Why Investing in Procurement Makes Organizations More Resilient

by Rafael Ramírez , Ciaran McGinley and Steve Churchhouse - June 17, 2020

For decades, we’ve placed efficiency at the center of strategy: We’ve run operations as close to full capacity as we can. We’ve ordered from suppliers in ways that are tightly aligned with our production schedules. We’ve worked hard to minimize costs, “sweating assets hard” under the guidance of the CFO, and we’ve delivered financial returns on a quarterly basis. In many ways, this is a system that has worked remarkably well. But as the COVID-19 pandemic has made painfully clear, it has a major flaw: It doesn’t help firms develop resilience.

That’s going to have to change. To survive times of crisis and thrive over the long term, firms will need to shift their strategic thinking from just-in-time to just-in-case.

We’ve known this for a while, even if we haven’t done much about it. The 2008 global financial crisis revealed the potentially catastrophic dangers of running banks as efficiently as possible, with a minimum of reserves. In the aftermath of that crisis, regulators mandated that banks hold bigger reserves, to improve their resilience. This represented an important reform, but in most countries, it was taxpayers who paid for this change, which let bank owners and their customers off the hook. Not surprisingly, the banks therefore felt that the change could be folded in as a cost of doing business, and efficiency in that sector remained the name of the game - as it did throughout private industry.

Things are different now. Governments around the world have printed and distributed so much money to save failing businesses during this pandemic - roughly $15 trillion through the end of May - that they have now acquired a major stake across every sector of the economy. In the years ahead, this will profoundly change the nature of the dance that’s done between public and private sectors. Now that the public owns so much debt in private firms, it will develop a growing urge - and a growing ability - to orchestrate what happens in the market. State involvement at this new level will mean new values. Think, for instance, about how much broader your expectations are as a citizen than as a consumer.

What we are witnessing is an accelerated movement toward the “stakeholder economy.” This is a shift in which firms are accountable not just to shareholders but also to employees and customers, suppliers and distributors, investors, and society at large. More than ever, firms will now have to pay heed to the municipalities in which they have facilities, the environmental effects of their products, and the norms, cultures, and rights of the many communities in which they operate.

How can firms develop the resilience they’ll need to strategically and effectively meet this new challenge and satisfy what at times will be competing interests and values? By taking power away from the CFO and investing it in procurement.

Yes, that’s right, procurement. Centuries ago the word had a broader sense, involving “the process of bringing something about,” and we propose that leaders start thinking of it in that sense again today. Deployed strategically, procurement can help firms build whole constellations of value - rather than simple chains of value - in which stakeholders of all sorts are connected to one another holistically and dynamically. As one of us (Ramirez)  wrote about with Richard Normann for HBR way back in 1993, value constellations are highly resilient systems that simply cannot be created by focusing on financial efficiency.

That article cited the model of IKEA, which treats its clients as suppliers (of assembly space, assembly labor, and delivery) and treats many of its suppliers as clients (giving them advice, bulk-buying for them, instructing them on what equipment to utilize and what standards to meet). At IKEA, the article suggested, value is not produced in discrete steps by one actor at a time and ‘added’ to by the ‘next’ one, sequentially. Instead, it is co-produced by many actors interacting with each other at once - a much more effective and resilient way of generating and maintaining value. Importantly, every player in this constellation is taken by IKEA’s value creating design to be simultaneously a producer, a seller, a buyer, a partner, and so on.

Ramirez and Ulf Mannervik recently updated these insights in Strategy for a Networked World, which looked at how the design of such co-production systems is actually undertaken. One of the cases in the book showed how the French electricity utility EDF identified opportunities in its South East Asia customers’ procurement process, where it thought it could support them, and then went on to create an entirely new company with partners, the Nan Theun 2 Electricity Company, to supply those needs. In the co-production model, what matters is not relative power but rather relations among all stakeholders, and the multiple roles they hold in relation to one another. Design a system that creates value by improving those relations, and everybody wins. Thinking strategically about procurement makes that possible.

We recently had the privilege of making that case to the senior leadership of a European procurement department - a department that each year buys many billions of dollars of services and goods from a very complex set of international suppliers. The department had approached us for guidance in redesigning their supplier system, and to that end, we created and ran strategic workshops with them. In these workshops, we included case studies that focused on organizations that had designed and implemented new value-creating systems based on strategic procurement. These workshops took place against the backdrop of the unfolding COVID-19 crisis, which allowed the participants to explore how they might design similar systems in a post–COVID-19 reality.

Below we’ll briefly summarize two of those cases, both of which provide a number of insights into how and when procurement can be used strategically.

Rolls-Royce. In the early 1990s, when Rolls-Royce was a relatively small player in the propulsion-technology market, with a very traditional supply chain, it set out to reset the value-creating paradigm of its industry. It started with a basic insight: Working with traditional supply chains meant having endless “margin fights” with both customers and suppliers, and those fights inevitably led to win-lose outcomes for many actors, particularly those with relatively weak market power. Instead of focusing on efficiencies within that context, RR decided that a better approach would be to focus on long-term relationship management. Famously, this led the company to decide to offer airlines power-by-the hour contracts, which established that they would not simply buy engines and spares from Rolls-Royce but would pay for the propulsion they consumed. The company opted, in other words, to sell something that clients felt to be more of a service rather than a good - a decision that rapidly made it an industry leader.

