting target KPIs for the share of spending that is dual sourced or for average miles traveled for supplies.First and foremost,however,SM
33、Es often face challenges in attracting the right talent.SMEs often fail to identify basic price variances,hurting competitiveness and margins.5How medium-size enterprises can better manage sourcingWhile a lack of brand recognition could hinder hiring,SMEs often source talent without a strategic mind
34、set.When it comes to hiring for a procurement function,the experience and skill sets required to make a strategic impact are often not part of the job requirements.The traditional mindset of SMEs is that experience or exposure to a category family is the main requirement for category manager job can
35、didates.To hire the best team,however,companies might consider candidates with track records of bringing about change at the organizations theyve worked for or candidates with more diverse profiles that have skill sets outside traditional category management,such as data scientists,to find ways for
36、procurement to drive broader business value.Procurement managers could also be empowered with greater analytics capabilities to address the complexities of their job.Along with buying roles,various other support roles could be introduced to best manage external spending.Data analysts,for example,cou
37、ld perform activities such as category analytics,spending intelligence,predictive analytics,and running advanced-analytics models of business relevance.Procurement organizations that are more advanced can even look to include software engineers and scrum masters to help develop customized automated
38、business solutions,such as commodity indexing and forecasting supply chain disruptions.Underused digital tools and automationHigh-performing category managers at large organizations spend much of their time finding ways to propel value for the business through negotiations and supplier-sourced innov
39、ation.In contrast,category managers at SMEs tend to spend their days handling transactional work and managing disruptions.Inefficient workflow patterns at SMEs often evolve because repetitive processes are still carried out manually rather than being automated.In contrast,large companies have often
40、digitalized procurement,thereby effectively managing costs and avoiding value loss.Legacy systems are still commonplace in SME organizations,and smaller companies often lack resources to continuously improve system infrastructure and tools.Exclusion of procurement and supply chain in business decisi
41、onsThe role of CPO at many SMEs is still limited to category and supplier performance management.Accordingly,the CPOs role in an organization should evolve to become that of business enabler and driver of customer value.The CPO should be a partner to engineering and marketing functions from early pr
42、oduct development stages.The evolution of the role will require new skills,including strategic thinking and problem-solving abilities.A minor change in roles and responsibilities can not only help better manage cost of end products but also get an organization ready for the future.An action plan for
43、 procurement cost savingsNo easy fix exists when it comes to external spending optimizationand addressing just one challenge is unlikely to make a transformative difference.However,five interconnected strategies can help SMEs identify procurement cost savings opportunities:establishing center of exc
44、ellence(CoE)teams,improving forecasting,expanding the use of digital procurement tools,gaining greater market intelligence,establishing a culture of and processes for continuous cost optimization,and incorporating supplier-driven product improvements.In addition,SMEs can consider several structural
45、changessome that would echo those of their larger corporate counterparts,and others that would capitalize on the strengths of SMEs(see sidebar“Further actions to enable next-gen procurement”).Establishing CoE teamsEstablishing a CoE team to support sourcing teams is now the norm at advanced procurem
46、ent organizations.The focus of CoE teams is to empower buyers with deep category analytics and negotiation support.They perform category market analysis and supplier profiling,create fact packs and negotiation playbooks for supplier discussions,and develop component“should cost”models to provide gre
47、ater cost transparency and buying leverage.One reason for value loss at procurement organizations is a lack of understanding of the full opportunity 6How medium-size enterprises can better manage sourcingpotential for a supplier and supporting facts during price negotiations.CoE teams can lay the gr
48、oundwork for establishing short-and long-term strategies at the category and commodity levels.Improving forecastingA dedicated centralized planning team that works with the procurement team can be another value add and can forecast demand at the SKU,business unit,or product levels,with input from op
49、erations and marketing.Furthermore,they can provide transparency in future award timing and volumes.Suppliers become long-term partners with a stable forecast of business and are more willing to collaborate with companies to find cost opportunities.The planning team can also answer questions about m
50、inimizing risk through dual sourcing versus single sourcing of components,request-for-quotation strategies and frequencies,annual negotiations,and local sourcing versus best-cost country sourcing.Expanding use of digital procurement tools Digital tools can help make processes more effective and effi
51、cient by improving communication and efficiency across operations while reducing the manual workload on procurement managers.Digital procurement tools are also affordable and can elevate the standards of SMEs to match large corporations in terms of internal capability.While there is no one-size-fits
52、-all approach to digital procurement,successful organizations are experimenting with digital innovation,sometimes designing custom solutions.Examples of leading digital procurement tools include spend intelligence tools,e-sourcing solutions,e-auctions,parametric 7To regain control of spending and cr
53、eate cultures of continuous improvement,small and medium-size enterprises(SMEs)need to overcome several major hurdles,which can take significant time.Successful SMEs often take several actions that span structure,operations,and strategy.Transformation office.A dedicated central team can help ensure
54、cost transformation is realized.This team can manage an idea bank,set up idea generation sessions,organize regular troubleshooting meetings,organize governance meetings,conduct implementation follow-up sessions,and closely track achievement.Cost control cell.A cost control cell is a governance team
55、that reviews and approves all price changes.Governance.Implementation remains key to any transformation.We recommend holding regular governance sessions with middle and senior management.Cost savings targets.Continuous improvement requires a change in culture.Setting year-over-year cost savings targ
56、ets is an important step on the transformation journey,helping to update the workflow of category managers,which involves moving from day-to-day management to proactive contract negotiations.Incentive plan.An incentive plan acts as a key motivator for timely execution and helps justify the additiona
