Procurement in value chain model
Procurement defines activities related to acquiring goods and services. The principle activities are to identify requirements, and find product supply chain. This process consists internal and external communications. The company’s internal interactive communication defines requirement, while external interactive communication determines product and supply service chain. Market research, vendor evaluation, and contract negotiation are some of external communications. Purchasing defines activates related to ordering and receiving goods. It is a subset of the procurement process (Purchaing Insight 2012). This paper intends to explore procurement and purchasing concepts in one entity.
A firm performs a series of activities before producing the final product or service to the buyer. The goal of these activities is to generate profit. In other words, the sum of all activities can be expressed through some monetary value. This value is defined as cost. The goods or services are sold to customers after adding some extra value to cost. Michael Porter in his book Competitive Advantage developed generic sequences of activities, which can be applied to the wide range of firms. Porter named the overall sequences as value chain (NetMBA n.d.). Porter’s main goal was to organize the business system into a series of activities through which an organization develops a competitive advantage and shareholders value (NetMBA n.d.). From manufacturer assessment sum of activities has cost. Firms make a profit by adding a margin to the cost. From consumer's opinion, the value of a product and service is how much they pay for the quality. Consumer’s opinion is based on perceptions what is received and what is given (Oh, 2000). The value of the product or service has to satisfy both producer and consumer. We can express this idea through the equation, Value = Quality – Price. This equation conceals Porter’s concept of company’s profit from value chain model and consumer’s opinion of receiving exceptional value at a competitive price. Firm’s benefit is margin added to the value chain activities. Consumers’ perception of value is to pay low for a quality of product or service.
Value chain model identifies two types of activities: primary and support (NetMBA n.d). Primary activities consist of inbound logistic, operations, outbound logistic, marketing & sales, and service. These basic activities are supported by infrastructure of firm, human resource development, technology development and procurement (NetMBA n.d.). Porter defined procurement in this model as a support activity.
Procurement in shared value model
Michael Porter explained that modern day business could not be successful by focusing only on creating demands of its products (HBR.ORG 2011). Modern day business also needs a healthy community and supportive environment. At the same time, a community needs a successful business that would provide jobs, create opportunities, and build wealth. Porter reminds that capitalism is an exceptional system for meeting human needs, creating jobs, and building wealth. However, recent years business activities show that it has become a leading cause of economic, social, and environmental problems. Is capitalism under siege, or it cannot create wealth to solve societal issues? The solution, according to Porter is in bringing the business and society together, creating shared values. Shared value concept does not call the business to participate in charity, or taking social responsibility.
It is a new way to achieve economic success. Companies like Google, IBM, Intel, GE, Johnson & Johnson, Nestle, Wal Mart and Walgreens have started to develop shared values between society and corporate performance (HBR.ORG 2011). These companies recognize that tackling social problems as core business objectives could generate economic growth. Forty percent of total work force at Walgreens largest distribution center located at South Carolina consists of physically and mentally disabled persons (Walgreens n.d.). This is an example of shared value. Other supply chains like Best Buy, Procter & Gamble, Lowe are planning to adopt Walgreens shared value concept in their business. Porter explains shared value as company’s policies and practices that enhance its competitiveness while advancing social and economic conditions of community in which it operates (HBR.ORG 2011). This implies that the company needs to have a deep understanding of social problems and their relationship with the business. A firm can achieve competitiveness thru shared value concept in three ways: reconceiving products and markets, reconfiguring value chain and establishing local cluster development (HBR.ORG 2011; FSG n.d.). The first approach requires finding solution thru products and services. Wels Fargo developed tools and products help customers mange budget, pay credit and debt. IBM and Intel invented digital intelligence help consumers make saving on power usage. GE made significant revenue growth on Ecomagnition products. The second addresses the issue by consuming natural resources as efficiently and productively as possible.
Wal Mart has reduced carbon emission and saved $ 200 million in cost by reducing packaging and delivery rerouting. Implementing innovation in logistic saved British retailer Marks & Spencer 175 million British Pounds (HBR.ORG 2011). The third encourages investing outside the company’s operations that are connected with the productivity potential and company’s growth. Yra, the largest mineral fertilizer company first recognized the farmers’ societal problem as the lack of good transportation infrastructure in many parts of Africa. The company is handling this problem investing $ 60 million to improve roads and ports. This program will help Mozambique and Tanzania agricultural growth corridors.
The core concept of Porter’s value chain model intends to develop the company’s competitiveness. Reconfiguration of the value chain is a way to address the shared value issue. Energy use, logistic, resource use, procurement, distribution are parts of activities in the value chain. All activities in the value chain are also at the same time, are shared value issues. In shared value concept, procurement is not a support activity but a strategic issue. This new strategy is aimed to increase productivity and thus competitiveness; hence, procurement also becomes a strategic issue in the context of shared value.
