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How profits vanish

The Bermuda Triangle of Business Procurement: How to Exploit Dormant Potentials, by Gerd Kerkhoff

THE Bermuda Triangle is the area between Florida, Puerto Rico and Bermuda. According to popular culture, a number of aircraft and ships have disappeared under mysterious circumstances in this location.

Business consultant and author, Gerd Kerkhoff, uses this image to describe what happens to corporate profits as they pass through the procurement department. This book explains why, and what is to be done to arrest this waste.

Most businesses regard the procurement department as a necessary department, but hardly one that is vital to the success of the enterprise. For that, one looks to research and development, production, marketing and sales.

The question to which this book is an answer is “How do I increase profits with sales down, in a shrinking, and over-supplied market?”

This book, written nine years ago, is even more relevant today than it could have been prior to the financial meltdown, from which the world has yet to recover. (I discovered this book, still shrink-wrapped, in our guest room, abandoned by some kind visitor, whom we have not been able to identify!)

Kerkhoff argues that the solution lies in the procurement department. Additionally, the results of changes to procurement do not take years or even months to have an impact on financial results. Almost every business can reduce procurement cost by 1.5%, and most by much more.  

With materials making up 55% of the turnover in manufacturing, this makes procurement critical for corporate success and the impact of the saving multiplied.

This is not the speculation of an academic; it is the experience of Kerhoff’s consulting firm’s work in a wide variety of businesses who have achieved results way beyond the 1.5% achievable by everyone.

Procurement has been the neglected stepchild for so long that it has been given scant attention in most companies. In the large banks and savings institutions of Europe only about 20% of the staff in procurement have a university education. In medium and small firms, the number is only 8.5%. Salaries for staff in procurement are almost half those paid to sales staff.

Procurement staff typically spend 80% of their time working on administrative tasks. Many offices bypass the procurement department entirely or partially.

Even management theorists have largely overlooked the topic of strategic procurement.

Lower procurement costs directly improve net income. Procurement optimisation must be the simplest and most effective tool for short-term profit enhancement. It is surprising, therefore that it has been overlooked for so long.

What has gone wrong?

According to Kerhoff, it begins with the lack of awareness by the most senior executive of the savings possible from strategic procurement. This probably explains why senior executives demand so little of this department, and the department in turn achieve so little.

If the procurement department was given profit impacting targets in the same way as sales, the results would be decidedly different. In most instances, the only target they are given is the turnaround time. A common complaint about procurement is  “they take too long; one might as well do the work oneself”. Having time as the only demand leads to a cause of overpaying – using known suppliers and paying whatever they ask.

Setting profit targets would address a secondary effect, understaffing and underskilled.

If a company procuring one hundred million rand worth of input goods a year, with a profit margin of 5%, could save 3% in costs of goods,  the value (close to 5%,) would certainly justify a more fully staffed department.

Such a department would have the man-hours to procure even better.

Strategic procurement requires market knowledge, comprehensive supplier research, and an understanding of competitor behaviour, and more.

Fully respected and properly staffed, procurement would evolve from its current role as “paperwork slaves” to a type of information broker. Purchasing could be where other departments turn to for details on the market and suppliers. Conversely, it could be where suppliers should find competent partners with whom they can communicate about all queries.

The conceptual tools necessary to do a professional job in the procurement department are available. Price hammering is no longer the only tool in their armoury.

“Total cost of ownership,” a well known but insufficiently used tool, includes all the additional costs in the calculation for the purchase of a product or service. A supplier’s price may be slightly higher, but if “just-in-time” delivery is offered, the total cost of ownership may easily justify the difference. Storage costs would be lower, a serious consideration for larger products, and less capital would be locking up capital in stored goods.

Less obvious costs, such as transaction costs, could similarly justify a higher cost per item. More obviously is the savings over a time on a higher quality product when repair, trading interruption, downtime, and other factors are included.

Retailers who purchase for sale have held procurement in higher regard than companies procuring ingredients of products they produce. Less successful retail buyers hammer price for volume, their more sophisticated counterparts, with a clear commitment to offensive procurement, are more creative.

Aldi, the German-based international leader in grocery retailing with over 5 000 stores across the world, has achieved a reputation for high quality products combined with low prices. They achieve this by sourcing domestically and internationally, and by making ever increasing, but reasonable demands on the suppliers. While the negotiations may be tough, both sides know they have a reliable business partner who will honour agreements fully.

When creativity, depth of knowledge and profit impact targets are expected of the procurement department, the calibre of staff will increase. Additionally, staff’s motivation will rise, as will the respect they can demand and will receive internally and externally.

There is money to be made quickly by giving serious attention to this Bermuda Triangle. Kerhoff’s practical book is a good place to start.            

Readability       Light -+--- Serious
Insights        High -+--- Low
Practical        High -+--- Low

* Ian Mann of Gateways consults internationally on leadership and strategy and is the author of Strategy that Works. Views expressed are his own.

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