57、l responsibility for managers.Central data repository.Effective data management is critical to sustainable cost improvement.Organizations can miss out on opportunities if a central repository is not maintained.Upskilling.With continuous changes in technology,it is important for teams to understand a
58、nd leverage all available skills and resources.Further actions to enable next-gen procurement transformationHow medium-size enterprises can better manage sourcingshould-cost models,automated contract analysis and management,and negotiation simulation for capability building.Investment in digital too
59、ls can also prepare SMEs for long-term sustainable operational efficiencies while keeping their spending in check.Taking a more data-driven approach,especially for SME manufacturing organizations,has exponential benefits because digital applications can play a major role.For example,e-auctionsonline
60、 auctions with potential suppliershelp eliminate the need for multiple rounds of negotiation with suppliers and increase transparency of the business award process for both buyers and suppliers.Gaining greater market intelligence Market intelligence can include product changes,supplier market dynami
61、cs,material price changes,tariff changes,global and national policy changes,total capacity utilization,currency fluctuations,and other variables.For example,by carefully tracking market fluctuations,SMEs can prepare buying strategies that are more resilient in the face of external disruption.Market
62、intelligence can also lead to greater transparency with core supplier partners,empowering buyer organizations and providing greater visibility to suppliers,which are focused on growth and future readiness.For instance,a North American SME used market intelligence to develop a cost savings model to a
63、id in the procurement of steel for fabricating products,sourced from countries across Asia and Latin America.The model used different indexes(such as freight and raw material)to provide data on the best total landed cost for steel products from various suppliers and is now considered by category man
64、agers to be a robust solution for making informed supply chain decisions.Establishing a culture ofand process forcontinuous cost improvementLarge organizations work to generate cultures that encourage continuous cost optimization.SMEs could start by holding internal workshops at regular intervals to
65、 create“idea banks”that map out opportunities.These workshops can be run at the product family or supplier level.At the same time,SMEs could define their own procurement cost-cutting programs and communicate these programs to internal stakeholders,including product design,manufacturing,and quality t
66、eams,to identify potential opportunities to reduce costs.Companies will likely find it necessary to work closely with their long-standing supplier partners to find procurement cost savings,given the impact of component price on margin and,ultimately,what the customer pays.SMEs have limited resources
67、 available,so prioritizing efforts to capture the value identified is necessary.SME leaders might also consider a five-step“escalatory ladder”to generate fast procurement savings with minimal effort(Exhibit 3).Developing an“external spend cube”that is,a structured data set of the firms spending patt
68、erns with external suppliersand a specification library for top procurement categories could also help when establishing a cost savings performance baseline,generating cost-saving ideas,shaping category strategy,and identifying synergies across business units.Companies can define short-term and long
69、-term opportunities by category and develop an understanding of the effort required to carry them out.As savings accrue,companies can focus their attention on the sustainability of savings through cost control cells and governance mechanisms dictated by upper management.Incorporating supplier-driven
70、 product improvementsMore SMEs could work with their suppliers to drive product improvement.As many companies look to outsource their manufacturing and maintain only key process steps in-house,suppliers now have a significant stake in the end product.Therefore,it is important to involve suppliers in
71、 product development and enhance the free flow of ideas about product improvement.SMEs can entice supplier participation in product optimization 8How medium-size enterprises can better manage sourcing9Exhibit 31Best alternative to a negotiated agreement.2Least acceptable agreement.3Most desirable ou
72、tcome.4New product development.Source:McKinsey analysisMcKinsey&CompanyProceed only if target not achievedSet aspiration Develop spend cube or spec librarySize potential opportunity for each category by using latest advanced spend analytics1Targets established(BATNA,1 LAA,2 MDO3)Mock negotiationsEfe
73、ctive conditioning and follow-upReview top spend outsourced partsAssess available capacity and capabilitiesRapid renegotiations with top suppliersMake-vs-buy analysis2Validation of suppliers and production partsConsolidation of SKUs and modularizationClearly established approval process and validati
74、on requirements Shared or dedicated resourcesRobust governanceEnsure engineering uses only catalog parts and standard modules as much as possible for NPD4 and product refreshes5Build spec catalog to enable market engagementCritical-to-quality parametersDrawingsInventory requirementsSupplier selectio
75、nBusiness requirements3Conduct request-for-quote(RFQ)roundsBuild parts catalogComprehensive RFQ with target prices High-touch cultivation with suppliersSupplier selectionSupplier auditsUse sourcing events to obtain supplier input on SKU reduction4RateDesignIncreasing resource intensityCritical-to-qu
76、ality parametersDrawingsInventory requirementsSupplier selectionBusiness requirementsHow medium-size enterprises can better manage sourcingDesigned by McKinsey Global PublishingCopyright 2023 McKinsey&Company.All rights reserved.Deepanshu Chawla is a knowledge expert in McKinseys Gurugram office,Rya
77、n Fletcher is a partner in the Southern California office,and Stijn Tollens is a partner in the Stamford office.programs through an incentive program,which shares the gains of supplier-driven initiatives with the supplier.Not only can a program optimize specification,but overall,products can also be
78、 improved by supplier-side innovations.For example,suppliers for an industrial-machinery manufacturer suggested that the manufacturer adopt new compressor technology.Newer compressors were energy efficient but came at a slight premium.But in the long run,the new compressors helped the company to dif
79、ferentiate its product offering and entice new customers.Cost transformation is never easy,especially for SMEs.It requires a concerted effort on the part of CFOs,CPOs,and even CEOs.However,if done correctlyfocused particularly on procurement automation,strategic sourcing,and structural changescost t
80、ransformation can generate significant savings and boost profits.But for organizations to make meaningful,effective change,they must stay ahead of the curve.Simply responding to crises and wielding the budget knife,without ensuring business units are aligned and implementing improved processes,will only postpone what needs to be done.10Scan Download PersonalizeFind more content like this on the McKinsey Insights App