Procurement concept changes during globalization
In small or large companies, procurement was always an essential part, but it was not viewed as prestigious. In the increasingly globalize economy, and in today’s economic conditions conventional procurement theory and practice do not yield beneficial results. Procurement organizations within companies are now plying significant role because only improving performance cannot anymore produce satisfactory and cost effective results. In recent years, procurement organizations are now looking towards adopting the philosophies, methods, and processes that would deliver a competitive product or service to the consumer. Today’s procurement encompasses procurement strategy, procurement operations, and procurement performance measurement (Logistic Bureau n.d.). Recent years economic activities indicate that procurement strategy is of paramount importance. Today’s economic conditions consider procurement on a global basis. Hal Sirkin, the senior partner and Managing Director at the Boston Consulting Group has mentioned that in recent years, procurement has taken greater strategic importance, and it will receive greater weight in the years to come (Knowledge Wharton n.d.). Procurement strategy combines three things together: product, process, and location. In a global environment, outsourcing has become a new strategy in product location. Outsourcing for the benefit of outsourcing cannot reach competitiveness unless it is investigated along with important parameter savings. If we use Porter’s value chain concept in outsourcing, we can detect other parameters in product outsourcing chain. Hal Sirkin indicates in outsourcing strategy product quality has to be a viable in price saving (Knowledge Wharton n.d.). In today’s global environment design and implementation of supply chain, its review and deployment are parts of procurement strategy. Purchasing, Inventory Management, Forecasting are parts of procurement operation. Purchasing performance has become a vital aspect to remain competitive in today’s economy. Firms need to establish performance benchmarking, procurement metrics and performance measurement system. In the past few years global sourcing has been of an economic concern. Companies find that the supply chain issue has often been underestimated by not considering all other elements of the value chain. Companies paid more attention to the low acquisition cost, rather than entire supply chain cost (Logistic Bureau n.d). Companies observed the following anomalies in outsourcing: low responsiveness of supply chain, increasing logistic cost, unstable supply, quality and environmental concerns, inadequate supply chain coordination, lack of genuine partnership, lack of consistent performance (Logistic Bureau n.d.).
Procurement challenge: Supply chain management
In today’s economy, procurement supports strategic objectives of the organization. Initial goal of a business management is to attract independent resource to the organization to support its activities. This business management applies the knowledge and experience to ensure effective and efficient resourcing, and this is called strategic procurement. Strategic procurement can influence entire business. Strategic procurement is the success concept of McDonald’s, Wal Mart, Toyota, and Dell. The key lever of strategic procurement is supply change management (boozallen n.d.). In today’s economy, global supply chain is growing, and its management plays a crucial role. Supply chain management incorporates sourcing and planning the procurement, conversion and logistic organization to fulfill customer’s request; integrates demand and supply management within and across companies. The objective of supply chain is to maximize overall value. Value defines delivered products' usefulness to the client and costs activities of the supply chain. This opinion reflects Porter’s value chain concept. Porter in 1985 introduced the concept value chain (boozallen n.d). Keith Oliver, a consultant at Booz Alien Hamilton, UK, first introduced the supply chain concept in 1982.
Two key elements of supply chain are information and products or materials. One does not exist without the other. The principle characteristic of supply chain is it starts from the customer and ends with the customer. It integrates the following steps: consumers and their insight, demand and planning, purchasing, manufacture, order management, distribution, and supplying product to the customer (ning.com n.d.). This complex activity requires different management principles; optimize simultaneously costs, service, and agility; make supply chain process multi functional; continuous improvement by discovering key performance indicator; apply strategic, tactical, transactional, and physical managements (ning.com n.d.). Supply chain management and application of shared value to it is the strategic challenge of today’s procurement. Figure 2 displays shared value concept embedded in supply chain management idea. Three key components are compliance, sustainability, and creation of shared value.
Strategic approach of supply chain management requires compliance with the highest standards, meeting today’s need without sacrificing future generations need, creating shareholders and societal value in business. Nestle supply chain management activities between 2001 and 2011 show 17 % reduction of Green house gas emission, 58 % per ton water withdrawals reductions, 42 % per tone energy consumption reduction, renewable energy consumption rose 12 % of total energy consumption, 64 % reduction of water discharge per tone of product (ning.com n.d.). Nestle in Bangladesh was able to use above strategic pyramid in arranging honey supply. Nestle worked with the local NGO Porishka in arranging honey supply. Porishka management agreed on Nestlé requirement and GAP assessment, made development plan from cultivation of land in arranging delivery of honey to Nestle plants. Farmers and agricultural officers jointly developed use of fertilizer based on soil properties, limit pesticide use for bee visits. Cross pollination due to the visits of bee increased crops production, fruit production, mustard seed production. Farmers could make more money by both honey production and crop production. The above is a good example of supply chain management with shared value concept (ning.com n.d.).
Aforementioned study and analyses presented three concepts: value chain, shared value, and supply chain management. In 1985, Michael Porter derived value chain concept to explain competitiveness. His value chain model characterized all activities in two categories: primary and support. He classified procurement in support category. In 2011, his work How to reinvent Capitalism classified procurement as a strategic element. This work thru the study of the value chain, shared value and supply chain management evaluated cause of Porter’s opinion change.
Figure 3 shows the key schematic of procurement job. All activities of procurement job are embedded in developing a supply chain. The traditional procurement method used local supply chains. With the globalization of the world economy and competitiveness, companies started using outsourcing of supply chain. Procurement did not pay attention to the strategy, rather to low cost. However, time proved it was a wrong step. In the context of current economic trend, it is not enough to locate a cheap supply chain. Today’s economic environment demands procurement to be strategic. This was explained in the value chain management section along with the example of honey supply arrangement by Nestlé in Bangladesh.
Indeed, the place of procurement is no more a support activity, rather a strategic in the global economic environment. This enabled Michael Porter to see procurement in strategic light than just a support activity.