Member Article

How big should your procurement department be?

Juraj Priecel, vice president of Efficio shares his views on the role of procurement.

Most senior executives have a good idea of what the procurement operation within their organisation does. However, for those who are concerned with best use of resources, the question of how big it should be is often much less clear.

The answers will always depend on company-specific circumstances but looking at the fundamental principles involved will assist with this important question and provide useful guidelines to gauge the appropriate size of a procurement organisation.

Background

CPOs often ask how many people they should have within their procurement organisation. They are already responsible for a functioning department but it is not always clear if and when they should increase or decrease the size of their team, given the volume of work that needs to be done and the value the procurement department can contribute to the business. As such, they are often looking for supporting arguments and benchmarks to justify the size of their existing team or to defend against downsizing.

From another perspective, senior executives external to Procurement, some of whom still consider Procurement to be a transactional support function, may be seeking evidence to justify the existing headcount. This is especially apt given the testing times currently faced in global markets.

The business case

The key challenge for a responsible CPO in this context is to produce a robust case for maintaining, increasing, or decreasing the size of the procurement department.

Rough measures and benchmarks with a number of other companies of comparable size and operating in the same industry are often used with the view that they represent the “industry standard” and hence the model is copied. This approach is fairly common. The problem is that there is no guarantee that the other organisations based their decisions on appropriate facts and analysis. The upshot is that it simply becomes a case of the “blind leading the blind”.

The real issues

To determine the appropriate size of a procurement department, the potential value such an organisation can generate (top line approach) and the volume of work that needs to be done in order to do so (bottom line approach) should be assessed while taking into consideration other factors such as team capability levels (basic, advanced, world class), the support systems in place, the lifecycle stage of the company, the strategic focus of the business (growth versus cost effectiveness), and so on.

1) The Top Line Approach
It is important to look at the size of the business as a whole, and more specifically at its direct, indirect and CapEx spend under procurement control, and then to assess how much value the procurement function may be able to create either through strategic sourcing initiatives or through professional supplier management and ensuring that negotiated deals are being enforced. While a number of factors can impact the savings potential, as a rule of thumb it can be said that procurement can save 7-12% on indirect categories and 2-6% on direct categories that have not been addressed recently. Core, larger and strategic categories can be addressed more than once and deliver the same level of savings by deploying different
levers.

Similarly, if there is no capacity to oversee the deals and supplier relationships for core categories it can be said that 50%, possibly more, of negotiated savings will be lost every year, equating to 4-6% of expenditure for indirect categories and 1-3% of expenditure for direct categories in the first year.

Once the value the procurement function can deliver has been estimated it is then very straight forward to calculate the return on investment (ROI) of the procurement resources in question.

2) The Bottom Line Approach
There is a complementary “bottom line” approach which looks at the number of categories, spend areas or projects to be addressed, as well as their complexity, in order to determine the size of the team that can perform the work that needs to be done.

Some very large organisations, based on their revenues or profitability, could justify a very large procurement team, however even for them there is an inflexion point after which additional resources would not generate a sufficient ROI and so, on this basis, their procurement organisation would be lean in relative terms.

3) Other factors
Other factors to consider when determining the “ideal” size of a procurement department are as follows:

The relative maturity of the procurement organisation and the quality (education, skills, demonstrated results) of people employed. Generally speaking, the more advanced it is the more efficient the people are and hence fewer are required Geographical complexity – a decentralised procurement organisation operating out of several countries will need a larger team to support business needs than a business
operating from one country or even from a single location. Relative sophistication of the IT systems supporting procurement and the tools used.The effectiveness of interaction within the business, recognition of Procurement as a “strategic” function and its ability to communicate its achievements and raise its profile within the wider organisation.

One of the main reasons why procurement departments are sometimes considered to be just a cost function and are either understaffed or not staffed with people of the required calibre is that business stakeholders often do not understand the value-add it can deliver.

Procurements’ ability to convincingly document the value it has generated and describe it using the “language” used by stakeholders in various business functions, whether it is Operations, Finance, IT or Marketing, is therefore important.

Procurement departments often accept being boxed into a supporting service role instead of assuming the role of a partner with responsibility for the commercial element of a project or a deal, while the business function retains the responsibility for the service capability and competence of business partners / suppliers.

The recommended way to raise the profile of Procurement and justify the size of the team is through delivery of successful sourcing projects, robust supplier management that is in line with business needs, transparency and robust savings measurement systems.

Build an effective case

Building an effective case for altering the size of a procurement operation should therefore not be a case of benchmarking but instead a pragmatic and logical application of some sound basic principles that are driven by the specific situation of the business. As a CPO or senior executive, one can then be rest assured that the procurement department is operating efficiently, producing results, and achieving an optimal ROI on the resources deployed.

This was posted in Bdaily's Members' News section by Georgina Golding .