The article below is written by Robert den Braber on July 7, 2011

For companies that focus on innovation as a key business driver, tapping into the supply chain for innovation remains a challenge. Surprisingly, there has hardly been a role for Procurement to enable this, even though Procurement is regarded as the interface with suppliers. What should Procurement do to take this role successfully and contribute to innovation?

Markets develop towards more open innovation

Most industries increase the outsourcing of non-core activities: the average percentage of revenues procured externally has risen to over 60% in the last decade due to increased outsourcing. In addition, companies are increasingly outsourcing critical business functions, including the outsourcing of R&D to the supply base. In some industries, where 70-90% of products are sourced from suppliers, the majority of products is actually designed and developed by these suppliers. This has resulted in an increase in the complexity of supplier relationships.

The increase in outsourcing coincides with an increased openness of innovation processes. Companies are finding it more and more difficult to keep up with the pace of innovation through internal R&D alone. Intelligently tapping into knowledge bases of (amongst others) suppliers speeds up the process of innovation and reduces total cost. To manage a greater dependency on supplier innovation, Procurement departments have been moving towards stronger partnership models with a limited set of key suppliers. These partnerships are based on shared risks and rewards instead of traditional transactional relationships. But strong supplier relationships alone are not enough and a limited set of (incumbent) partners is not necessarily a good source of innovation. To leverage that relationship Procurement needs to feed end customer needs into the supply base.

Challenges for Procurement

The move towards open innovation creates the need to leverage and manage the innovation capabilities in the supply base, to:

  • Deliver more innovations
  • Accelerate design and launch cycles
  • Improve quality
  • Meet intensified cost/risk reduction demands

These are not the usual Procurement KPI’s, with the exception of the cost/risk reduction demands. The economic downturn has only increased the emphasis on traditional KPI’s such as cost. Because of this focus, Procurements’ involvement in innovation is limited to work on cost/risk reduction by sourcing and contracting suppliers. In practice, this means Procurement is involved once all specifications are set in stone and the innovation is ready for ramp-up. This is characteristic for silo-thinking in which departments/silos are involved one at a time in order to add their value. Siloed-thinking has remained while the innovation processes have become more open and collaborative. Although usually working in team structures, silo-thinking remains prevalent within departments and people. The result is a very linear process with hand-overs to the next department, with a fresh set of specific targets in every step.

The hand-over to Procurement usually occurs well after supplier involvement by R&D and beyond a point where a significant impact can be made on cost reduction and value creation of the product. At this point it is too late to deliver new innovations or significantly increase development. The only variables remaining are cost and risk reduction, and even these have been compromised; Procurement can no longer fully influence cost or risk as the specifications are largely set and suppliers have been deeply involved in the design process. Furthermore, traditional Procurement targets (such as savings, security of supply, contract coverage and compliance) conflict with project targets which may compromise the value of the end product for the customer. Delays are likely to occur through these conflicts or unrealistic expectations of supply chain capabilities.

For Procurement to break free from this situation, it should obviously ensure earlier involvement. However, Procurement in its traditional form is not capable to handle the ‘chaotic’ processes found in early innovation stages. Making a true contribution to innovation processes requires Procurement to redefine its business model. This will enable them to tap into supply base capabilities and manage supplier involvement.

Traditional versus Innovation Driven Procurement

The difference between traditional and Innovation Driven Procurement is best explained with a simple example. Say you are looking for a home espresso machine that serves you the perfect cup of coffee in the morning without a hassle. You will have a wide range of needs and criteria the product must meet such as newness, appeal, reliability, value for money, etc. As we live in an open innovation world, we would expect the producer to combine internal know-how with the latest technology available in the market to create the best product for your needs. The producer in fact manages a system of solutions including the design, the pressure system and coffee packaging from a wide array of suppliers. The innovation process of this espresso machine will look completely different for the two Procurement business models.

Traditional Procurement

To deliver this kind of machine, the traditional producer has started an extensive innovation project. This begun with efforts by Marketing & Sales to understand your needs, and R&D trying to develop this. As we are in an open innovation domain, R&D will have worked with suppliers or even players from completely different industries to develop a new espresso system. In this traditional Procurement setting there will have been no involvement until there was a complete picture of the future product and its specifications. Procurement would then be asked to deliver its services. The internal clients’ needs are often specified in terms of contracts, savings, security of supply, etc. Procurement in other words is expected to negotiate a good deal to drive down total cost and risk. As we have seen before, this may cause serious conflicts as the specifications are largely set and freedom of choice in the supply base is limited. The best Procurement can do now is to set up multi-disciplinary teams to discover what the internal clients’ needs are and make the most out of it. To do this, Procurement connects with (potential) suppliers and conducts sourcing activities, negotiates contracts and puts the operational processes to work. If conflicts occur (i.e. a part cannot be sourced at a decent price), it will be forced to push the innovation project back into the design phase. This may compromise specifications, the total cost and the time-to-market. The end result is that you will eventually find your “traditional” espresso machine on the store shelves at a reasonable price. But you’ll probably have lost interest in it because it was overtaken by a competitors’ machine before it even came to market.

Innovation Driven Procurement (IDP)

The IDP producer will also listen to your needs as a potential customer through Marketing & Sales. But now it’s not just R&D who’s listening in; Procurement has joined the project from day one. This enables Procurement to thoroughly understand the external clients’ needs and to assist R&D with the development effort. Now that Procurement knows what to look for, it can connect the supply base with R&D and at the same time work on a sound supplier involvement strategy (reducing the risk of conflicts). The team setup above changes the partner structure of Procurement; it now consists of both suppliers and the “internal clients” in the entire innovation process. With involvement in innovation, Procurement must match its activities to early innovation stages. This still includes cost awareness, but there is much greater focus on scouting supplier markets, enabling supplier involvement and managing supplier inputs in the project. All of these are focused on the wide range of targets of the external client. In later stages traditional Procurement activities come back into play to operationalize the new product, but the real value is created in the earliest stages. The end result here is that you’re the proud owner of the “IDP” espresso machine standing on your kitchen table.

Impact of Innovation Driven Procurement

Involvement in innovation exceeds merely involving Procurement earlier. A change of attitude and perspective of Procurement must be embedded in the governance of the organization. The role of Procurement in innovation projects changes, and the way Procurement is managed is clearly different from Traditional Procurement as it breaks through functional silos. This means companies need to review decision making protocols, process design, target setting, leadership involvement, team structures, competences and information flows.

This will enable Procurement to drive much more value from the supply base, while improving time-to-market, collaborating internally and creating a better focus on the end product. In other words, it enables Procurement to make a significant contribution to innovation and the bottom-line.

Robbert den Braber

Management Consultant

Procurement Transformation