That decision has been widely heralded, but what’s less known is that Rolls-Royce created the conditions for success by working hard to develop a highly persistent network of trusted procurement partnerships with airlines, overhaul shops, producers of systems and parts, financial institutions, and even nations. The company often created bespoke offerings for different actors in the system according to their existing competences and their aspirations. All efforts were focused on maximizing and reconciling the many different kinds of value in the total lifecycle of the engine asset, from design to disposal. The key currency exchanged was not money or hardware but data. The result was a genuine pooling of risk, the co-production of values, and the sharing of reward, all of which brought into being a resilient value constellation that has benefitted everybody involved.

This case has many lessons to teach, among them:

• What is bought (a good or a service) is a strategic design decision, not a given.
• Long-term business relationships built on shared values - beyond simple monetary outcomes - are more resilient than ones built solely around transactional efficiency.
• Building resilient, long-term business relationships requires intentional design. The design should center on a key offering - such as power-by-the-hour - and a network of supporting offerings with both customers and suppliers.
• Designing each offering involves un-bundling and re-bundling different elements.The architecture of the bundle, and how it relates to those of other offerings, is a key aspect of resilient relationships, as became clear in Rolls-Royce’s re-bundling of engine design, manufacture and  services in accord with the new constellation of values it was developing.
• Designing and building a resilient value-creating system requires human competences outside the classic transactional procurement toolkit. As part of its efforts, Rolls-Royce focused on long-term asset management enabled by remote diagnostics - a pivotal human and technical competence.
• These designs bring about a new culture of procurement that, compared to the traditional model, is more networked (less centered on dyads), less transactional (win-lose), involves longer time horizons, and is more collaborative (win-win).
• Procurement extends from just defining work-sharing (make-buy) and risk-sharing (warranties, etc.) to co-designing the offering and the R&D that it requires.

European Patent Office. In the late 20th century, the EPO was one of the biggest clients in Europe for many international vendors of IT equipment. During that period, it designed important value-creating systems by organizing them around IT platforms, and by orchestrating information-exchange standards. These systems cemented operational relationships among the world’s intellectual-property offices, improving how patent processing is implemented both with and among those offices. In parallel, the organization used those same IT platforms and their derivatives to reach a wider public, which ultimately allowed it to create a new Patent Information industry. By the turn of the century, thanks to this broadly strategic approach to procurement, the EPO had ushered in a new era of online interactions with patent attorneys and representatives. Today, its value-creating systems have become a key element not only in its own strategy and success but also those of the broader European Patent System.

This case, too, has several lessons to teach:

• In sociology, an “actor” is someone who acts and whose actions affect those of others. But in strategy-making, not just people but also things can be considered actors. This comes across clearly in the EPO case, where technology, legal frameworks, strategic partnerships, and common interests were all important actors that the organization factored into the redesign of its procurement systems.
• Each actor will behave differently, following its own logic. For a value-creating system to be coherent and resilient, all of these actors - and the many values they produce and co-produce - need to be orchestrated. Strategic procurement makes this possible, particularly when it uses longer-term horizons, where give-and-take is easier to reconcile than in the logic of single “transactions.”
• Understanding which values matter at any point in time is essential. The EPO recognized that the smooth, transparent functioning of the global patent system was critical to the success of its new value-creating system, and getting this shared value to be the basis of how others fit in worked well.
• Sometimes, the real barriers to reconfiguring systems - or to bringing on entirely new ones - are legal contracts and ongoing operational obligations to the legacy systems serving those contracts. In IP, the legacy has to live alongside new configurations, so procurement needs to design technology obsolescence into both its legal frameworks and strategic partnerships.

Conclusion

As companies focus less on efficiency and more on resilience, procurement becomes central to strategy. That’s because it is uniquely positioned to orchestrate long-term value-creating systems that can accommodate incompatible value holders, withstand exogenous shocks, share loads, and grow dynamically. There’s an important lesson to be learned here: When resilience is your priority, procurement done right can be your strategy.

Rafael Ramírez is the first Professor of Practice at the University of Oxford, where he directs the award-winning Oxford Scenarios Programme, in the Saïd Business School. He is a Fellow of Green-Templeton College and a co-founder of the strategy consultancy NormannPartners.

Ciaran McGinley is is a senior associate at the strategy consultancy NormannPartners. He served for 34 years at the European Patent Office, 20 of which were in a wide range of senior management roles.

Steve Churchhouse enjoyed a varied 36-year career with Rolls-Royce, finally as director of Digital. He is now an investor and non-executive director in a number of technology start-up companies, and is also a senior associate at the strategy consultancy NormannPartners.