How a Strong Procurement Function Can Help Banks Cut Costs
by Ognen Borozanov, November 2010
In 2009, a survey by Deloitte identified managing cash flow and controlling costs as two of the key strategies of CFOs in countering the impact of the financial crisis. In our experience with the financial sector, we see that banks are shifting the focus of controlling costs towards reducing non-personnel-related operating expenses. For example, Lloyds Banking Group expects reduction in external spend to contribute 17 percent towards its £2 billion savings target for 2011. Another top-tier European based bank is reducing external spend (also known as procurement costs), by 25 percent in 2010 — over higher-than-expected cost savings in personnel (8 percent) and capital investment (2 percent).
How Banks Cut Costs
In general, organizations employ four main levers for optimizing procurement costs and achieving cost reductions.
Price management means achieving reduction through pricing, e.g. contract renegotiations or competitive bidding.
Vendor consolidation reduces the number of vendors across business units and geographies and focuses on selecting “preferred suppliers” per spend category.
Demand consolidation is achieved through increased coordination and integration of buying power across the organization (one face to suppliers) and reducing uncontrolled ad-hoc purchases (known as maverick spend).
Demand optimization most often takes the form of curtailing spend by, for example, temporarily freezing non-critical purchases or opting for limited or fewer product and service requirements.
However, banks face particular organizational and capability challenges in delivering systematic savings in external spend, compared to companies in sectors such as manufacturing, transportation or retail. The main drivers behind this are the presence of decentralized structures and unclear governance issues caused by mergers and acquisitions activity within the industry. Another driver is the underinvestment in procurement expertise due to historically higher margins in the sector, and the corresponding lack of urgency.
In addition, banks differ from other organizations in the relative contribution per spend category. This translates to a lack of specific procurement expertise for particular spend categories due to difficulties in attracting talent from other industry sectors. Experience from Oracle customer shows that most of the spend (approximately 40 percent) is in the professional services category (e.g. temporary workforce, legal advisory and management consultancy). IT spend (purchase and maintenance of hardware, software and telecommunications) and facility management spend (building lease and maintenance, office equipment and supplies) are at about 20 percent each, with marketing communication (advertising, postal services) and specialist spend (plastic cards, external information services) making up the rest. Each of these categories differs on a variety of dimensions, such as number of suppliers per category, average spend per supplier, or number of invoices per category. Hence, the aforementioned procurement levers need to be applied in a tailored approach per category to define savings initiatives and deliver savings potential.
Creating a Strong Procurement Function
All of the above contributes to a great deal of variation in the level of professionalization of the procurement function within banks. There are four stages of evolution in the procurement function within banks:
Transaction administration - A person or team with limited powers assists general management in the administration of purchases
Purchase management - A person or team performs an advisory role to management, negotiates with suppliers, and issues purchase guidelines
Category management - A number of independent divisions provide active management and control of spend for select major categories, such as IT hardware, facility services or advertising
Procurement organization - An independent, C-level division has centralized spend approval and ownership of saving programs
To answer the challenges, the procurement function needs to be transformed to show it understands and supports business needs and delivers tangible cost savings. There are three ways this needs to be achieved, progressively applied for each of the four stages above:
Improving internal processes is the initial step to upgrading to the purchase management stage starts by automating invoice systems and integrating with finance systems. The next step on the improvement journey towards category management is automating approvals and introducing purchase orders, followed by proactively engaging with business users in planning and identifying gaps of future needs. At the last stage of a procurement organization, the challenge is to transition from project-based savings to an integral savings program and embed procurement aspects at the initial stages of all decision-making at the business-unit level.
Aligning the governance structure is a necessary component to ensure ownership and gain traction with senior management and the broader user community. After creating a separate procurement office role, the next step to the transformation is to establish procedures for developing business requirements and implementing spend guidelines. Progressing to the category management stage is enabled through delegating the sourcing and control responsibility from business users to category managers and enforcing multi-tier phased approval procedures. Finally, creating a C-level procurement board to monitor business demand and cost saving initiatives ensures the successful functioning of a centralized procurement organization.
Each of the internal process transformation steps requires increases in infrastructure capabilities. The initial step is upgrading the billing and processing systems. At stage 2, purchase management is enabled by introducing reporting tools and data and system integration. Category management necessitates investments in project management tools and upgrading to real-time data and system Integration. Ultimately, the transformative journey to realizing an organization-wide savings strategy is enabled through the introduction of a centralized procurement portal and the use of sophisticated business analytics tools.
Banks that have completed this transformative journey are characterized by a strong and independent procurement organization that ensures enterprise-wide compliance, and provides strict direction and centralized approval for all external spend. Procurement and the business user community jointly develop business requirements and have a firm governance structure in place to regulate the responsibility of business, finance and procurement. This enables procurement to identify and steer saving opportunities across organizational and spend categories boundaries. The ultimate result is to place the procurement role firmly in the driver’s seat to deliver structural operational cost savings, year on year.
Ognen Borozanov is a director in Oracle’s Industry Strategy and Insight Program based in Amsterdam, the Netherlands. He focuses on financial services in the EMEA region.