Managing Risk in Procurement to Optimize Value
By Sanjay Agarwal and Rudrani Bose, Proacure Research Team | May 15, 2022
Risk mitigation in the organization enables a robust supply chain, smooth and profitable operations, and solid financial performance.
What is Risk?
Procurement involves a balanced risk in order to reduce costs, generate savings, and optimize value.
Every purchase involves transactional data exposed to risk, from vendor reliability, quality of the purchase, compliance with legal, financial and environmental norms, and most importantly customer satisfaction and reputation of the company.
Managers are often apathetic to risk, undermining the potential disruptions to the supply chains from risk. According to a study by Supply Chain Resilience in 2016 , 66% of managers did not have adequate 360 degree visibility of their supply chain, leading to 70% of them facing disruptions in the previous year, 41% of which occurred in Tier 1 suppliers, and 34% of managers experienced incidents with cumulative losses of at least $1 million, resulting in the organizations suffering reduced profit margins, decreased revenue, damage to the brand and company reputation, delayed product and service deliveries and, ultimately, losses in their customer bases.
Dealing with procurement risk involves analyzing data to know exactly what the organization needs, when it needs it, and who can deliver it on time with proper compliance measures, at the best price.
Types of Risk in Procurement
Procurement risk exposures generally involve:
- Poor analysis of needs: Inadequate understanding and planning regarding needs can cause rogue spending, piling of inventory or stock-outs, and inaccuracies in financial planning and procurement strategy. Big data-powered procurement software provides insights into spending and usage patterns for efficient purchasing.
- Inefficiencies in contract management: In modern procurement, contracts are a way of managing mutually beneficial relations with suppliers. Without proper management, contracts are open to both cost saving and compliance risks. By centralizing sourcing and contract data, data analysis and centralized document libraries automatically update, so approved vendors can provide new opportunities for profitable sourcing.
- Poor supply chain management: Without a centralized vendor-evaluation method, an intransparent procurement function might fall prey to fraudulent record-keeping and embezzlements. An automated centralized procurement system and spend analysis helps bring transparency in transactional information and a complete audit trail. Supplier mapping and monitoring provides insights into tier 3 and 4 suppliers, with digital systems highlighting potential shortages and disruptions in services.
Reducing Risk Digitally
The 2020 CPO Flash Survey by Deloitte highlighted the strategies that successful CPOs listed as most important to succeed during COVID and after. Two of these are as follows:
- Higher visibility into tier 1 and 2 suppliers, as you can’t manage what you can’t see
- Prioritizing digitization in procurement with virtual procurement as the next normal.
A digital procurement strategy with flexible, connected digital infrastructure powered by accurate data and scenario-modeling to achieve resiliency and planning efficiency helps bring systemic long-term changes allowing organizations to thrive in volatility.
According to Jonas Jantunen, CEO of Cloudtail for Middle East and Africa, “Managing risk effectively from a procurement and supply-chain perspective, means knowing your business back to front and inside out”. Efficiency depends upon both digital connectivity and integration of the procurement system with ERP and CRM.
Some industries require more data and digitalization for risk mitigation. For CPOs in banking and capital markets, data quality and digitization were ranked as the third and fourth most critical factors for success.
Digitization will thus be necessary in helping organizations reallocate resources, analyze spend, maximize supply chain visibility, and maintain robust supplier relations to minimize disruptions.
The CFO’s Role in Risk Management
With black swan events like the COVID pandemic, a sustainable procurement strategy becomes even more important for long-term success. In the 2020 Deloitte CPO Flash Survey, 70% CPOs expected a longer economic downturn, continuing beyond 2021. The Chief Procurement Officer plays a vital role in this.
CPOs highlighted the following focus areas for achieving success:
- Data analysis for smarter insights to act on risk intelligence regarding suppliers (at all tier levels)
- Redesigning sourcing strategies based on risk and risk mitigation, with focus on risk-sharing and performance-based contracting
CPOs also prioritized a day-to-day focus on digitization and expanding the supply base to tackle supply-side vulnerabilities. CPOs who had higher visibility into tier 1 and 2 suppliers were twice as likely to prioritize a digital procurement strategy and seven times more likely to expand the supplier base.
With the CPO role expanding beyond cost and revenue, it is now seen to converge with finance, HR, IT, and marketing organizations, hence the role is important not just for risk mitigation, but as a strategic business function.
Tail Spend and Risk Management
A few years ago, active tail spend management was not considered seriously, but today firms recognize that these low value transactions, forming 20% of total spend, add up to billions in large organizations. IBM’s report about the long and short of tail spend mentions that tail spend is the part of spend that is not actively managed across spend categories, endangering financial performance such as COGS and SG&A.
Actively managing tail spend can help an organization in the following ways:
- Reduce business risk through efficiency in contract compliance
- Ensure supply base diversity and eliminate trivial suppliers as unwatched suppliers beyond the long tail, which can fall in high-risk categories
- Manage maverick spending and reduced frauds in invisible parts of the supply chain
P2P tools like P-Cards and B2B marketplaces can provide data visibility into spend and help select the spend appropriate for less-controlled channels. Tail spend analytics to track noncompliant transactions along with a powerful contract management workflow helps with early identification of risk areas and opportunities.
Proacure is a procurement technology & data-science organization based in the San Francisco Bay Area. Our ‘Koreografy’ model leverages multiple frameworks like congruence of different data sets, fusion of digital, analytics and business processes, and synchronous collaboration between various stakeholders. The model enables 100% Spend Visibility with prescriptive actionable insights to transform Strategic Sourcing and help realize untapped value in the Supplier and Tail Spend. Proacure’s deliverables include cost savings of 7-30%, a 20%+ increase in EBITDA, cash flow optimization, and reduced supply-chain disruption.